But if indirect agents could produce an indefinitely large product at any given moment, the supply of present goods could be indefinitely increased. The supply of utilities, therefore, is limited by "diminishing returns" in the use of agents, making their maximum yield depend upon the lapse of time. The uses any given material can yield in a limited period have an absolute limit: an acre of land with the most perfect cultivation cannot feed the world; but remove the limit of time, wait an eternity, and the acre would yield an infinite crop. The economic return of a given agent in a given period is reached much sooner than the technical return. If agents are forced to yield more bountifully, it is at the sacrifice of utilities in other agents, and a point of maximum net yield is found in any given period. Here also the lapse of time is the condition of the increase of the net utilities derivable from limited agents.
4. The rate of capitalization of income and the rate of contract interest on money capital tend to unite into a single market rate. A person wishing to exchange present goods or income for future goods may buy an income-bearer at its capitalized value, or he may create a new rent-bearer. Having saved a sum of money, either he may purchase a factory known to be profitable; or he may hire the services of men and unite them with materials and machinery to create a new industry or a new form of income-bearer; or he may loan his money to others to make either kind of purchase. In any one of the three cases it is evident that capitalization (that is, the discounting of future rents in goods) is the primary and important fact making possible the emergence of a surplus, or net yield, over and above the value of the capital. The expected uses contained not only in whole industrial establishments, but in the particular materials and agents united to form new agents, are purchased at their capitalized value; that is, the future uses have been discounted and have entered into the price of the goods as less than they will be when realized as actual rents. This is the crucial point in the theory either of contract interest or of time value; for to explain the rate of interest as due to the process of "producing" capital agents out of other materials, is to beg the question involved. The surplus yielded by capital above its cost is but the realization of a net income made possible by the discounting of future rents.
A person wishing to make an exchange of the opposite kind to that described may sell his wealth for money; he may exchange for present enjoyable goods his income at its capitalized value; or he may use up what he has, let it depreciate, fail to make repairs, convert it to various consumption purposes, and thus invade his earning power. When the interest rate is five per cent., the sacrifice of any unit of regular income permits the spending of twenty times that amount for present enjoyment. The advantages of these various methods tend to equilibrium. If the owners of developed productive agents hold them at too high a capitalized value, investors will apply their efforts and savings to duplicating these forms of wealth. If, in turn, any of the minor factors, as materials or uses of goods, are overvalued (overcapitalized) it will appear ultimately in a check in the demand for them at these prices, and in a reduction in the demand for money loans. As it is possible for any investor and for any borrower to choose among these investments and loans, there is practically but one rate, the rate which expresses the general ratio of exchange between present and future income. Owners and investors take the line of least resistance, get the most they can for their money, and choose whatever form is most advantageous. The interrelations between the various interest rates are therefore close and constant. The market rate of interest thus extends over all forms of wealth and pervades every phase of business. The value of every durable agent is fixed with reference to a prevailing interest rate, through the discounting to their present worth of all the incomes it is believed to contain.
5. Where goods are sold at forced sale or sacrifice, it is equivalent to a contract loan at a high rate of interest. Market values being dependent upon market conditions, the offer of goods at a given moment may not find the usual or normal number of buyers or the usual demand. Just such conditions are most likely to exist at the times when business men feel an unusual need of money. Two courses are open to them in this emergency, either to borrow the money at a very high rate of interest, holding the goods for better prices, or to sell the goods under the unfavorable conditions. The end of both courses is the same—to get ready money; and the methods are not essentially unlike—the exchange of greater future values for present values. The sacrifice sale thus reveals the merchant's high estimate of the interest rate. The purchaser of some kinds of property in times of depression is securing them at a lower capitalization than they will later have. The rise in value may be foreseen as well by seller as by buyer, but the low capitalization reflects the high interest rate temporarily obtaining. A. T. Stewart is said to have laid the foundation of his fortune when, being out of debt himself, he bought up the bankrupt stocks of his competitors in a great financial panic. The high contract interest at such times is but the reflection of the high premium on present purchasing power. Here then is another mode in which the prevailing rate of interest on money loans is kept in close harmony with the rate of time valuation.
