The Positive Theory of Capital

Eugen v. Böhm-Bawerk, from the Warren J. Samuels Portrait Collection
Böhm-Bawerk, Eugen v.
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William A. Smart, trans.
First Pub. Date
London: Macmillan and Co.
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Book VI, Chapter I

The Loan and Loan Interest


In the previous book I tried to show, and account for, the natural difference that exists between the value of present and the value of future goods. I have now to show that this difference of value is the source and origin of all Interest on Capital. But as the exchange of present commodities for future commodities takes various forms, the phenomenal forms of interest are as various, and our inquiry must necessarily deal with them all. In the following chapters, therefore, I intend to take up, in succession, all the principal forms of interest, and I shall endeavour to show that, notwithstanding all differences in shape and appearance, the active cause in them all is one and the same, namely, the difference in value between present and future goods.


By far the simplest case of this difference in value is presented in the Loan. A loan is nothing else than a real and true exchange of present goods for future goods; indeed, it is the simplest conceivable phenomenal form, and, to some extent, the ideal and type of such an exchange. The "lender," A, gives to the "borrower," B, a sum of present goods—say, present pounds sterling. B gets full and free possession of the goods to deal with as he likes, and, as equivalent, be gives into A's full and free possession a sum of entirely similar, but future, goods—say, next year's pounds sterling.


Here, then, is a mutual transfer of property in two sums of goods, of which one is given as recompense or payment for the other. Between them there is perfect homogeneity, but for the fact that the one belongs to the present, the other to the future. I cannot imagine how an exchange in general, and an exchange between present and future goods in particular, could be expressed more simply and clearly. Now, in the last chapter, we proved that the resultant of the subjective valuations which determines the market price of present and future goods is, as a rule, in favour of present goods. The borrower, therefore, will, as a rule, purchase the money which he receives now by a larger sum of money which he gives later. He must thus pay an "agio" or premium (Aufgeld), and this agio is interest. Interest, then, comes, in the most direct way, from the difference in value between present and future goods.


This is the extremely simple explanation of a transaction which, for hundreds of years, was made the subject of interpretations very involved, very far-fetched, and very untrue. Since the days of Molinæus and Salmasius,*1 the Loan has been conceived of as a transaction analogous to the Hire; as a transfer of the temporary use of fungible goods. This method of interpretation seems simple and natural enough. It has, too, the advantage and support of being in harmony with popular ideas and popular speech. We do not say, "I sell you, or exchange you £100;" but, "I lend you £100." The transaction is a loan, and interest a usura, a use of money. But, before a scientific basis could be given to this popular conception, a whole series of subtilties had to be invented, and to obtain these out of the circumstances of actual life taxed all the resources of sophistry.


First it had to be shown that, in transferring a thing, it is possible to transfer more than the whole of it; namely, that in giving the borrower possession of the loaned thing, it is possible to transfer to him the right to all and every use that can be made of the thing, even to the consumption that annihilates it, and, besides that, the right to a separate kind of remnant use, for which a separate claim, the claim of interest, can be made. Then the further subtilty had to be invented, that, in perishable goods—goods which perish in the act of use—there is, all the same, a continuous use, ever rising anew from its own ashes; a use which lasts even when the good "used" has long ceased to exist! It had to be discovered that a cwt. of coal can be burned to cinders on 1st January 1888, and yet be "used" uninterruptedly throughout the whole year, and, perhaps, for five, or ten, or a hundred years to come; and, what is best of all, that this lasting use can always be bought for a particular price, although and after the coal itself, and the right to consume it to the last atom, has been given away for another and a different price!


