§4. Altering Income by Loans

To illustrate this reasoning by a chart, let us suppose the income stream to be represented as in Chart 5, and that the possessor wishes to obtain, by borrowing, a small item X' of immediately ensuing income in return for a somewhat larger item X'' later on, X'' being the amount of X' at interest. By such a loan he modifies his income stream from ABCD to EBD. But this change will evidently produce a change in his time preference. If the rate of time preference corresponding to the income stream represented by the unbroken line is 10 per cent, the rate of preference corresponding to the broken line will be somewhat less, say, 8 per cent. If the market rate of interest is 5 per cent, it is evident that the person will proceed to still further borrowing. By repeating the operation several times he can evidently produce almost any required conformation of his income stream.

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If, instead of borrowing, he wishes to lend (Chart 6) he surrenders from his present income stream the amount X' for the sake of the larger amount X'' at a later time. After the operations are completed and the final conformations of the income streams are determined, the rates of time preference are all brought into conformity with the market rate of interest.

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In practice, of course, the adjustments are never perfect and, in particular, the income stream is never a smooth curve, such as it is here for convenience represented.

In practice, also, loans are effected under the guise of money. We do not confessedly borrow and lend real incomes, but money and credit. Yet money—that universal medium in practice and universal stumbling-block in theory—merely represents real income, or capitalized real income. A hundred dollars mean the power to secure income,—any income the present value of which is $100. When, therefore, a person borrows $100 today and returns $105 next year, in actual fact he secures the title to $100 worth of income—immediately future, perhaps—and parts with the title to $105 worth of income a year later. Every loan contract, or any other contract implying interest, involves, at bottom, a modification of income streams, the usual and chief modification being as to time shape.

One reason why we often forget that a money loan represents real income is that it represents so many possible varieties of real income. A fund of money is usually the capitalization not simply of one particular future program, or lay-out, of income but of a large number of optional income streams, and is not restricted, as in the first approximation, here considered, to a simple income stream and its modification by loans or their equivalent.

We may distinguish six principal types of individuals in a loan market—three borrowing types and three lending types. The first type of borrower (Chart 7) is supposed to be possessed of an increasing, or ascending, income stream AB, a fact which, in his mind, results in a rate of preference above the market rate. This leads him to borrow, and relatively to level up his ascending income stream toward such a position as A'B'. The second type of individual already possesses a uniform income stream AB (Chart 8), but having, a strong propensity to spend, he too experiences a rate of preference above the market rate, and will therefore modify his income stream toward the curve A'B'. The third type is shown in Chart 9 and represents even more of a spendthrift. This individual has also a rate of preference in excess of the market rate, in spite of his having a declining income stream pictured by the descending curve AB. By his borrowing, he obtains a curve A'B' of still steeper descent.

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In a similar way, the three types of lenders may be graphically represented. Chart 10 represents a descending income AB, which the owner, by lending present income in return for future income, converts into a relatively uniform income A'B'; Chart 11 represents a uniform income converted, by lending, into an ascending income; and Chart 12 an ascending income converted into a still more steeply ascending income.

The borrower changes his income curve by tipping it down in the future and up in the present. The lender tips his income curve in the opposite direction. Of the three types of borrowers and of lenders, the first in each group of three (see Charts 7 and 10), is the usual and normal case. In both these cases the effort is to transform the given income into a more uniform one, the rising curve (Chart 7) being lowered and the falling curve (Chart 10) being raised toward a common horizontal position. Chart 9 and Chart 12, on the other hand, represent Edition: current; Page: [111] the extreme and unusual cases of the spendthrift and the miser.

But whatever the personal equation, it remains true that, for each individual, other things being equal, the more ascending his income curve, the higher his rate of preference; and the more descending the curve, the lower the rate of preference. If the descent of the income stream is sufficiently rapid, the rate of preference could be made zero or even negative.51

These foregoing types of income streams are, of course, not the only ones which could be considered, but they are some of the more important. To them we may add the Edition: current; Page: [112] type of fluctuating income, as represented in Chart 13, which may result in alternate borrowing and lending so as to produce a more nearly uniform income stream. Such financing over the lean parts of a year is often practiced when the income is lumped at one or two spots, such as dividend dates.

It must not be imagined that the classes of borrowers and lenders correspond respectively to the classes of poor and rich. The factors, environmental and personal, discussed in Chapter IV, will determine whether a man's rate of preference is high or low, and therefore whether he will become a spender or a saver.

When we come to the second and third approximations and have to study so-called productive loans, especially of risk-takers, or enterprisers as Professor Fetter calls them, we shall find still other influences determining whether a person shall be a borrower or lender or both. At present we are only at the first approximation where it is assumed there is no risk and no such series of opportunities to vary the income stream as lie at the basis of so-called productive loans.