6. The rate of contract interest on safe long-time loans registers pretty nearly the prevailing rate of time-discount in the community. There are of course different capital markets, and the estimates put upon next year's income as compared with this year's is very different in Montana, New York, and London. Because of the friction in the transfer of investments from one locality to another, these differences may persist indefinitely; but within each capital market the interest on any particular loan must, for reasons readily seen, tend to conform pretty closely to the prevailing rate. Various groups of men living in the same community have, however, varying estimates of time-value. The increase of safe long-time bonds issued by strong corporations and by wealthy nations as, for example, the New York Central Railroad, and the government of Great Britain, gives a large number of choice investments where the element of risk is almost entirely absent. Various agencies have developed for making the loans, that is, for bringing the borrower and lender together with the minimum of trouble and expense. Other efficient, but somewhat more costly, agencies for bringing together the owners of loanable capital and men wishing to use capital are savings-banks, building and loan associations, insurance companies issuing endowment policies, and mortgage-investment companies of many kinds. While on the one side of the bidding are thousands of lenders offering to exchange ready money for assured incomes, on the other are thousand of borrowers offering to exchange the promise of assured incomes for ready money. If either of these classes got far out of touch with the prevailing rate of capitalization, to which all the valuations are adjusted, that class would lose greatly.
7. All the net usufructs actually yielded by wealth are rents; economic time-discount is never a realized income; it is merely a calculation form, or anticipation of the difference between present and future gratifications. There has been much discussion as to what should be the relations in thought between rent and interest. Space permits here only an indication of the view on this question involved in the foregoing treatment. Rent, as the term is here applied, includes all the net productivity attributable to the ownership and use of capital, whether the yield be in economic form (in an increment of value) or in contractual form. Even contract money-interest must be looked upon as a species of the genus contract rent, the peculiarity in the money loan being merely that the thing which it is agreed to return is a certain number of units of the standard money.
The term "interest," first applied in the Middle Ages to a payment for the use of a money loan, came to be used more broadly by the earlier economists as the income attributable to those goods which generally were bought and sold in terms of money. In other words, interest was supposed (though erroneously) to be uniquely connected with the particular production instruments to which the term capital was narrowly and mistakenly confined. Still more to add to the confusion, the term interest was about this same time identified with the broad problem of time-value. The terminology has remained ever since in this stage of arrested development. Our suggestion is to retain the word interest in its original meaning, still almost universal in business circles, of a contractual payment on money loans, applying the term time-value (for lack of a better word) to the subtler economic problem.
Time-value is here understood to be that all-pervading difference in the values of uses and gratifications of wealth at different points of time. A comparison of the value of momently appearing uses of wealth is the rent problem. Here are, therefore, very different aspects of the value problem. The rent conception is earlier grasped by men, is nearer in point of logic; the concept of time-value has only recently been clearly recognized. If men lived only in the moment, they would be concerned only with rent; living in the future also, they are constantly regulating their acts with reference to time-value.
CHAPTER 18
RELATIVELY FIXED AND RELATIVELY INCREASABLE FORMS OF CAPITAL
§ I. HOW VARIOUS FORMS OF CAPITAL MAY BE INCREASED
1. Men seek to increase income by increasing capital. Men may strive to increase their rents without expressing the rent-bearer in terms of capital. Peasant owners and small proprietors, toiling fondly on their little estates, seeking steadily a larger crop, a larger income, accomplish wonders in bringing waste land to a high state of cultivation. Working on the soil that is at once their livelihood and their home, they do not consciously reckon the value of the labor they are putting upon it. No money can buy that which to them is beyond price. But, in our money economy, efforts are largely directed toward the increase of the capital sum. Investment takes the form of putting in a sum of money in the hope of getting an income bearing a certain relation to it. The first thought is of the value of the wealth invested, which has been carefully measured and expressed in dollars and cents. Wealth looked at in the older way was valued for what it did immediately for its owner, for its concrete fruits; looked at in the modern way, it is valued as a marketable income-bearer readily convertible into a multitude of other forms. Thus investments come to be thought of in terms of general purchasing power, from which it is expected to realize an income of a given percentage.