In my former book, Capital and Interest, I subjected this singular theory to a searching critical examination. I showed how, under peculiar historical conditions, it came into the world as the birth of circumstances, in which, to save interest and justify it against the unquestionably unjust attacks of the canonists, a decent foundation had to be found for it at any price, or, if not found, invented. I showed that this theory had its troubled source in a fiction. It was a fiction adopted, in its time, by the old jurists, in full consciousness that it was simply a fiction set up for certain practical legal purposes; but afterwards, by a strange misunderstanding, this fiction was adopted as a sufficient scientific fact. I tried, further, to show that this theory is, in itself, full of mistakes, internal contradictions, and impossibilities, and how, finally, when carried to its logical conclusion, it leads inevitably to further contradictions and impossibilities. In opposition to it, and in place of it, I now offer my own positive theory, then unpublished, and confidently leave it to the reader to judge on which side lies illusion and error, and on which truth.*2


I would gladly refrain from any further commentary here, were it not that, quite recently, we have had a new literary pronouncement in favour of the Use theory which I opposed, and directed against the Exchange theory which I advocated; and were it not that this revived pronouncement emanates from no less authority than Karl Knies.


In 1885 Knies published a second edition of his book Das Geld. In it he replies to the criticism I made on some passages of his first edition, and, at the same time, expressly repeats certain positive objections he had made to the conception of the loan as an Exchange. On both counts I feel bound to answer.


It is unfortunate that Knies's reply touches only one of the many points on which I attacked his Use theory. I had, among other objections, put forward this;—that his method of proving the actual existence of a durable use in perishable goods rested on a dialectical confusion; and I had endeavoured to strengthen my contention by an exact analysis of the very words of his argument.*3 To this Knies answers that I have, notwithstanding, mistaken his meaning, and he repeats his positive statement in such "altered expression, and with such additions" as may put his real meaning beyond question. As now put, Knies's demonstration is very much amplified (in the first edition it occupies pp. 72 and 73; in the second edition, pp. 106 to 114), but, substantially, I cannot consider it any more satisfactory. On the contrary, it seems to me to bring out more clearly that the existence of this durable use, which I disputed, is not proved, but only assumed.


In one of the weightiest of the new passages (p. 109), Knies has no hesitation in explaining, in so many words, that in the Loan, although "not the same individual grains of corn and pieces of money are returned, but (only) an equally large and equally valuable amount of grains of corn and pieces of money," still, "to economical consideration, the same goods are given back." Here he sanctions the fiction of identity between fungible goods, in optima forma, within the sphere of economical theory and economical discussion. All that follows he bases on the foundation thus obtained. He finds the essence of hire and lease in the fact that here "the hirer, leaseholder, etc., gets the land, house, or the like, transferred to him to use for his own purposes for such and such a continuous period, at the expiry of which he has to give back the good in question." In the Loan, perishable goods are likewise transferred "to be employed by the borrower for such and such a continuous but limited period of time." Consequently Hire and Loan are, essentially, analogous transactions—which was the point to be proved.


To this I would simply answer, that the second premiss is not truth but poetry. The sober, prosaic truth is that, in the Loan, perishable goods are not transferred to the borrower "for a continuous but limited period of time"; they are transferred definitely and for ever; they are never given back. What is given back is, in fact, other goods. What now becomes of the inferred analogy?


I am not blind to the use of analogies, and even to the demonstrative force which analogies may have under certain circumstances. I have myself often used them in the course of this book to drive home an argument. But an analogy is a weapon which requires careful handling. Comparisons, as every one knows, are always imperfect; if the compared things have one side in common, they have always another in which they differ. The "legal person," for instance, may very well be compared with the physical person in questions relating to property, while, in questions relating to the family, it would scarcely be safe. If, then, we draw some conclusion from the similarity of two things, our conclusion must keep within the sphere in which the similarity actually exists; from similar circumstances in one sphere we cannot draw a conclusion that the circumstances are similar in another sphere to which the similarity does not extend. No one, for instance, would consider an argument like this legitimate:—the legal person is as much a person as the physical person; a physical person can marry; therefore, a legal person also can marry!


