CHAPTER V

INTEREST ON CAPITAL

PRELIMINARY REMARKS

AFTER mature consideration I submit for the second time the theory of interest which I originally published in the first edition of this book, unaltered apart from quite unimportant verbal changes. To all objections which have come to my attention my only answer is to refer to the original text. They have merely induced me not to shorten it further. Otherwise I should have been glad to have done so. But since the things which seem to me most prolix and labored, and which impair the simplicity and cogency of the argument, anticipated correctly the most important objections, they have acquired a right to existence which they perhaps did not have originally.

In particular the previous exposition made it so clear that I do not deny that interest is a normal element of the modern economy — which would indeed be absurd — but on the contrary try to explain it, that I can hardly understand the assertion that I denied it. Interest is a premium on present over future purchasing power. This premium has several causes. Many of them constitute no problem. Interest on consumptive loans is a case in point. That anyone in unexpected distress (for example, if fire destroys a business) or in expectation of a future increase in income (for example, if a student is heir to a well disposed aunt of tender health) values a hundred present more highly than a hundred future marks requires no explanation, and it is self-evident that interest may exist in such cases. All categories of government credit requirements belong here. There have always been such cases of interest, and obviously they could also exist in the circular flow in which there is no development. But they do not constitute the great social phenomenon that needs explaining. This consists of interest on productive loans (Produktivzins). It is to be found everywhere in the capitalist system and not only where it originates, that is in new enterprises. I merely want to show that productive interest has its source in profits, that it is by nature an offshoot of the latter, and that it, like that which I call the “interest aspect” of returns, spreads from the profits incident to the successful carrying out of new combinations over the whole economic system and even forces its way into the sphere of old businesses, in whose life it would not be a necessary element if there were no development. This is all I mean by the statement: “the 'static' economy knows no productive interest” — which is certainly fundamental to our insight into the structure and workings of capitalism. And is it not almost self-evident in the last analysis? No one can deny that just as the business situation decides the movement of the rate of interest — and business situation means normally, that is to say, neglecting the effects of non-economic forces, simply the existing tempo of development — so the money required for innovations constitutes the chief factor in the industrial demand on the money market. Is it such a great step from this to the recognition that the chief real factor is also the fundamental theoretical factor, by which alone the other source of demand is brought into play, while the latter — that is the demand of the old businesses in the tested, continually repeated round — would normally not have to come into the money market at all, because old businesses are adequately financed by the current return from production? From this the rest follows — especially the theorem that interest attaches to money and not to goods.

I am concerned with the truth and not with the originality of my theory. In particular I willingly base it upon that of Böhm-Bawerk as much as possible — however decidedly the latter has declined all communion. From his point of view too it must be a question of purchasing power in the first place, even though he immediately passes to the premium on present goods. Actually, of the famous three reasons upon which he bases the value premium on present purchasing power, I reject only one: the “discounting” of future enjoyments, so far as Böhm-Bawerk asks us to accept it as a cause not itself requiring any explanation. On the other hand I could claim that reason which he calls the changing relation between wants and means of satisfaction, as a formula into which to fit my theory. And what of the third, the “roundabout methods of production”? If Böhm-Bawerk had kept strictly to his expression “adoption of roundabout methods of production” and if he had followed the indication which it contains, this would be an entrepreneurial act — one of the many subordinate cases of my concept of carrying out new combinations. He did not do this; and I believe it can be shown with the help of his own analysis that no net income would flow from the mere repetition of roundabout methods of production which have already been carried out and incorporated in the circular flow. A point soon comes at which our explanation enters upon a fundamentally different course. However, our analysis fulfils the requirements of Böhm-Bawerk's theory of value throughout, and at no point is it exposed to any of Böhm-Bawerk's objections so far advanced.1

§ 1. Interest on capital, so experience teaches us, is a permanent net income that flows to a definite category of individuals. From where, and why? First there is the question of the source of this stream of goods: in order that it may flow, a value, out of which it may come, must first of all exist.2 Secondly there is the question of the reason why this value becomes the spoils of these particular individuals: the question of the cause of this current in the world of goods. Finally there is by far the most difficult question, which may be described as the central problem of interest on capital: how does it happen that this stream of goods flows permanently, that interest is a net income which one may consume without impairing one's economic position?

The existence of interest constitutes a problem because we know that in the normal circular flow the whole value product must be imputed to the original productive factors, that is to the services of labor and land; hence the whole receipts from production must be divided between workers and landowners and there can be no permanent net income other than wages and rent. Competition on the one hand and imputation on the other must annihilate any surplus of receipts over outlays, any excess of the value of the product over the value of the services of labor and land embodied in it. The value of the original means of production must attach itself with the faithfulness of a shadow to the value of the product, and could not allow the slightest permanent gap between the two to exist.3 But interest is a fact. What now?

This dilemma is difficult, much worse than the analogous one which was relatively easily overcome in the case of profits because there it was only a question of temporary, not of permanent, streams of goods, and consequently we did not come so sharply into conflict with the fundamental and undoubted facts of competition and imputation; on the contrary we could safely draw the conclusion that the services of labor and land are the only sources of income whose net return is not reduced to zero by those facts. In the face of this dilemma we may proceed in two different ways.