2. There are some classes of goods that can be increased without any noticeable increase in difficulty. The extremest examples are undiminished goods such as air, sea-water, the water of large rivers. These are free goods because, however much is used, the supply is immediately renewed. But they are undiminished only in a relative sense and in reference to present need. The water in the Western rivers long flowed on, undiminished by the uses made of it. But progressing civilization required more water for cities, for mining, and for irrigation, and now states and corporations are going to law over these formerly undiminished free goods. Some kinds of goods are produced from such very common materials that it might seem possible, by the substitution of agents, to produce an unlimited supply. How can bricks be limited in number, being made as they are from one of the commonest materials on the earth's surface? But the largest clay banks are limited in size; a large proportion of the places where bricks are needed are not near a supply of clay of good quality; and after a brick-yard has been used for a time there is increasing difficulty in getting out the material. While, therefore, bricks are scarce and hard to get from the outset in some places, the scarcity grows more marked in many places at first well supplied. If materials are scarce in any degree, their continued use for one purpose increases their scarcity in all other uses. Economic goods are goods having value; value implies scarcity, and an increasing demand means inevitably a higher value at some point. This is true of clay, stone, water, and the commonest kinds of labor.
It has long been customary for economists to talk of economic goods that could be increased indefinitely (meaning infinitely or, in any event, without any limit ever appreciable to man) without any increase in the cost or scarcity. This class of goods was considered to be very large. There is no such class of economic goods; it is evidently impossible that there should be. If they are already "scarce," increasing demand must make them scarcer. There are, however, some goods that practically can be increased with so little difficulty that their limitation is not of great social importance. Progress, population, prosperity, are not primarily conditioned on their amount; limitation will be felt far earlier elsewhere. They are at one end of the scale; they are the relatively increasable goods.
3. There is a large class of goods whose increase is seen to be gained with increasing difficulty. This is seen most clearly in the diminishing returns from land. In the attempt to get some food-products in greater quantity from a given area at a given time, increasing difficulty is met with at once. This attempt continued for a series of years results in historical diminishing returns, as was strikingly illustrated in English experience during the Napoleonic wars, when wheat rose in value because of the greater difficulty of producing the larger supply needed. Some replenishing agents will restore themselves if given time; the forest will grow up if left untouched by man; the field will recover its fertile quality if allowed to lie fallow. But this self-replenishing of agents is a slow process, and time is costly. Man therefore tries in other ways to force more uses out of goods, until checked by the increasing difficulty. The goods subject to "the law of increasing cost," as it was called formerly, were considered to be a peculiar class comprising only a small portion of wealth. But it can now be seen that the law may apply ultimately, though in differing degrees, to every kind of economic goods. Indeed, the principle just discussed is no more than one phase of the law of economic diminishing returns, which has a universal application to the realm of values.
4. There is a class of goods, natural agents and stores of materials which appears to be relatively fixed in quantity or which is increasable only with much difficulty. The first part of this proposition expresses mildly the thought that long obtained among economists: it was said that the supply of certain things was absolutely fixed, the chief of these being land used for agriculture. The idea as held by Malthus and Ricardo was modified by John Stuart Mill in somewhat inconsistent ways. Land, it was said, is a thing which "man cannot make," therefore its supply is fixed. The second part of the opening proposition expresses the view here held: the supply of no important class of goods is absolutely fixed, in any reasonable sense. Most, if not all, belong to the class that is increasable, although it may be with much difficulty. Even when the exact thing cannot be duplicated, as a bust by an ancient sculptor or an autograph of a dead author, many substitutes serving the same or closely related wants, affect and limit the demand, and thus increase the supply. Men cannot, it is true, increase the stores of copper in the earth, but they devise new processes to extract it from ores before worthless, and invent methods of procuring aluminium, which yields some of the same utilities as copper. Even the supply of land, as is shown elsewhere, is constantly changing. Thus all kinds of wealth can be increased in some degree; many kinds in the course of time are very greatly increased with little or no direct effort, but the supply of all alike can be secured in larger amount at any given moment only at the cost of increasing difficulty.
