It can not be otherwise in the particular problem of value called capitalization. The first task of scientific study is to state clearly the nature of the problem. In this case it is seen to be the exchange of a present sum of wealth for a series of future rents. Whenever there are income-bearers and buyers and sellers of them, there are the conditions required for the determination of the market rate at which those future incomes shall be discounted. Manufactures and commerce have no peculiar relation to this process. By a flight of scientific imagination we might assume that the stock of indirect agents in the world consisted only of natural food producers, and that this stock and its yield were absolutely unchangeable by man's will or efforts. Each man in such case would have to stand with hands tied, and take the fruits as they matured. Even in such a case there would be capitalization and a rate of discount on future rents. The fruit-tree (that is, the whole future series of fruits) would bear a certain relation to one year's yield; the field would bear a certain relation to its crop. Wherever there are buyers and sellers of more or less durable agents of it matters not what kind or origin, there are present the elements and causes for the fixing of a rate of time discount.
4. In practical business may be seen innumerable instances of the capitalization of both permanent and limited series of incomes. The simplest case is the capitalization of an unvarying and supposedly perpetual series of rents. Whatever the rate of time discount prevailing, rents infinitely distant become infinitesimally small when discount is compounded. The present rent is worth most, next year's less, and so on in a decreasing series.
But social changes alter rental values, and so far as these changes are foreseen, these anticipated or expected rents are made the basis for present capitalization. Investors and owners alike may foresee that a piece of land used only for agriculture will, within a few years, be taken up for city lots, or will be needed for a factory or as the site of a railroad station. The capitalized value would not in this case be based upon a series of uniform rents each of the amount yielded annually now, but on the progressive series expected. In some cases the physical output of an agent may decline while the price of the product increases. Modern foresters foresee that the selling price of the timber will be greater twenty-five years from now than it is to-day, and they therefore estimate the rental value of the forest on the basis of the future price, thus justifying expenditure that would be unwise if present prices were to continue.
Again the expected series of incomes may be declining, as the royalties (not typical rents) secured from mines. If the income is expected steadily to fall, and to disappear at the end of the twenty-fifth year, the value of the mine would be the capitalized sum of a limited and degressive series of incomes.
Every exchange of a durable agent involves an estimate, rough and imperfect it may be, of that agent's future. The practical men, however, who are thus fixing the "capital value" of goods, are usually only dimly conscious of the logical nature of the process. In fact the process goes on in a way much less analytical and conscious, much more empirical, than this analysis would indicate. Most men simply buy as cheap as they can the agents which at the price they believe will add most to their income. The future changes are only roughly, not accurately estimated. The shrewd bargainer is the one who foresees more clearly than his fellows the complex changes to come. Other men blindly follow. The ability and the inability to foresee such changes make men rich and poor. In all this bidding for capital the logical basis of the value is the series of rents. When the agent is bought outright, the very concluding of the bargain fixes a relation between the expected value of the income and the value of the capital invested. In other words, the exchange of durable agents virtually wraps up in them a net income, which it is expected will unfold year by year when rents mature and are secured. At the moment of the investment, the expected rents are expressed as a percentage of the capital sum.
§ III. THE INCREASING ROLE OF CAPITALIZATION IN MODERN INDUSTRY
1. Where a system of exchange is highly developed, things are looked upon as capital yielding an objective income rather than as wealth yielding immediate means of enjoyment. In the old organization of industry most men got most of their living from the things they raised or made. At the present time goods are gotten in the most indirect ways; men seek wealth because it will yield them an objective or money income, knowing that if they can get the income, they can get other things by exchange. In business to-day, wherever there is a rental, it is capitalized, has a market value, is bought and sold. Men compete in the purchase of income-yielding agents. There is a continual contest in judgment among investors to secure the largest rent for the smallest outlay. On the other hand, the owners of any rental strive to secure the largest capitalization for it that they can. In this market for capital it is money rents that are exchanged as an indirect means of arriving at gratifications.