Yet it seems to me that it is into this vicious and false use of analogies, that Knies and the other theorists of his school have fallen. I grant at once that, in a certain point of view, the individual goods replaced may be looked upon as if they actually were the same individual goods which were given away in the loan: they have identically the same effect on the economical position of the lender who receives them. Now, so far as the ground of this identification extends, so far also is one justified in drawing conclusions from it—but no further. The analogical conclusions of the Use theorists, however, are entirely beyond this justifiable sphere. What has the theoretical question whether, in perishable goods, a continuous use is possible or not, to do with the fact that it is all the same, as regards the interests of the lender, whether he gets the individual goods X or the individual goods Y? Nothing at all—any more than the question of the marriageableness of a legal person has anything in common with the fact that, in matters relating to rights of property, an institution or a corporation may without hesitation be conceived of as an independent "person"! Indeed, if the reader will excuse a ridiculous but, as I think, a convincing example, one might as well use the identity of fungible goods to prove that oysters may keep fresh for ten years; they have only to be lent out for ten years, and the lender receives "them" back still fresh oysters! The application is so evident that I need scarcely put it in words. The identity of the oysters lent with the oysters returned is no true identity, but only an identity assumed ad hoc. So far as concerns the practical interests of the lender the identity may pass, but, as a scientific question of fact, like the physical question whether oysters can remain fresh for ten years, there is no identity at all. And just such a scientific question of fact is the question whether, in perishable goods, there is a continuous one year's or ten years' use. It is a question that must find its answer in considering the nature of the perishable good and the nature of the use; properly speaking, not the shadow of an argument can be got from the fact that it is of no moment, as regards the practical interests of a person, whether he receives the particular good X or the particular good Y!


Now Knies does make the attempt—and this is a second and indeed the weightiest of the new passages in this edition—really to point out a durable use in perishable goods, and to give some indication wherein that use consists. He names, by way of illustration, "the maintenance of life, and of labour power, the averting of a loss, the attainment of a business return or profit" (p. 112), as useful effects of this sort, which the borrower "may obtain and make for himself from the consumption (of the loaned goods) during the entire period of time before the similar quantum of perishable goods is given back." But by illustrations like this Knies again shows that he is on the wrong track. The enjoyment of effects indirectly obtained from the consumption of goods is not in the least a utility which we get in addition to the consumption; it is just the utility we get from the consumption. Accordingly it can never be the ground of a special equivalent which we should have to pay over in addition to the equivalent of the perishable good itself. What would be said of a person who proposed to sell a cwt. of corn on the following terms:—"For the quarter of corn itself, that is, for all the useful services which may be got from the corn by its—sudden or gradual—consumption, I want thirty shillings. But for the lasting indirect use of the corn—the use which consists in the subsequent enjoyment of useful effects, such as life prolonged, labour power maintained, and so on—I want another shilling." Now, if,—as probably no one will deny,—in selling grain, it is not possible to conceive of the subsequent enjoyment as the ground of a special equivalent; if the subsequent enjoyment is obviously included in the purchase price of the good transferred into the buyer's possession; it is inconceivable that, all at once, in the case of the loan (where, too, the quarter of corn passes into the full possession of the borrower, and justifies him in drawing all the uses he can from it), every indirect use is to be separately paid for. And why, again, should this indirect use be paid for only during one, five, ten years, or for so long as the loan runs? Is the utility of sustained life not enjoyed so long as life lasts? Is the utility of preserved labour power not one which lasts so long as we can work?


In Capital and Interest I had so thoroughly and, in my own opinion at least, so clearly laid down the facts about the lasting "indirect use," and shown the impossibility of its being the ground of loan interest,*4 that I really did not expect to see the thing emerge once more as stay and support of the Use theory. Least of all did I expect it from a writer who knew what I had said on the subject, and that without a single word of explanation being vouchsafed in answer to the objections I had raised meantime. I cannot but express my regret—not indeed for personal reasons, but in the interest of our science—that Knies has taken so little notice of, and given such meagre answers to the theoretical considerations which I brought against the Use theory. He replies on one single point, and that a point which, however important it may be in itself, has only the importance of an incident in the struggle that is to decide the victory or defeat of the Use theory; while, to the multitude of really cogent considerations directed against that theory as a whole—considerations which, quite apart from the issue of this incidental question, show it to be internally contradictory*5 and theoretically inadmissible,*6—he has, unfortunately, found no word of rejoinder. Once submitted for discussion these considerations must be met, and certainly no one was more called on to speak in the defence of his own Use theory than was Knies.*7