§ II. SOCIAL SIGNIFICANCE OF THESE DIFFERENCES
1. Not the fixity of the physical amount of agents, but the economic supply is significant. There is danger of confusion between these two ideas. The statement that "land" cannot be created and that therefore "the supply is fixed" involves a fallacy. The word supply means the amount that is available at the moment or during the period spoken of. The land in Greenland is not, and probably never can be, a part of the supply of land in England. The land in America for centuries was not, but now has become, for some purposes, a part of the supply in the same market as the land of England. The question of importance in economic discussion is not whether the physical material can be brought into existence, but whether the economic "supply" can be increased. The existence of coal-mines in Venus or Mars is of no economic importance to us, but coal-mines on the earth, yet undiscovered, present a potential supply that at any moment may be realized.
2. Discovery of new lands and of new natural deposits continually enlarges the economic supply of the agents most nearly fixed in physical amount. This proposition states a historical fact. Any explanation of the economic occurrences of the last five centuries or of the immediate future, that ignores this fact of the increasing supply of many kinds of land and natural resources in the markets of the civilized world, must lead to false conclusions. The rate of this movement has been more rapid in the past century than theretofore, and perhaps more rapid than it will be henceforward; but that this development will continue in large measure and for a long period, is not open to question. Undeveloped areas will be opened to the world, and new geologic realms will be explored. Yet the notion criticized above is found in all the older text-books. The idea arose in England in the first quarter of the nineteenth century when land and food were rapidly rising in price, and it has vitiated a large part of both the economic theory and the practical conclusions on this subject.
3. Invention, including new modes of transportation and new processes, increases the economic supply of most scarce goods and provides substitutes for the others. Some inventions increase economic supply by making available the uses in goods that were before unavailable. Subsoil ploughing annexes to agricultural land new layers of soil that are just as important as new acres added to the surface. If land could be used three times as deep, it would be as good for many purposes as if it were of three times the extent. New trade routes and new means of transportation add to the supplies available in the older countries as effectively as if their areas were increased. The building of railroads in western America had an effect on English rents identical in nature with that which would have been produced had an equal area of somewhat less fertile land touching England, risen out of the ocean. Every country in Europe has repeatedly felt the shock of these great economic changes which have compelled the recapitalization on a lower plane, of nearly all kinds of their landed wealth. Where the same agents have not been multiplied, substitutes have been found that are just as effective in meeting the economic need. It is the result, the gratification, that man seeks: any particular good is but the means to an end.
4. Increasing wealth and new labor make possible the increase of the agents that appear most nearly fixed in supply. When the need arises men turn to new enterprises. The reclaiming of land in Holland is a striking but far from isolated example. Among the larger undertakings of this kind are the draining of the Haarlem Lake in 1840-58, by which 40,000 acres of rich land were made available, and the draining of the Zuyder Zee, which is adding 1,300,000 acres. Though there have been many minor undertakings of the kind, the area reclaimed is relatively small compared with the whole area of the land in the world used for agricultural purposes. There are still great areas of fens, swamps, and marshlands, such as those on the Jersey coast in this country, which with moderate effort could be reclaimed. While the possibility must be recognized, the increase of the area of available agricultural land by means of such physical changes is relatively small.
The work of the pioneer, as a producer of a supply of land, is, however, of the greatest importance. The pioneer annexes new areas to the economic world and to the market in which he has lived. This is recognized of late by writers that perhaps do not fully mark its significance to economic theory. The work of the explorer and prospector is that of a producer of mineral resources, and daily market quotations reflect the changes in "the supply" of these natural stores.
