Cyclopædia of Political Science, Political Economy, and the Political History of the United States
INTEREST, after the Historical Method. Several distinct yet fundamentally related inquiries arise with respect to interest. What are the causes that determine in a given age and country its general or average rate? What are the causes that determine its tendency to rise, to fall, or to remain stationary in the progress of society? What are the causes that determine its temporary fluctuations?
—The causes determining its average rate have differed essentially in different ages and even in different parts of the same country in the same age. At a primitive social stage interest was unknown, and when the practice of exacting it emerged, it was considered immoral and generally prohibited by law. Archbishop Whately incorrectly defined man as an exchanging animal; exchanges did not take place in the earlier communistic stages of human progress. For a similar reason man can not be defined as an animal that pays interest on loans. The owner of superfluous wealth was in primitive times considered bound to lend it or give it gratuitously to any one in need; a distinct conception of individual proprietary right not having been developed. It was not until late in the reign of Henry VIII. that the payment of interest was legalized in England; a maximum rate of 10 per cent. being at the same time fixed. Before this act the receipt of interest was branded as usury, and contrary to both the common law and the canon law; although social exigencies, stronger than law, had in the later middle ages firmly established the practice of paying it, subject, however, to very different conditions throughout the country generally on the one hand and among mercantile people in the principal towns on the other.
—Throughout the country generally, there was but little accumulation in the middle ages. If we take the produce of taxes as evidence, the pecuniary value of the whole movable property of England during the thirteenth and fourteenth centuries never amounted to a million. So late as 1523, it was estimated in parliament that all the movable wealth of the kingdom, money included, was under the value of three millions. A case, indeed, is reported in one of the year books of the reign of Edward III. from which it would appear that a deceased person had left goods and chattels to the value of 200,000 marks (£133,333), of which his widow claimed a moiety; but the amount is incredible, and is probably ascribable to some mistake of a copyist in the numerals. But if there was little accumulation, there was still less loanable capital. The great mediæval landowner was commonly needy, and his accumulations, if any, took the form not of loanable capital but of castles or manor houses, cattle, sheep, horses, arms, clothing, together with some plate and jewelry. One of the most instructive inquiries in economic history relates to the forms of accumulation in different states of society and different countries, and their causes; and it is an inquiry closely connected with variations in the rate of interest. One can without difficulty understand that the feudal lord built strong and imposing dwellings for power, consequence and security; and his possessions in cattle may also be easily explained. They were the natural produce of his land, and they fed a host of dependents in his hall. But if he rarely amassed money, it was not that the love of money was not strong in his breast, but because it was so scarce that even a thrifty noble with immense landed estates found it hard to procure. From the reign of Edward I. to the accession of Henry VIII. the entire amount of silver loaned in England was below £1,200,000, and the drain of money to the continent, especially by the papal court, during that period, was relatively enormous. Hence there was little money to lend in the country. Land, houses, cattle, sheep, and such kinds of property, movable or immovable, did not constitute loanable wealth. Loans, too, could not be effected by means of credit; the actual intervention of coin was necessary, and few persons had sums by them to put out at interest. The risk of the penalties on usury, and the rigor of the terms extorted by lenders under various covert devices, contributed to the difficulty of procuring loans, but the scarcity of money was a principal cause of the exorbitant rates of interest prevailing throughout Europe in the middle ages. Payments even to mercantile people in London itself were sometimes made partly in skins for lack of coin. Had banking and instruments of credit made it possible to effect loans without money, much lower rates of interest might have prevailed in spite of the penalties on usury. Hence the fall in the rate of interest in England, in the latter part of the sixteenth century, was undoubtedly caused in a great measure by the increase in the accumulation of money and the greater quantity entering the loan market after the influx of the precious metals from the mines of Potosi and the new coinage of Elizabeth's reign. In later times the growth of a system of credit has added so vastly in effect to the amount of loanable capital, that, unless in critical times when credit collapses, the quantity of loanable coin has no appreciable influence on the rate of interest, and would hardly be missed from the loan market.