2. The issue of capital stock is the putting of the incomes of wealth into marketable form. Stock companies, or corporations, are business enterprises which issue stock, or certificates of a share in their wealth and income. Doubtless the convenience of the sale and transfer of invested capital by the use of stock, has been one of several reasons for the large increase of this form of organization during the past century. Originally the stock of a company taken collectively represented all the capital invested, and each share entitled the owner to a given portion of the total income earned. The shares were issued in regular denominations in terms of money, and this amount expressed on the face of the stock remained fixed. But as a business proves more or less profitable, the value of a share of its income rises and falls regardless of the original amount of stock issued. At once there is a divergence between the nominal or face value and the market value of the stock. The nominal value is relatively permanent, the same year after year; it may increase by further issues, but rarely is it decreased. But when stock is the only form of claim on the earnings that is issued, the fluctuations of the market value of the stock record the real value of the business, that is, the capital value of the rents it is expected to yield. But in present practice there are several forms (of which stock is but one) in which an investor may buy a share in the earnings of a business. Bonds usually do not give their owner a vote in the management or make him in the technical legal sense a part owner in the business. Bonds representing money loaned to a company, and entitling their holder to regular interest payments, are nearest in form to the medieval rent-charge. Next stands preferred stock, which entitles the owners to share first in the dividends, if there are any; and finally the common stock, which gets a share only when the other claims are satisfied. By the multiplication and further variation of these readily salable claims on industrial incomes, the needs and desires of investors are met more fully and with greater precision.
3. Men seek to convert into marketable capital any increase of income in their wealth or business. A man who invests a given capital sum in machines, buildings, and materials buys them, as others do, at prices that represent their usual, or market, earning power. If he succeeds exceptionally in his business, he makes the capital earn more than the rents on which it was capitalized. The same material wealth becomes worth more because of the reputation of his products, and therefore the trade-mark and good-will of the business can be capitalized. In this sense a good name can be sold, and is at least as much to be desired, even in a mercenary age, as great riches. Likewise, social changes, new needs, the growth of population, increase the net income of wealth, or the rents of a business. The basis of capital value is income, and whatever be its cause, political or economic, material income can and will be capitalized and added to the market value of the privilege, wealth, or industry on which the income is conditioned.
Notable cases of this sort arise in connection with public franchises. If a street-railway or a gas-company is given the exclusive right to operate in a given locality, any income above average interest on the investment is capitalized either in the higher price of the stock or in additional stock issued without the addition of any material to the plant. If the franchise is unlimited, the income may be capitalized as practically perpetual; if the franchise is limited, and is to expire in thirty or forty years, only the limited series of privileged incomes can ordinarily be capitalized. When, however, the managers are able to exert influence enough to have the franchise extended, and the investors believe in the skill of the managers and perhaps in their power to bribe the legislators, the value of the stock continues higher than it could usually be under a limited franchise. Such circumstances becloud the question whether the exceptional income arising under the franchise should go to the public or to the company. Granted, however, that the company is entitled to the income, the burden of proof is on those who object to the capitalizing of the income as is done in every other business.
4. The manipulation of dividends and the resulting changes in capitalization open up great opportunities for the dishonest increase of private fortunes. A great change in the market value of stock is made by a comparatively small change in the income it regularly affords, for if the prevailing rate of interest on money loans is five per cent., each dollar of dividends is capitalized at $20. It might seem that the dividend would be declared if earned, otherwise not. The matter is not so simple and impersonal, however. The control of corporations is vested in the hands of a small group of directors who have both the opportunity and the temptation to withhold dividends when they are earned, to pay them with borrowed money if unearned, and in either case to keep the stockholders and the public in ignorance of the real condition and earning power of the business. The stocks can, by this manipulation of dividends, be made a lottery for the legitimate investor, a trap for the unwary, and a source of unrighteous gain by men recreant to their trusts.
