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.

Money borrowed to buy consumption goods.

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.

Money borrowed to buy indirect agents.

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.

The special case of money borrowed to pay debts.

Productive borrowers seek a profit on their investments.

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 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, etc, 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 a larger set of facts - those, indeed, which determine in the long run the rate of capitalization in the community.

The developed market for money loans.

Every person is a buyer or a seller of present goods.

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.

Questions On Chapter 16. Interest On Money Loans

1. Some money-lenders in cities get 10% a day from fruit-vendors for the advance of small sums of money, and the losses are very slight. Pawnbroking pays frequently 25 to 100% per year. In these cases what affects the rate of interest?

2. Through what agency does the Western farmer borrow Eastern capital?

3. How do Englishmen invest in American railroads?

4. In what ways can a lender collect a high rate of interest without appearing to do so?

5. What would be the effect upon the rate of interest in a new state if it passed a law preventing the collection of loans by outside lenders?

6. Why has interest been about 10%in the West, 1% in the Central States, 5% in New York, 4%in Germany?

7. What is the money market? Who are the buyers and sellers, and what do they buy and sell?

8. In a panic, interest rises on short loans and prices fall, while it is almost impossible to borrow money; does this show that the amount of money determines the interest rate?

9. When gold is leaving England, the bank raises the rate of discount (interest); does this show that the quantity of money determines the rate of interest?