—It should be added, with respect to mediæval interest, that the customs of trade at length established in the commercial towns a rate with which the ordinary tribunals did not interfere. In England, in the reign of Edward III., the customary rate in London was 10 per cent., or half the customary rate of profit. We find here the emergence of the condition which in modern times has become the dominant one determining ordinary interest, but which in the middle ages operated only among the small number of trading people in towns, namely, the rate of commercial profit. The ordinary borrower in old times did not borrow to make profit, but because he was in immediate need of money to pay his debts. In modern times the fluctuations of interest are often caused by borrowing, irrespective of profit, on the part of persons or governments in immediate want of advances; but unless in critical states of trade, or on other extraordinary occasions, modern borrowing is chiefly on the part of people in business seeking to make profit on the capital thus obtained, and the interest they can pay is accordingly limited by the profit they can make. Thus, one of the fundamental differences between the causes determining mediæval and modern interest is, that the greater part of the capital lent in our age is lent to producers, and the main source of interest is the profit they make on production. There are still some unproductive private borrowers, and governments may pay interest out of taxes, but the general rate is determined by a commercial or industrial standard.
—There is no other country in the civilized world in which the modern movements of interest, and the conditions affecting them, can be so advantageously studied as in the United States. Here the causes governing the rates in both old and new countries, and the course they follow as social and economic progress advances, can be investigated together. For, relatively speaking, the eastern states form an old country, the western states a new one; and again in the latter we can observe new regions at different stages of early development. The salient facts as regards interest are, in the first place, in the eastern states an average rate of interest not much above that prevailing in the chief countries of Europe; secondly, in the newest regions of the west an extraordinarily high rate, which has sometimes reached 25 per cent.; thirdly, a fall of interest in these new regions after cultivation and industrial development have gained considerable ground. To understand the significance of these economic phenomena we must take in connection with them some others no less remarkable. Wages, too, are found at their highest point in the new regions of the west at the beginning of their industrial career; they are lowest in the long settled eastern states; and they begin to decline in the western states when the first stage of their development has been passed. The explanation of the concurrent phenomena thus exhibited in the movements of interest and wages is simple. With the aid of the scantiest supply of capital the first Californian gold diggers might count on winning, on an average, an ounce of the precious metal, equal to sixteen dollars, a day. The first farmers could raise enormous cereal crops by merely plowing and sowing; and horses and herds, which they had only to take possession of, covered rich natural grass lands. Out of such returns both high wages and high interest could easily be afforded, and the scarcity of capital enabled lenders to exact a considerable proportion of the whole produce. But when the cream, as it were, had been skimmed by the first comers, both capital and labor had to content themselves with a poorer and harder earned yield. Gold was no longer to be won by mere digging, and needed deep and costly mining. The soil was found to require irrigation after a few crops had been raised, and even manure came into request. Not a herd was to be seen on the plains that was not marked with an owner's name. Capital was no longer scarce, but the returns were comparatively scanty. Nature did less and less to assist the advance of each successive wave of immigrants, until the difference between the productiveness of capital and labor in the new state and the old eastern states became one only of degree, not of kind.
—It is objected, however, to this simple explanation of the phenomena of the coexistence of extraordinary high interest and extraordinary high wages in new and naturally prolific regions, and of the decline of both as such regions are peopled, brought under cultivation and developed by capital, so as to begin to display the features of long settled and advanced states, that the productiveness of labor and capital, that is to say, their wealth-producing power, is not less but greater in old than in new countries. In old countries, it is argued, the subdivision of labor is carried to a much farther point and directed with much greater skill, and their wealth is such that they not only support a large unproductive population, but have a numerous and rich idle class, whereas in new countries in their earliest stage every one is a producer. The richest states of America, it is pointed out, are not the western but the eastern, and the richest state in the world is Great Britain, with natural resources far inferior to those of Mexico or Brazil. But the single fact that labor and capital desert Great Britain for new countries affords conclusive proof that they are more productive, and therefore find more remunerative employment, in the latter. The wealth of England is no doubt greater than that of any new country, but a great part of its wealth is made not in England but in the very new countries in question. And the total wealth of England would be much less than it is, were the returns to English capital no greater in any other region than in England itself. England is rich because, on the one hand, it reaps harvests all over the world, and gathers the produce together into its granaries, and because, on the other hand, the aggregate capital it employs in production transcends calculation, although part of it yields but scanty returns from poor soils and inferior mines. A million might return 25 per cent. to the California corn grower and only 5 per cent. to the farmer in Middlesex, yet if for every million in California, there be a hundred millions in Middlesex, with London in its midst, Middlesex may have a revenue equal to that of twenty Californias; no inconsiderable fraction of it being, perhaps, actually drawn from California.