In this way it may be seen that an earning power not known to bidders in the market does not enter into capitalization; a fictitious earning power, however, is capitalized so long as the investors continue to be deceived. Instances of this kind present problems not only of private morality, but of the preservation of free industrial institutions. The solution of these problems would perhaps be hastened if the a economic nature of capitalization were more clearly understood. Capital value in modern industry is everywhere the expression of the serial rents of wealth, discounted at a prevailing rate of time discount.
CHAPTER 16
INTEREST ON MONEY LOANS
§ I. VARIOUS FORMS OF CONTRACT INTEREST
1. Interest, the amount paid according to contract by one person to another for credit given in terms of money, is but one expression of a larger problem, that of the difference in present worth of goods at two periods of time. This larger problem appears under several forms: first, as a difference in value, due to time, where there is no money expression (to be considered in the following chapter); second, in discount on a money loan for a short, definite time; third, in a long-time money loan at a fixed rate of interest; fourth, in a credit loan—that is, the sale of the thing on credit in terms of money.
The last three cases involve interest more or less clearly. Time-discount, as will be more fully explained, is the basis of interest. The interest may be greater or less than the time-discount in the goods, owing to miscalculation on the part of the borrower or to an unforeseen change in the conditions. Men bid for the use of wealth with the intention of repaying it at some future time, and the interest they agree to pay is based on their estimate of the discount of future rents, which they think is involved in the present valuations of the goods. Time-discount is involved in goods, however, in numberless cases where there is no contract interest. Even a Robinson Crusoe must recognize in his consumption goods and in his various indirect agents differences in value at different periods of time, of which he must take account.
2. Gross interest must be distinguished from net interest. The forms of wealth yielding incomes are so mutable, and are used under such complicated conditions, that both in theoretical discussion and in practice much care is needed to distinguish between the yield attributable to the income-bearer, and that attributable to other wealth or services used in connection with it. That the sum paid as interest on a loan contains other elements is recognized constantly in practice. As in the case of contract-rent allowance must be made for repairs and depreciation, so in the case of contract-interest allowance must be made for risk, or the average loss occurring in the industry. Money loaned in hazardous ventures must yield a higher rate of interest. Likewise capital used by the owner in a hazardous venture must frequently earn very high returns (not all logically interest) to offset the losses that are likely to occur.
The lender must also, in estimating net interest, count the cost of placing, supervising, and collecting the loan. A pawnbroker lends only small sums and spends much time and effort to keep at interest a moderate capital. Five thousand dollars loaned in sums averaging ten dollars represents five hundred transactions, and yet if placed at five per cent, it yields but two hundred and fifty dollars a year. While, therefore, the borrower of a small sum estimates the economic interest (or anticipated gain in income) even higher than the oppressively high contract-interest he may be forced to pay, the lender must credit a large part of the gross interest to the labor he expends in carrying on the business.
3. The most usual form of short-time loan is that made by a bank or broker to business men on security of commercial paper. By commercial paper is meant promissory notes given by customers of the merchants, bills of lading for goods that have been shipped to their customers, and various other evidences of indebtedness that may be offered the banks for discount. When goods have been sold on time (as thirty, sixty, or ninety days) the seller has the choice between letting the time expire and collecting the bills direct from the customers, and discounting the bills for ready money at the bank. According to the conditions and needs of the particular business, either method may be chosen. In most industries there is need for larger capital at the seasons when the product is put upon the market. The merchant or manufacturer plans his business in the expectation of an average rate of discount at such times, and if it chances that the discount rates are abnormally high, he has no choice but to go on borrowing and paying the high interest out of the expected profits of his business. This risk of a change in the interest rate is one of many chances he has to run.
