§ 10. Time-series of incomes, monetary and non-monetary. Before ever a money-loan was made, before even money had come into existence in the world, time-preference existed. It lies in the very nature of choice by animals and by savages. (See Chapter 20, section 2.) In many ways it is interwoven into the valuations of every self-sufficing economy in the days of barter. It becomes generalized as a prevailing rate in each individual's economy and as a price for timeliness in all exchanges of goods and uses of different time-periods. The rate becomes equalized as between different series of uses, as the rate of time-preference and of time-price can not consistently be greatly unequal within any circle where time-choice is possible.7 The use of money in trade gave much greater exactness to this time-price as embodied in goods and to their prices in relation to the times of their use. To-day in the innumerable valuations of many business enterprises where there is no monetary borrowing and lending time-preference expresses itself in the capitalization (price) of the durative agents of the environment. Every loan of money (or of goods in terms of money) at interest therefore occurs where the price of goods already embodies this premium on the present possession. Indeed it is simply this which would give a borrower a motive for a new loan. Here are many different agents and many series of yields, the price of all of them expressed in terms of the money unit (let us say the dollar). The money prices involve the rate of premium on present valuations (and correspondingly a discount on future prices).

7 This approximation to a common rate of yield on various investments may be illustrated by some such table as the following, showing the choices that present themselves to an investor.

$100 capital invested will buy net incomes of as many dollars as the rate per cent.

   

Yield in Money Terms.

 

Form of Investment

Present price

1st

yr.

2d

yr.

3d

yr.

4th yr.

In perpetuity

Rate of income

House and lot .........

$1,800

100

100

100

100

100

5.55%

Farm and buildings.

5,000

250

250

250

250

250

5.00%

Horse ...........

200

12

12

12

212

...

6.00%

Cow .................

100

15

15

10

81

•..

6.00%

Agricultural products

1,000

1,070

• • •

■ • •

• ■ •

. . .

7.00%

Dollars ...............

1,000

50

50

50

50

50

5.00%

§11. Present dollars and what they can buy. A present dollar is purchasing power that gives possession of future incomes at discounted prices. The market would present itself something like the (greatly simplified) illustrative table. Whoever has a disposable dollar which he does not need or choose to use for present desires, may either buy something and hold it for the expected increase, or he may by the method of money loans lend it to another person to do the same. It matters not how the dollar happened to be disposable, whether it was stolen, or was received in payment for some other property, or is new savings from interest on other loans, or from wages, etc.; in any case the dollar gets its power of earning interest from this prevailing discount on the future, involved in prices. Because of this fact the owner of a dollar possesses an economic power which he can assign by contract to a borrower. Interest then might be described as the price paid by a borrower for the right to buy goods at discounted prices. Money is a generalized present good, and when loaned at interest is exchanged for the promise of future goods at a ratio reflecting prevailing capitalization.

§ 12. Blending of the investment premiums into a common rate. Now given the existence of these parallel series of time-prices in different lines of agents and products, it follows that they must, so far as exchange takes place among men, tend to embody a common rate. Aside from differences in the difficulty of keeping, ease of management, etc., all these series must, by the law of substitution, be leveled toward a common rate of income. This would include money also, for in its function as a medium of exchange, money will be spent always for the thing which at the moment has the highest value. In the hands of an investor buying money incomes, the money will be spent in the way to buy (other things equal, trouble, risk, etc.) the largest net income. Therefore, the bidding of investors for whichever income is offered at the lowest capitalization tends to level (up or down) the investment-power of a dollar in all the options of present goods offered. The different choices blend, in a variety of ways, into the common rate of which the interest rate is the superficial expression. As happens in the exchange of commodities, the individual valuations vary from the market-price - as a result of different circumstances of age, health, ability for business and liking for it, particular tastes inclining to this or that business, etc. This variation of values from market-price leads men to become borrowers or lenders, in this or that line of investment. The individual takes the market-rate as a fact, and adjusts his own conduct to it.8 Money being at the same time the medium of exchange, the common denominator of prices and the standard of deferred payments, is the unit in which all these valuations are expressed. In one form preeminently, the interest contract, the rate of time-preference comes to a definite arithmetic expression. The rate of interest sometimes appears to be the determining factor, whereas it is but the reflection of the choice of timeliness in the whole economic situation.

§ 13. Indicative nature of the interest rate. We have now before us the broad outlines of the theories of time-value, of capitalization, and of the rate of interest on money-loans. We understand how these are but aspects of the same problem, and how the market-rate of interest (after due allowance for risk and other deductions) registers a prevailing price for timeliness, which pervades the whole economic structure of society. Money is the unit in which capital and interest are expressed, but money is no more their cause than the hands of the clock are the cause of the time of day. And the rate of interest is no more the cause of time-preference than the shadow on the sun dial is the cause of the rotation of the earth on its axis. The interest-rate is but an index of the ratio inherent in the equilibrium of psychological forces, desires for present and future incomes; that is, time-preference. A change in the mental habits, in regard to this choice, on the part of any considerable number of men, must change the general distribution in time of the entire series of incomes under the control of men, collectively. Future incomes are maintained only through the constant exercise of the faculty of abstinence. This conserving and dynamic influence of abstinence we shall study further in Chapter 38.

8 This aspect of the case is given further attention in ch. 27, sec. 7, 8.