—In these facts we find also a refutation of the theory that the appropriations of land and the growth of rent are the causes of the decline of interest in new countries in proportion as cultivation, industrial progress and population advance. When the farmer and the miner are compelled to resort to much more laborious and costly methods than those by which they gathered the first fruits that Nature laid at their feet, wages, profit and interest must decline, whether land be appropriated or not, and whether there be or not some fortunate owners of virgin soil and rich deposits of gold, from which a large rent can be drawn. There might be no rent, were all the more fertile soils and mines so exhausted that capital and labor were driven altogether to parts of the new state which the earlier immigrants had passed by with contempt, but the absence of rent would not prevent a fall of both wages and profit, and of the interest which the lender of capital derives from the gross profit it yields. To call the rise of rent the cause of the fall of interest, is to mistake the effect for the cause. As population advances, land with inferior natural powers or advantages is resorted to, and superior fields for the employment of labor and capital can thus afford a rent. Whether this rent is appropriated by the central government, or belongs to the first settlers, wages and interest must fall. It is true that were the government to become the sole landowner, its revenue in rent might enable it to dispense with taxation, thereby setting trade free from fiscal burdens and fetters, and so raising indirectly the return to labor and capital. But this would be the result of the absence of taxes and restraints on production and commerce, not of the absence of rent.
—The general rate and movement of interest thus depend mainly on the profit which the capital employed in production holds out, and the movement will be downward as resort to less productive natural resources becomes requisite, unless science and art supply the deficit created by the failure of the bounty of nature. In the infancy of their development new countries afford a rate of interest which will never again be attained in later stages of their career, but whether interest must continue to decline throughout every stage of social advancement, is a question that can not be decisively answered, because the resources of science and art and the future powers of production of the human mind are beyond prediction. The human mind is a source to which capital may look for profit after some of the chief material sources at present known shall have begun to fail.
—Although, however, the rate of profit determines the limit or maximum of interest, because the managers or employers of borrowed capital can not pay more than they make by its use and must reserve part for their own remuneration, it does not determine either the proportion of gross profit that interest absorbs, or the temporary fluctuations of the latter, which often bear no relation to profit. The proportions of profit falling to the share of lenders as interest depends on the amount of loanable capital, on the one hand, and the demand for it on the part of both productive and unproductive borrowers, on the other hand. A high rate of interest tends to diminish the number of persons engaged in business and employing their own capital, and therefore increases the supply of loanable capital; while a low rate forces a greater number of capitalists to employ it themselves and to add the remuneration of management to interest, and thereby diminishes the supply feeding the loan market.
—Temporary fluctuations of the rate of interest result from a variety of causes, of which the chief is the state of credit. In ordinary times considerable loans are for the most part effected without the intervention of money in the proper sense of the term, but when credit collapses, nothing but cash is an available medium. The need of loans on the part of traders in difficulty becomes at the same time more and more urgent in proportion as credit contracts, so that at such periods the interest even people in business are ready to offer may bear no relation to the rate of profit in commerce. There are occasions, too, on which an urgent demand on the part, not of people in trade but of governments, is the chief condition operating on the loan market, and trade profit here again supplies no standard by which to estimate the terms on which loans are effected. Many other causes produce sudden divergences of interest from the rate which the standard of commercial profit would fix. The supply of money at call, for instance, may be abundant, and loans for a few days be obtained at little above 1 per cent., while the rate of discount on advances for three months may exceed 3 per cent.
—It must not be forgotten that the profit which trade offers is, after all, speculative only; it holds out, not a certainty, but a probability or expectation. The interest, therefore, which lenders of capital can look for is likewise speculative or probable only. Nevertheless this speculative interest is the principal condition governing the rate on the safest investments, such as the government stocks of countries like the United States, Great Britain and France, and determining their price in the market. If a man has drawn a ticket in a lottery which gives him an even chance of winning $100, the ticket is worth $50, and he is not likely to part with it for $40. In like manner, if he has a probability of making 20 per cent. on an investment in trade, he will give only half the price for government stock that he might have given were 10 per cent only the expectation, on equal probability, held out by trade.
T. E. CLIFFE LESLIE.
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