4. Most debts in modern times are outstanding for a term of years and represent the lender's purchase of a claim on the earnings of some productive enterprise. The simplest forms of long-time loans are those made on the security of real estate, which is mortgaged to the lender for the term of the debt. Usually the debtor is obliged to pay the interest either annually or semi-annually, and often, but not always, is permitted to reduce the principal by partial payments. These real-estate mortgages rest on the security of the particular mortgaged wealth, and, unlike most short-time loans in bank, are not personal obligations resting on the general credit of the borrower. Most other long-time debts share this character of being non-personal; if payment is defaulted, only the particular wealth can be sold for payment, not the general wealth of the borrower. Corporation bonds, issued by railroads and other large stock companies, have increased greatly in number in recent years. They yield an income fixed in advance, and are secured usually by mortgage on the entire property of the corporation issuing them. The income of some special kinds of "preferred stocks" is so guaranteed as to make them for investors substantially the same as bonds. Another large class of long-time loans are those made by national, state, and local governments. Tens of billions of dollars of public debts are now outstanding, held by private investors in every walk of life.
The contract in the case of each kind of these loans provides for a fixed term after which the borrower must repay or renew, and for a fixed rate on the nominal or par value of the loan. Nearly all the securities (bonds, certificates, evidences of indebtedness) are salable at a market rate. It is therefore the income that is fixed, the selling price (or capital value) fluctuating above or below the nominal sum except just at the moment when it is payable. The long-time loan thus is very similar in its economic character to the old-time rent-charge.
5. The sale of goods on credit is a mode of lending and involves interest in a disguised form. In some cases merchants will not sell cheaper for cash than for credit, for fear of offending their main body of credit customers; but this is exceptional, as there are good reasons why such a difference should be made. The credit sale usually involves interest, and often at a very high rate. In many stores there are two appreciably different prices, one for "slow pay," the other for "spot cash." If a bill paid at the end of the month is five per cent. more than the cash price, the difference is equal to sixty per cent. per annum for the privilege of postponing payment. Such a rate of interest is paid only by the improvident, but that is a large class ranging from factory workers to college students. The cash discounts allowed by merchants clearly express the time difference. On fifty to one hundred dollars of outstanding bills, many perfectly honest persons are paying interest at the rate of seventy-five per cent. per annum. The merchant is forced to make this difference because he must seek not only to earn interest on the capital thus invested, but to recover the costs of bookkeeping and collections, and the risk and loss of unpaid bills. The discounts allowed by manufacturers and wholesale houses measure in the same way the difference between cash and credit sales. Not unusual is a discount of "six per cent, in ten days, five per cent, in thirty, or sixty net." The buyer allowing his bills to run for two months (six per cent, for sixty days) pays thirty-six per cent, per annum for the use of that money. The difference is so great that it is impossible to carry on in this way a large business against strong competition. Such purchases on credit frequently are made, however, by dealers in small towns.
6. Interest is often concealed under other forms which increase the apparent rate. This fact is well shown in the ways by which usury laws fixing the legal rate of interest are evaded. A simple method is for the lender to charge a commission for making the loan, or, if it is a bank, to charge for a pretended cost of exchange to bring the money from some other city. Sometimes the borrower is required to keep larger deposits with the bank than he voluntarily would. Needing $5000, he is compelled to borrow $10,000 and to pay interest on twice as much as he is permitted to use. Again the borrower, in periods of unusual demand for money, is forced to make a long loan instead of a short one. When a one month's loan at ten per cent, would meet his need, he is forced to borrow for twelve months at six per cent., during ten months of which time four or five per cent, is the prevailing rate. In these and other ways the real rate, or burden of the loan, is made different from that which is expressed.
§ II. THE MOTIVE FOR PAYING INTEREST
1. Interest for loans to obtain consumption goods is paid because they are felt to have greater importance at the moment than an equal amount (either of goods or of money) will have in the future. A sudden stress of misfortune may impart to a thing at the moment far more than its usual value. One standing face to face with starvation cannot be worse off a year hence; often there is good ground to hope that if the present misfortune can be relieved, the future better fortune will make it possible to repay a loan with interest. In other cases, the object of a loan of consumption goods is to increase the future earning-power of the borrower. When the student borrows money that represents to him food, clothing, text-books, tuition, and other expenses incidental to a course in college, the expenditure is intended to increase the effectiveness of the worker. When he borrows he has little earning-power, but with that faith in himself which makes the young American so interesting, he pictures himself four years later, sheepskin in hand, drawing a munificent salary with which he can easily satisfy the most exacting Shylock. Such an expenditure is sometimes called "an investment of capital," but it should be called a consumption loan—nevertheless in many cases a loan wisely made. To call this an investment of capital is to confuse man, the end of production, with material means.
