§6. General Income Risks

Even when there is no risk (humanly speaking) in the loan itself, the rate realized on it is affected by risk in other connections. The uncertainty of life itself casts a shadow on every business transaction into which time enters. Uncertainty of human life increases the rate of preference for present over future income for many people,78Edition: current; Page: [217] although for those with loved dependents it may decrease impatience. Consequently the rate of interest, even on the safest loans, will, in general, be raised by the existence of such life risks. The sailor or soldier who looks forward to a short or precarious existence will be less likely to make permanent investments, or, if he should make them, is less likely to pay a high price for them. Only a low price, that is, a high rate of interest, will induce him to invest for long ahead.

When the risk relates, however, not to the individual's duration of life, but to his income stream, the effect upon the rate of interest will depend upon which portions of the income stream are most subject to risk. If the immediately ensuing income is insecure, whereas the remoter income is sure, the rate of preference for an additional sure dollar immediately over an additional sure dollar in the remoter period will, as was shown in Chapter IV, tend to be high, and consequently the effect of such a risk of immediate income upon the rate of interest will be to raise it. A risky immediate income acts on interest like a small immediate income.

But if, as is ordinarily the case, the risk applies more especially to the remoter income than to the immediate, the effect is the exact opposite, namely, to lower the rate of interest on a safe loan. The risky remote income acts as the equivalent of a small remote income. This example is, perhaps, the most usual case. If a man regards the income for the next few years as sure, but is in doubt as to its continuance into the more remote future, he will be more keenly alive to the needs of that future, and will consequently have a less keen preference for the present. Edition: current; Page: [218] He will then be willing, even at a very low rate of interest, to invest, out of his present assured income, something to eke out with certainty the uncertain income of the future. The effect of risk in this case, therefore, is to lower the rate of interest on safe loans, though at the same time, as already explained, it will raise the rate of interest on unsafe loans. Consequently, in times of great social unrest and danger, making the future risky, we witness the anomalous combination of high rates where inadequate security is given coexistent with low rates on investments regarded as perfectly safe. When an investor cannot find many investments into which he may put his money without risk of losing it, he will pay a high price—i.e., accept a low rate of return—for the few which are open to him. It has been noted in times of revolution that some capitalists have preferred to forego the chance of all interest and merely to hoard their capital in money form, even paying for storage charges, a payment which amounts to a negative rate of interest. During the World War some investors in the warring countries sought safekeeping for their funds in neutral countries.