5. Limitation of the supply appears first in the better qualities, and efforts to increase wealth are then directed to making available the poorer grades. Great quantities of the poorer grades of wealth, even of those things that are relatively fixed in supply, lie unused. Great areas on the edge of civilization still await the pioneer, the prospector, and the miner. Here is a source of wealth and a field for enterprise. The growth of society may cause some of the poorer agents in time to become the best. When men crossed the ocean to settle on Manhattan Island, it was a wilderness; but the growth of commerce has caused the land in New York city to become more valuable than that in London. Changes are still in progress, for of late the smaller ports to the south have increased their trade at a more rapid pace than New York has.
The difference in increasableness of the various forms of wealth is of importance in considering various social questions such as the effects of an increase of population, and the kinds of taxation most equitable and most favorable to the progress of society. Account must be taken of the fact that the number of bricks can be increased more easily than the amount of land; but there must not be overlooked the possibility of increase in any of these forms of wealth, nor the limits to the increase of any one of them. When one wishes to save or increase wealth, he turns to these great unappropriated fields, unused things or things imperfectly used, and tries to convert them into effective agents. The different forms of wealth may be ranged on a scale according to the ease with which they can be increased by effort. They may therefore be classed as relatively fixed and relatively increasable. Some natural resources belong at one end, and some at the other end of this scale. No hard and fast line divides the different kinds of goods, but the difference in degree of increasableness is a fact of great social importance, affecting the direction in which industry can and must progress.
CHAPTER 19
SAVING AND PRODUCTION AS AFFECTED BY THE RATE OF INTEREST
§ I. SAVING AS AFFECTED BY THE INTEREST RATE
1. In the case of consumption goods, present marginal uses are often less than future uses as judged at the present. The proposition that future goods sometimes have a greater instead of a less value than present goods may at first seem to deny the general fact of economic interest, which is a premium on present over future goods. The contradiction is only apparent, however, and the proposition is merely a proper interpretation of the theory of interest. The assertion that present goods have greater value than future goods, as we have accepted it, requires two explanations. First, it means that this difference exists when the two are judged and compared at the present moment. The future use when it matures may be much greater than the present use; indeed, the very existence of interest depends upon this surplus of value arising by the lapse of time in the future use. Secondly, the proposition does not mean that every concrete good, or every use of the goods, is worth more in the present than in the future; it means merely that the demand for present goods preponderates so that a market rate in favor of present possession prevails. In a great many cases a particular good may have a greater value to be kept for the future than to be used at present, in which case it is kept, or it is exchanged for something else having a higher value in the present. But this preference of the future over the present cannot pass a moderate limit without condemning the person to present misery, and at length to death. On the other hand the excessive preference of present over future would lead to the using up and wearing out of wealth, to the present enjoyment of every possible resource, on the penalty of future misery. Evidently somewhere between these two extremes there must be, in each economy, a ratio of exchange between present and future, which in fact is the interest rate. This rate applied to utilities traces through each good a line analagous to the isothermal line on the map, marking off a zone of utilities for the present and other zones for each period of the future. There is thus a close relation between saving and the rate of time-discount.
Let us illustrate by the case of fruit stored in the cellar for future use. In the fall after the appetite for apples has been gratified up to a certain point, there still remains a large stock which affords less gratification if consumed at once than if kept for a time. Thus wood, food, and clothing are stored in the summer for the winter's need. Even the animals act on this principle. Squirrels, bees, and ants store up in the season of superfluity for the season of scarcity. The animals recognize with their feeble intelligence or by instinct, that a time will come when these consumption goods will represent greater importance to their welfare than they do at the moment. It results from the nature of wants and the principle of diminishing utility that in many cases some portion of a large supply of present goods must be worth less now than at a future time. This part, the marginal, less necessary part, will be left for a future time, and it is to this part that our opening proposition refers. This is roughly illustrated by the diagram.