Sometimes this higher estimate of the present good is unwise, viewed in the light of wider experience. Goods that meet momentary desire make an exaggerated appeal to untrained minds. The child, the spendthrift, the savage, cannot properly estimate the relative values of present and future. The improvident sometimes lightly agree to pay an exorbitant interest for an immediate consumption loan, making a ruinous difference between present and future gratifications.
2. Interest on indirect agents is paid as a more or less indirect means of securing gratification. This can be clearly seen when durable agents are hired that produce gratification directly. A carriage bought with borrowed capital and used for the pleasure of the borrower is expected to afford a utility greater than that to be gotten by the amount of the interest in any other way. A spade bought with borrowed capital and used to cultivate the owner's garden is expected to add products of greater value than the interest.
But how is it in case the agent is used to gratify persons other than the owner? The music-teacher who buys a piano on credit expects to increase his earnings by a sum greater than the interest he has to pay. If the addition to his earnings exceeds the interest charge, it is because he has found a use for the borrowed capital greater than that on the basis of which it was capitalized in the market. The amount of the interest is secured through the pleasures and services the piano affords to the patrons of the teacher. In the most complex cases of the borrowing and use of indirect agents, there is ultimately this same basis for the interest: enjoyment afforded by the use of capital in the particular period. To the borrower, what the capital makes possible is an addition to his income as great as, or greater than, the prevailing interest. Most loans in our society are now of this sort. Money is borrowed to invest in business, to get better machinery or a larger stock; with this capital is secured a better or larger product, and the product finally being sold at a profit, the business man is at a point where he can satisfy his wants without encroaching on his capital. Logically, therefore, the consumer of the product pays the interest in the price, and the final consumer's enjoyment must be deemed the logical source of the money interest. The borrower's motive for paying interest on these indirect goods evidently is his hope of profit through realizing a greater money rent than he has contracted to pay for their use.
3. The money market in which short-time loans are made is peculiar in that the money frequently is borrowed to pay debts, not for investment. In beginning the discussion of interest, it always is remarked that it is not money, but capital, that is borrowed and loaned. This caution against the superficial errors that so easily beset the popular discussion of interest is much needed, but it is well to note a peculiar case which is apparently in contradiction to this statement. The usual method by which money is loaned in the great industrial centers is called discount, which is the exchange of a certain sum of money for a note or other credit paper of a larger amount, the interest thus being taken out in advance. Much borrowing in the form of discount is for the same purpose as other borrowing—to acquire control of more productive agents, to embark on new enterprises. The peculiarity of the discount money-market is that an unusual number of loans are made to meet contracts that have already been made. There is always a great mass of outstanding obligations, and merchants are compelled to renew these loans on penalty of bankruptcy. This market for short-time loans is not connected closely with the general market for loanable capital. When the need is for ready money, other concrete capital cannot flow in to meet it. This special money demand, therefore, in time of greater or less stress, may fluctuate rapidly, and the interest rate be temporarily higher or lower than the rate on long-time loans. This case is similar to that where two markets, as a retail and a wholesale one, exist side by side, but slowly exerting a mutual influence.
4. In the long-time money loan the money generally is borrowed first merely as a medium of exchange to get control of indirect agents. The borrower of a long-time money loan for productive purposes is always seeking to gain by investing the money in wealth that will yield an income larger than the interest he must pay. The borrower, therefore, invests in view of the rate of interest, of the market price of the goods in which he plans to invest, and of the probable chances for earning profits in the business. This case, where certain goods whose price is known are approximately selected before the money is borrowed for investment, is the type of loan to be kept most usually in mind in economic discussion.