Hitherto the discussion has been limited to attack and defence of the Loan theory of other economists. I have now to reply to an attack made on my own theory. The distinguished writer we have just been discussing has now repeated the objection he urged some years ago against my conception of the loan as a true exchange; it is, he says, in contradiction of the hitherto established conception of what an exchange is. "For an exchange—as we are not taking into account senseless and frivolous actions—takes place only when goods different in some way or other are bartered. But fungible goods, such as grain of similar kind and quality, are, economically, recognised as entirely similar goods."*8


I must say that this statement seems to me to beg the whole question. Instead of inquiring what the connotation of the conception of exchange is, and arguing from that whether the loan can be called a true exchange or not, Knies starts with a preconceived conception of exchange, and that an arbitrarily and unnaturally limited conception. As a fact, Knies's limitation of the conception of exchange to the barter of goods of different kinds is one we do not find in the nature of exchange, nor does it correspond with the "hitherto established" use of the conception. In the nature of exchange what is involved is that two goods are given, the one for the other—nothing more; as to "established usage," it is very easy to show that transactions in which entirely similar fungible goods are bartered for one another are considered by all the world true exchanges, and are called so. In proof of this I might point out that two people, simply from whim or fancy, will "exchange" two fungible goods, the one for the other, e.g. two new copies of the same book. Knies guards himself, indeed, against this argument by saying that "we are not taking into account frivolous and senseless actions," but this is making too light of the matter. For, certainly, it cannot be denied that such capricious actions may happen, and occasionally do happen, and it cannot very well be denied that such transactions, when they do happen, are neither Hire nor Loan, nor anything else than true Exchange.


But there is no need to appeal to rare cases like these. There is one group of instances where men, quite deliberately and on entirely rational economic grounds, do barter similar fungible goods; that is where goods, otherwise perfectly similar, are available under different modalities—to use a philosophic term—as, for instance, in different places. Take the case of a farmer A, who owns a plantation of trees two hours' journey away from his farm, while there is a plantation belonging to his neighbour B immediately beside him. In both plantations, the wood, cut or ready for cutting, is of exactly the same quality. Now, evidently, it is more convenient and more profitable for A to have ten loads of wood near his house than ten loads ten miles away from it. It will, therefore, be considered quite reasonable, and quite intelligible, to propose that B should make over to A ten loads from the near plantation, in return for which A will give B ten loads—or perhaps twelve loads, including a premium—of the similar wood from his far-away plantation. And if this is agreed to, everybody would pronounce it a real and true exchange.


Or can we imagine anybody, from the fiction of identity between fungible goods, drawing an analogical conclusion like the following about the nature of the transaction;—"A makes over to B ten loads of wood at a spot ten miles away from his house, and receives from B ten loads of wood here at his house. It is all the same to A whether he receives back the same ten loads or ten other loads. 'From an economic point of view,' therefore, it is essentially the same ten loads which he receives back, only at a different place. The essential nature of the transaction is, accordingly, not an exchange—since no exchange takes place between similar goods—but a transfer of the same goods to a different point in space,—that is to say, a freight transaction. And if, for the advantage which lies in this transfer from one place to another, A pays B a premium of two loads, the payment is essentially, from an economic point of view, an expense of carriage." I very much doubt whether anybody would follow him in this conclusion from analogy, although it is, feature for feature, the same as the one above. We should rather have expected that Knies would have been ready to own that the exchange of two amounts of wood, alike in every respect except that they are available in different places, was a real and true exchange.*9


And now I ask: If it falls within the limits of the conception of exchange when goods present in one place are bartered for goods entirely similar but present in another place, with what right can we exclude from the conception the case where goods present at one time are bartered for goods entirely similar, but present at another time? When so much has been made of analogies in the whole course of this controversy, why exclude the one analogy which is, most evidently, the appropriate one? If the difference of the place at which goods are available is a sound economic reason for exchanging fungible goods that are in other respects entirely similar, and if the advantage and convenience of the present place may justify the claim and allowance of a premium, just as much may the difference of the time at which similar goods are available be a sound reason for their exchange, and a guarantee that there will be a premium on the—more valuable—present goods. This premium, and nothing else, is Interest.