Things that cannot be kept, perishable goods, do not permit of this comparison. But if goods that can be kept continue to be used after utility has fallen down the scale, their high value for the future is cast away. Man lives not alone in the present but, in a far greater measure than do any animals, he lives in the future also. His economic life and his economic judgment comprehend a great number of periods at once. With the aid of memory and imagination he forecasts the future, and compares it with the present. The diminishing utility of goods, therefore, is modified by this fact that a thing has want-gratifying power at different periods. Before man uses goods for an inferior purpose he will ask whether, if they are kept for the future, they will not gratify a greater want.
2. The gradual rise of a consumption good with the lapse of time from the lower to the higher degree of gratification is the rent it yields. The difference in value of present and future rents is expressed by the discount of the future use when it is capitalized at any earlier moment, and emerges in the rise in value as the thing approaches to the time when it can render the later use. Next year the unit whose use is deferred will afford as much gratification as the earlier units do now, and more than if used at the present moment. The importance of any present utility is compared with its importance a year later, plus interest at a rate which expresses the limit to which future uses are discounted. Anything that makes men feel more the importance of future uses causes them to value those uses more. But the pressure of present want is such that a present use of a lower order competes with a future use of a higher order. Only goods of a lower order, nearer the margin, are reserved for the future. But just as the possibility of using a thing for several different purposes at present causes it to be valued more highly than if it had but one use, so the possibility of reserving to the future a portion of a stock imparts to every unit a higher marginal utility.
3. The saving of present goods for future use is encouraged by the motive of gaining the interest. Many consumption goods grow into higher uses in the hands of the owner, whether he uses them for himself or not. Ice may be stored in midwinter when it is all but a free good and a little labor serves to fill the ice-house. Kept until the summer months, the ice rises in value as the desire for it grows. Likewise the higher price secured by the owner of a thing kept for sale to others, reflects the change in utility, and affords practically a rent which is the motive for investing capital in that business. Any saver or abstainer puts aside present wants only when the future good, with the addition of time-value or of money interest, appears as large as the present good. Interest is therefore the equalizer of the value of things in different periods. Put into the scale of judgment when present and future are compared, it helps to balance the disparity in the gratifications given by economic goods in different periods of time.
4. The postponement of present wants results in bettering the economic environment for the future. Economic environment means simply the economic conditions in which men live, the stock of wealth, the supply of useful things with which they are surrounded. This betterment may be only temporary, only for the immediate future. Like the busy bee or the prudent ant, one may in summer store the cellar with consumption goods to be consumed the following winter. But often there is a more lasting way of improving the economic environment by converting savings into durable indirect agents. The accumulation of wealth that will yield its fruits only after years of growth is the record, so to speak, of the successful competition of forethought with present desires. It means that the two periods have presented their respective claims and that men have decided in favor of the future. Saving thus lifts society from poverty to wealth by the progressive enlargement of the sources of future utilities.
5. Abstinence is the faculty of mind that enables present wants to be subordinated to future wants. Abstinence may be considered as a quality, or faculty, of the mind, or as an act resulting from that quality. There is little danger of confusion in this usage, but it is well to note the distinction and the fact that the former is the primary meaning. Abstinence expresses an act of the will, a choice made by man. It is the guardian of the future, so to speak, against the greediness of the present. For convenience we may speak of conservative abstinence as that which keeps men from using up or invading their present stock of resources, and of cumulative abstinence as that which impels them to add to that stock. There is no sharp dividing line, no abrupt break, between these two, yet on the whole they differ. There is a quality of mind very like the inertia or momentum of physical matter. The inertia of mind makes men resist stubbornly the reduction of wealth and of inherited social position; but it requires a more positive quality of mind to add to wealth at the cost of present sacrifice. Abstinence is embodied in individuals, never elsewhere, and is found in most varying degrees of strength. Upon it depends the growth and betterment of man's environment.