Evidently the price of these goods, to control which is the real object of the loan, is merely the sum of the expected rents they will yield, capitalized at the prevailing rate of time-discount. The borrower expects either to make these particular goods earn rents larger than those on the basis of which they have been capitalized, or to transfer them to an economy where goods are capitalized at a higher rate than he is paying. The income yielded by these goods, if the borrower's expectation is fulfilled, is but the difference between present and future rents that has been wrapped up in their capitalization. As time elapses and the rents emerge in wisely chosen investments, the borrower has a surplus large enough to pay the contract interest. It appears, therefore, that the motive of the borrower is to get control of future rents at prices that already involve, in their capitalization, a rate of discount somewhat greater than the interest he contracts to pay.
5. The rate of contract interest on money loans is adjusted at each moment in the money market by the bidding for money loans. This is a true statement only if it is understood in a somewhat superficial sense. No error connected with interest is, however, more crude than the view that the interest rate is in any broad sense due to the quantity of money. Some loans are made apart from the general market, by private agreement between borrower and lender; but in nearly every such case the rate agreed upon is seen to be closely related to that of the general market to which either borrower or lender can resort if he wishes. The greater number of borrowers and lenders of money have a range of choice in their bargaining. The interest rate in modern developed money markets is that rate which brings to equilibrium the demand for money loans and the money capital available within the period. If the ready, loanable money in private hands, in banks, in insurance-company reserves, &c., increases, a lower rate must be offered to borrowers; if the supply decreases, a higher rate will be quoted. In the one case, more men borrow; in the other, fewer borrow and more seek to lend. Thus a rate results, but a rate that is closely connected with larger set of facts—those, indeed, which determine in the long run the rate of capitalization in the community.
6. The individual must adjust his business dealings to the market rate of interest. The market rate is fixed by the bidding of individuals, and every one has something to do with fixing it. In a multitude of minutely small ways, as present and future goods are compared by men, the rate of interest is affected positively or negatively. But for practical purposes the individual, counting for little in the midst of millions, must look upon the interest rate as beyond his influence. Therefore, while the rate is determined by each to some degree, all that any one does is to buy or sell present goods, borrow or lend capital, use up or save wealth, according as his own estimate of time-value is less or more than the market rate. In fact, the estimates of individuals diverge constantly from the market rate, but are brought into harmony by their actions with reference both to money loans and to the use and valuation of the various forms of wealth. A Robinson Crusoe working on his island and valuing future goods relatively to present goods higher than before, consumes less; or, valuing them lower, consumes more. The business man who values indirect agents above the market rate borrows, and if he miscalculates and fails to make them earn the expected rent, he loses. In this experimental way many other acts are influenced by the prevailing interest rate and in turn affect it, thus aiding to formulate society's estimate of the value of present as compared with future rents.
CHAPTER 17
THE THEORY OF TIME-VALUE
§ I. DEFINITION AND SCOPE OF TIME-VALUE
1. Time-value is the difference between the values of things at different times. Things differ in value according to form, place, quality of goods, and according to the feelings of men, and—not least important factor—according to time. The simplest and clearest case of time-value is the difference noticeable in the same thing at different moments. Is this good worth more now or next week? Shall this apple be eaten now or next winter? These questions can be answered only after comparing the marginal utilities which differ according to the varying conditions of the two periods.
All the other cases of time-value can, by the practical device of substituting other goods of equivalent value, be reduced to the typical case of comparison of the same thing at different times. The comparison may be between very similar things, the one consumed being replaced by a duplicate. An apple borrowed now may be returned next year in the form of one of the same size and quality. The essential thing in this comparison is not physical identity, but equivalence in size, sort, and quality at the two periods. This is borrowing under the renting contract.