A great tree does not fall at one blow. And I cannot expect that a loan theory, which has dominated human intellects for centuries, should fall at the first attack. But I venture to hope that I have at least awaked a general feeling that it is necessary to submit the principles of that theory to critical revision. There is one task which the next economist who proposes to maintain the Hermann-Knies loan theory will not, I imagine, venture to omit; namely, once and for all, to point out positively the existence of that "enduring use" of perishable goods, distinct from their consumption, for which interest is supposed to be paid, and to say, clearly and distinctly, wherein that use peculiarly consists. Up till now its defenders have acted in a somewhat curious way; they have pointed out, by more or less questionable analogies, that, in the loan, a temporary use is transferred, and concluded from this that there must be such a use; the consequence being that—with the exception of this last unfortunate attempt of Knies's—the nature of the use, its contents and so on, were left entirely in the background. I consider that our science has a right to demand the opposite and the natural method of demonstration. Let it first be shown that there is such a use, and wherein it consists; if that can be done, we shall willingly believe that it is transferred in the loan. If that cannot be done—and I doubt very much if it can—then I shall have the greater confidence in pointing to my solution of the question. To the latter, at any rate, I have no fear that the stigma of sophistry and unnaturalness can be attached.


Passing from this polemical digression—which I considered only due, as well to the importance of the subject under dispute, as to the scientific standing of my esteemed opponent,—let us return to the main subject. According to our conception interest is a complementary part of the price payable for a sum of present goods in future goods. It is a part-equivalent of the "principal" lent. In itself there would be nothing to prevent this part-equivalent being paid along with the bulk of the price; in other words, interest and "principal" might be put together in one single payment at the end of the whole loan transaction. Reasons of practical convenience have, however, made it the general rule that, in loans made for any considerable length of time, the premium should be paid separately, and in rates graduated according to time,—monthly, half-yearly, yearly, etc. With the essential nature of interest this method of payment has nothing to do; it may, indeed, be expressly provided otherwise by the loan contract. But quite possibly it is the case that this custom, which, practically, has prevailed from time immemorial, of separating the payment of interest from the payment of principal, has assisted—perhaps, even, directly caused—the popular opinion that the principal sum paid back is, by itself, the equivalent of the sum originally given, and that interest is a thing by itself, an equivalent for another and separate something.


Now and then a loan may be granted without interest; but the reason of this is seldom or never that the market price of present goods, as against future goods, is so favourable to the latter, that, in the general loan market, they can purchase an equal amount of present goods without premium. Almost invariably these are cases where the lender dispenses with the payment of premium on some special personal ground, such as friendship, charity, humanity, class obligation, and so on. It has been usual to conceive of the loan without interest as a gift of the temporary "use" of the thing lent.*10 Our theory, of course, demands another conception. We put this kind of loan simply among cases where a man, from some personal motive, parts with his commodity under the market price. We say it is the same thing as where a manufacturer gives personal friends at the cost price, say, of 4s. the article which he can sell anywhere at the general market price of 5s.