§ II. CONDITIONS FAVORABLE TO SAVING
1. Political security and domestic order are essential to the development of saving. As saving results from a comparison of the future with the present, any lack of certainty regarding the future decreases the appeal it makes. Men employ roughly the theory of probabilities in this matter, and count a utility only half as much when there is but one chance in two of enjoying it. In countries where there are constant revolutions and border wars, as in Africa and South America, and in lands where brigandage is common, as in Italy, Macedonia, and Bulgaria, the motive for saving is cut in two. Oppressive and irregular taxation kills the motives of providence, and decreases the appeal made by the future. While the miserable subjects of the state live from hand to mouth, the very sources of the public revenue disappear. Improvidence grows upon such a people into a prevailing national custom; ambition is wanting; industry is the sport of chance; economic order and economic prosperity are impossible.
2. Social institutions that give a motive to the individual are essential to saving. Among these institutions the most important are the family and, closely connected with it, the institution of private property which, in its ideal manifestation, places the responsibility for economic welfare on the individual or the family. Through it the state says to men: "Save if you will; the wealth and its fruits shall be yours. But if you spend and consume all you can, you alone will suffer the consequences." It is true that the institution of private property never is found in an ideal form. Dishonest public officials weaken and defeat its benefits. Every propertyless family marks a failure in its purpose. Private property is a favorite object of attack by social reformers, but it never can be safely abolished in a civilized state until some other incentive is provided, equally effective to make men subordinate present desires to future welfare. Unless the mass of men can be greatly changed, property creates the only motive that can induce saving regularly and on a large scale. It diffuses responsibility for present consumption. It multiplies the motives for abstinence and thus increases the welfare of all economic society.
3. Opportunity for the investment of small savings favors a spirit of abstinence. The institution of small property, peasant proprietorship, worked powerfully in this direction in many parts of Europe, and the same effects have resulted in America from the wide diffusion of property in land. If the decline in the number of small independent farmers has somewhat weakened this influence in America, in other ways other agencies are effectively performing the same functions. Savings-banks, penny banks, building and loan associations, penny-provident funds, and other convenient means of investing small sums, encourage men to reduce their tobacco bills, their candy bills, their saloon bills, and to lay aside for the winter's coal, for the children's education, for houses, for business investments, or for old age. Probably no one thing has given a greater stimulus to saving than has the development of insurance and the endowment policies in connection with it. While the great modern corporations have destroyed many of the small business enterprises into which so much of the saving of the past was put, at the same time the increase of negotiable paper, of loans, and of stock in joint-stock companies, has opened up other large fields for investors.
4. Variations in the rate of discount of the future react upon the spirit of saving in various ways. This very general proposition requires more detailed discussion. In general, a high rate of interest gives a large motive to save, for as the discount on the future is large, so is the reward for waiting. But this favoring motive may be offset by other unfavorable conditions, and is, in fact, wherever the high rate continues. In countries backward economically, where war, brigandage, and political oppression prevail, the rate of interest is frequently ten and twelve per cent. on the best secured loans. A high interest rate does not of itself insure a high degree of cumulative abstinence; it is only one of several factors. But in a new and favored country like America, a high rate of interest is a strong stimulus to saving. Again, interest may fall while saving continues at the same or a greater pace. Ordinarily a fall from six per cent. to five, giving men a smaller motive for abstinence, would be expected to cause less saving, yet this is not always the case. Custom and example help to fix a habit of saving in individuals and cause them to continue saving at a lower rate of interest. With the growth of wealth, the prevailing ideas as to the amount needed for a competence change, impelling to greater saving. The tendency, however, of a fall in the rate of interest is to weaken, and that of a rise of the rate, other things being equal, is to strengthen the motive to save. But the influence of the interest rate on saving is relative to the character of men.
§ III. INFLUENCE OF THE INTEREST RATE ON METHODS OF PRODUCTION
1. The individual saver is enabled to improve the agents that he uses. The simplest case is presented when means of enjoyment are improved and made more durable. If Crusoe on his island spends less time and fewer resources on gratifying his immediate wants, he may improve the quality of his clothing and the convenience of his house and furniture. By thus putting his consumption goods into durable instead of temporary forms, he will increase eventually the sum of utilities enjoyed. Again, abstinence permits the tools of the laborer to be made more convenient. If the farmer spends less time in the garden and he and his family live on plainer food, while he makes a plow, mends a rake, and builds a shed, he will be enabled thereafter to gather a greater crop with less effort.