But two or more quite different things may be expressed in terms of another thing and so be made comparable. Money becomes the value-unit through which different things may be reduced to the same terms for comparison. With this mode of expressing the value-equivalence of various goods, the interest contract first becomes possible, money (the standard of deferred payments) being the thing exchanged (possibly only in name) at two periods of time. What is really compared are various gratifications which may be produced by very different material things or services. In its last analysis comparison of values at different periods of time must be a comparison of psychic incomes, of two sums of gratification. The comparison of the value of a bushel of apples with that of a barrel of potatoes or a suit of clothes at the same moment appears simple enough. When all are expressed in terms of money, the comparison of each with its value-equivalent at a later date becomes easy. The simplicity and obviousness of time-value in the case of money loans at interest led men at first to recognize that phase of the problem exclusively, and later the term "interest," not without much confusion of thought, was given a wider significance. Let us now see how large a part of the whole problem of time-value is outside of the money loan.
2. The problem of time-value is quite separable from the concepts of money and capital, though usually connected with them in practice and theory. It is true that the problem of time-value was first clearly recognized in connection with money and a formally expressed capital sum. Misled by this fact, and taking a very narrow view, writers seventy-five years ago recognized but dimly the problem of time-value in connection with the valuation of the incomes derived from land. It is true, as has been shown above, that the mere putting of an estimate on a durable good such as land involves the process of capitalization, which in turn implies a comparison of the values of the rents expected at different periods. Diminishing returns in the use of agents involves a loss of time to secure the usufructs emerging. The relation of these facts was not clearly seen until of late.
The phenomenon of time-value as above defined may be seen to be broader even than that of capitalization. The difference in the value of the successive rents of wealth must have been recognized and in some degree measured before there was any conscious calculation of capital value. Differences in value due to time are everywhere. The problem of time-value often is present where money is not even spoken of or thought of. Money no more causes this time-difference in value than balances cause weight.
3. The problem of time-value is involved in repairs and depreciation, and in the use of consumption goods. It is possible, as we have seen, to increase the sum available for present needs, and to encroach upon the future by postponing repairs on intermediate goods. The balancing of the cost of repairs against the future income is a never-ending task in practical business. One making repairs must purchase the needed materials and labor at a capitalization determined by their expected earning-power in other industries. If the repairs in question will not ensure an annual saving as great as this expected rent, they will not be made. When an industry is declining, it may, for the sake of putting the capital into a better business, be good policy to let the machinery fall into bad repair. The problem of time-value is involved in the application of one's energy to repairing one's own possessions. It is a thought of wide bearings that numberless minor decisions in every petty business involve, if they are correctly made, a measuring of the rate of capitalization.
As will be more fully shown in discussing the relation of the prevailing rate of interest to saving, the recognition of time-value is implied in the use men make of consumption goods, in their postponement of enjoyment, in their storing of goods for future use. The varying gratifications yielded by consumption goods, and their values in different conditions cannot be explained without taking account of differences in time. Wherever there can be a choice in the time at which, and consequently in the conditions under which, a thing can be used, there is a choice presented between the different values. Time-value is present even in a period during which no goods continue to exist, as when a good is consumed at a moment of greater need, to be replaced at a time when less valuable. If an apple is borrowed on the promise to return an apple and a peach at the end of a year, the peach represents the time-difference in value but in the meantime there has been no apple in existence. It is only in a figurative sense that it may be said that interest is paid on that "capital." Interest is paid because of a difference in want-gratifying power, but during the interval there is no material capital.
4. The problem of time-value is involved in much foolish pleasure, in prodigality, and in vice. Economics touches frequently on the borders of ethics. If there were to be formulated an economics of personal conduct, it surely would give a large place to the comparison between present and future pleasures. Forethought, or prudence, is the virtue of recognizing not only future dangers to be avoided, but the greater future joys to be gained in exchange for present pleasures. The reckless and the prodigal underestimate the future and barter all to gratify the moment's impulse. The drinker exchanges the hopes of worthy life for the exhilaration of the spree. Indulgence in social pleasures, if secured at the price of lost sleep, weakened health, and debauched character, are loans from the future made by youthful prodigals at usurious interest. If no one ever paid more than a moderate rate of interest for the gratification of his present whims and impulses, most hospitals, drug-stores, and medical colleges would close, and half, if not all, the prisons would be empty.