Lastly, it very seldom occurs, and then never as regards present and future goods in general, but only as regards one particular kind of goods, that the relations of supply and demand are such, that future goods obtain a higher price than present goods of the same kind, and that a premium in present goods must be paid for future goods. It will only happen in cases where, presumably, the relations of supply and demand in the future will be essentially more unfavourable than in the present, and where, at the same time, for personal or technical reasons, it is not possible to preserve the present ample stocks till that future point of time when they are assured of a higher value.*11 Suppose the case of a brewer whose ice-cellars are too small for his requirements. If in January he puts in as much ice as the cellars will hold, and has still two hundred carts of ice over, he may be very willing to exchange these for one hundred carts of ice deliverable in August.*12 But the possibility of such a case seems to me rather to afford a not insignificant proof of my loan theory. For, I should like to ask, how would the Use theorists explain this? As a transfer of use like the loan; only that the use has a negative value, and that the borrower, instead of paying a premium, demands a premium? Or, perhaps, as a storage transaction, the difference between the quantity given and that received being considered a fee for safe deposit?


I think both interpretations are so clearly artificial and fictitious that very few people would seriously entertain them. Probably the Use theorists would be quite willing to admit this as a case of real exchange; but, so far as they did so, they would be untrue to their own contention, according to which exchange is only possible between goods of different kinds, and not between fungible goods of the same kind. Our theory, on the other hand, explains everything naturally, and by one formula. Without forcing an interpretation, it can recognise that, here, the position is exactly the same as in the loan. There is a mutual transfer of property in two sums of goods, which are entirely similar in every other respect but that of being disposable at different points of time. And to this entirely similar state of matters it gives an entirely similar explanation: that, in both categories, there is an exchange between present and future goods, the prices of which are the resultant of the subjective valuations put upon these two classes of goods within the market.

Notes for this chapter

See my Capital and Interest, p. 29.
See Capital and Interest, pp. 214-259.
See Capital and Interest, p. 239. It goes without saying that I could mean nothing else than an involuntary dialectical confusion in the writer's mind, and nothing was further from my intention than to charge a scholar, so much esteemed by myself and by all the world, with wilfully misleading his readers. I should have thought that the very sincere expressions, in that and other writings, of the respect in which I have always held the person of that past master of our science, and particularly the express recognition of his "thorough and conscientious efforts" with which I introduced this very criticism (p. 239), might have sufficiently protected me against any such misconception. I was therefore more than astonished to learn that Professor Knies had taken my words as conveying an offensive imputation of wilful misleading of his readers. Although I scarcely think that any one of my readers will have understood me in this sense, I do not hesitate to explain here, emphatically and publicly, not only that I had not the slightest intention of any offensive imputation, but that I am exceedingly sorry if my inconsiderate choice of words should unwittingly have made such an interpretation possible.
P. 229, and pp. 235-239.
Capital and Interest, pp. 228, 247.
Ibid. p. 264.
The criticism which Knies directs against me in the note to page 106 of his second edition is limited unfortunately to a few passing remarks on points which are, for the most part, of secondary importance. Moreover, several errors of fact have slipped into these, and two of them I cannot let pass unchallenged. First, I cannot admit that I have done what Knies ascribes to me, and explained that the replaceableness of goods—that is to say, the fact that one sample of a class can be adequately replaced and represented by another—is simply a legal fiction. I only said that the actual identity of replaceable goods was a legal fiction (Capital and Interest, p. 253); and these are two very different statements. And, further, in my book I do not regard it as certain that, if a person speaks of uses in respect to perishable goods, he ought to point out, and wishes to point out, exactly the same kind of process of use as is to be observed in non-perishable goods. On the contrary, my entire criticism of Say and Schäffle (p. 232), of Hermann and even of Knies himself (p. 233), rests on the idea that it was a matter for the opposed theory to point out the existence of a something otherwise constituted than the usual material services, and that it had not succeeded in this attempt.
Der Kredit, part i., Berlin, 1876, p. 10: shortly repeated without new arguments in the second edition of the book Das Geld, p. 106, note 1.
I may note that it would be easy to multiply examples in which the same state of things occurs. Grain merchants, e.g., may find it to their advantage to exchange stocks held in different stores; bankers, to exchange sums of money disposable at different places, etc.
"A loan without interest is a gift of the use of so much capital," Roscher, Grundlagen, § 189.
See above, p. 251.
Similar cases may perhaps occur after very abundant harvests, where the producers have not enough storage accommodation to secure the surplus.

End of Notes

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