2. Consumption goods, when saved, may be exchanged for services, and these may be used to create durable agents. Various ways are open to one wishing to increase his stock of durable agents. He may forego seeking immediate enjoyments while he makes durable agents himself. Or he may make and save a stock of consumption goods, a surplus supply for the future, and exchange it for durable agents. Finally, one who has accumulated consumption goods can always exchange them for the services of those seeking subsistence and enjoyment; and thus in control of a labor force, he can direct it toward the production of new forms of productive agents.
3. In modern industry, saving frequently takes the form of money, which is then loaned to productive borrowers. This is the typical form of saving in modern industry. As it is more and more the case that income takes first the form of money, saving most conveniently takes the money form. The clerk on a salary of $60 a month spends $50 and saves $10 which he lends to a neighbor or deposits in a savings-bank. The borrower is thus empowered to increase his stock of productive agents in the measure that the lender has limited his consumption. The complexity of the process by which money saving becomes embodied through a money loan in new productive agents should not blind to its real nature. The money is saved as a means to the exchange of present goods for future income. Money even in our day is occasionally stored away for future use under hearthstones or in old stockings and hollow trees, but this is a primitive and wasteful method, involving the loss of all the additional rents that its exchange and investment would yield.
If the money saved by the thrifty saver is loaned to a thriftless borrower, wealth is not increased, but merely changes hands. The prodigal mortgaging his wealth, spending the money, and living beyond his income, absorbs the savings of the other. One saves and adds to wealth, the other consumes it. There is no net increase of goods, but two individuals have shifted positions; each has gotten his reward of growing affluence or penury.
The "normal" end, however, of savings and loans is productive. The borrower, in getting control of purchasing power, aims to put a new machine where it will be useful, to remove obstacles, and to make economic agents more effective. Along the border-land of industry the active and alert borrower seeks out opportunities to make new agents earn a rental, and having found the opening, turns to the money market for the means to profit by it.
4. A fall in the rate of interest normally accompanies an increase in the mass, efficiency, and valuation of durable economic agents. A lower rate of interest means a higher capitalization of all incomes. It is not that either can be called the cause of the other; rather both are aspects of the same thing, the interest rate merely registering the change in capitalization. If the rate of interest has been five per cent., an income of $100 has been capitalized at $2000. When the rate falls to four per cent. the income is recapitalized at $2500. All along the line of investment there is an increase in the value of the durable economic agents.
Another phase of the change is the greater complexity of the processes of industry. Production becomes technically more complex when interest falls. Rental, product, and present goods, bear a smaller ratio to the value of capital, and therefore it becomes advantageous to apply newly formed capital to uses which before did not justify the investment. Where formerly the utility of a second tool did not justify its making, now it can be made to earn the smaller rental needed to balance its capital value. One form, therefore, which the change takes, is a multiplication of the tools already used. Things are placed wherever most convenient. Another form this change takes is the putting of new links into the chain of technical production. Cost of operation constantly is compared with fixed charges, the interest with the capital investment. Expensive improvements on railroads, the straightening of curves, the tunneling of mountains, the reducing of grades, the replacement of lighter by heavier rails, have been made possible by a fall in the rate of interest. A fall in the rate of interest disturbs the equilibrium that has been arrived at, between the cost of operation, the amount paid for wages, coal, etc., and the income on permanent investment. If the rate of interest has been five per cent. and falls to four per cent. many permanent improvements before unwise become economical. One thousand dollars paid annually in wages then balanced an interest charge on a capital investment of $20,000; now it balances the interest charge on $25,000. It becomes a paying thing for the railroad to abandon or throw aside an enormous capital represented by the old, less perfect roadbed, and build a new one alongside of it. The changes of this kind one sees in traveling on the great and progressive railroads, reflect in part the growth of traffic, but in part also a change of the interest rate, making it a net saving to increase the capital investment in order to reduce the cost of operation per unit of traffic.