Indeed, time difference in value is a universal phenomenon of life and conduct. Contract interest is but one phenomenal form of time-value, and this in turn is but one phase of value. This section may serve to suggest how much more varied and pervasive the fact of time-value is than has usually been recognized in popular or economic discussion of the subject of interest.
§ II. THE ADJUSTMENT OF THE RATE OF TIME-DISCOUNT
1. The fixing of the discount on future goods is, in its essentials, like the fixing of the market price of consumption goods. This problem appears to be one of the most difficult in economic theory; but reduced to its simplest terms, it is an aspect of exchange value, and its ultimate explanation must be found in a comparison of psychic incomes. There must be noted the conditions of demand and supply, the interplay and final equilibrium of the two forces. The declining and marginal utility to the two parties to exchange must be carefully analyzed. One who can do these things is prepared to find the answer to the problem of time-value. Whenever a group of buyers and sellers meet, a ratio of exchange commonly will be arrived at. The ratio of exchange between buyers and sellers of present and future rents likewise is fixed at the estimates of a "marginal pair," at which point the amount offered and taken comes to equilibrium, for at that point no motive exists for any one to change sides.
2. Time-value as the premium rate on present goods is unlike the ordinary market price, of goods only in the special nature of the utilities exchanged. The one peculiar need in the theory of this subject is a clear understanding on this point. The goods exchanged, or compared, are direct and indirect goods, or present and future goods, or, more generally speaking, two goods or groups of goods unequally distant in time from present enjoyment. What are sold in a case such as capitalization, involving an estimate of time-value, are present goods or gratifications; what are bought are future gratifications, or indirect agents which stand for, typify, or make possible, future gratifications. Practically every man in a market acts on the knowledge of what the exchange of direct and indirect goods means; yet abstractly stated, the thought seems at first difficult. In valuing any durable good, the theory of time-value is implied. Every time a machine, a house, a book, a field, is bought, the distinction between direct and indirect goods is acted upon, for a choice has been made between present enjoyment and future provision. Anything that endures is an indirect good and implies in its valuation a premium rate on present goods.
The real nature of the exchange in time-valuation is made unclear by the uncertainty of life, leading men to work on to provide against possibility of mishaps; for the most part the world's treasures never afford to their temporary owners the gratification that they typify, or could give. The nature of this exchange is made unclear also by habit, under the influence of which the exchange in so many cases is not carefully thought out, is not the result of a close comparison of the utilities of goods in present and future moments. The real nature of this exchange is made unclear by the indirect, or induced, gratification derived from wealth. Wealth gives to its owner power, prestige, the esteem of his fellows, and pride in evidences of success and growing prosperity. Its very possession creates a new need and imparts to it another utility, that of insuring against the misery of a declining fortune one who has enjoyed wealth and power. Men make the greatest efforts up to the last moment of life to retain wealth that they will enjoy only in this subtle and indirect way. Thus every motive that leads men to postpone present enjoyment makes them bidders for indirect agents and for future goods, and helps to determine the market rate of premium on the present, and of discount on the future.
3. There being a limited number of indirect agents, their limited powers in a given period limit the supply of present goods. The principle is familiar that value is always connected with relative scarcity. Now the desire for the present goods is indefinitely large. If the right kind and quality could be had at will, an enormously greater amount of present goods would be used. But the present goods are dependent on indirect agents. The psychic income of a civilized community is dependent on a favorable and extremely refined environment: houses, libraries, theaters, the agencies of travel, as well as the sources supplying the more material needs. These indirect agents, even in the richest community, are limited in variety, in quality, and in number.