First, it may be accepted. It then appears that interest must be explained as a kind of wages or rent, and since the latter is not feasible, then as wages: as the spoliation of wage-earners (the theory of exploitation), as the wages of the labor of capitalists (labor theory in the literal meaning), or as the wages of the labor embodied in the instruments of production and raw materials (the conception for example of James Mill and McCulloch). All three efforts at explanation have been made. To Böhm-Bawerk's critique I have only to add that our analysis of the entrepreneur, especially his isolation from the means of production, also cuts part of the ground from under the feet of the first two variants.

Secondly, the theoretical conclusion which leads to the dilemma may be denied. Here again we may either extend the list of costs, that is assert that with wages and rent all necessary means of production are not yet paid, or search in the mechanism of imputation and competition for a hidden brake which permanently prevents the values of the services of labor and land from reaching the height of the value of the product, so that a permanent value surplus is left over.4 I turn to the cursory discussion of these two possibilities.

Extending the list of costs means in this sense not merely asserting that interest represents a regular expenditure in the accounts of a business. This would be self-evident and would have no explanatory force. It means much more, namely conceiving interest as an element of cost in the narrower and special sense which was formulated in the first chapter. This is equivalent to constituting a third original productive factor, which bears interest as labor receives wages. If this were satisfactorily achieved, our three questions, the question of the source, of the basis, and of the non-disappearance of interest, would obviously all be answered at once, and the dilemma would be escaped. Abstinence might be such a third factor. If it were an independent productive service all our requirements would be fulfilled in a manner free from objection, and the existence and source of a permanent net income as well as its assignment to definite individuals would be explained beyond doubt. Only it would still have to be proved that in reality interest does rest upon this element. But unfortunately this explanation is not satisfactory, because such an independent element does not exist, as has already been shown by Böhm-Bawerk, and need not be further discussed here.

Produced means of production might also be constituted a third productive factor independent of abstinence. With them it is the other way round. There can be no doubt about their productive effect. It is so clear, that the investigator's glance very soon fell upon it, and that to-day the fundamental proposition of the equality between the value of the product and of the services of labor and land still excites astonishment. It is so clear that even to-day it is still extremely difficult, as experience teaches, to divert even specialists from this wrong track. Yet it does not explain a permanent net income. To be sure, produced means of production have the capacity of serving in the production of goods. More goods may be produced with than without them. And these goods also have a higher value than those which could be produced without the produced means of production.5 But this higher value must also lead to a higher value of these instruments of production, and this again to a higher value of the services of labor and land employed. No element of surplus value can remain permanently attached to these intermediate means of production. For, on the one hand, no discrepancy can exist permanently between the value of the products to be imputed to them and their own value. However many products a machine may help to produce, competition must always lower their price until equality is established. On the other hand, however much more than hand labor the machine may do, once introduced it does not continually save labor anew, so that it does not continually yield a new profit. The extra receipts due to it which are so conspicuous, the whole sum which the “user” is ready to pay for it, must be handed over to workers and landowners. In general it does not produce the value which it adds to the product, as is often naively 6 assumed, but the latter is only temporarily associated with it, as was argued in the previous chapter. A coat containing a bank-note has indeed, as long as this is the case, a correspondingly higher value for its owner, but it only received this higher value from outside and did not produce it. Similarly a machine has a value corresponding to its product, but has only received7 it from the services of labor and land which existed before it was created, to which the value has already been imputed as a whole. It is true that a stream of goods flows to the machine, but it also flows through it. At this point it is not dammed to form a reservoir for consumption. The possessor of the machine does not permanently get more than he must pay out, either by value or by price accounting. The machine itself is a product, and therefore just like a consumption good its value is conducted on to a reservoir, from which no interest can flow any more.

Hence on the basis of the arguments in the first and fourth chapters and of the reference to Böhm-Bawerk we can state that the above opens up no way out of the dilemma and that no source of value at all exists here for the payment of interest. At the most a difficulty occurs in the case of goods which are said to increase “automatically” — for example seed-corn or cattle used in breeding. Do not the latter ensure to their owner more corn or more cattle in the future, and must not the more corn and the more cattle be more valuable than the original seed-corn and cattle? Everyone to whom these ideas are familiar knows how firmly most people are convinced that they are proof of the existence of an increase in value. But seed-corn and breeding cattle do not increase “automatically”; on the contrary, well known items of expenditure must be deducted from their “return.” However, it is decisive that even the residue left over after this deduction represents no gain in value — for the crop and the herds are certainly dependent upon seed-corn and breeding cattle, and the latter must therefore be valued according to the values of the former. If seed-corn and breeding cattle were sold, then (assuming no substitution is possible) the value of crop and herd, after deducting costs still to be incurred and making allowance for risk, would be fully expressed in their price. Their price would be equal to the price of the product imputed to them. And corn and animals would be employed in reproduction until their employment no longer yielded a profit and their price only just covered the necessary expenditure in wages and rent. The marginal utility of “their” product, that is of the share of the product imputed to them, would consequently tend towards zero.

§ 2. Here I should like to observe that it is not correct, or rather not expedient — it means committing oneself to a definite view — to characterise the state of affairs represented in this stage of our argument as follows: “We cannot explain the gap between value of product and value of means of production in this way. But it actually exists. And we must try to explain it otherwise.” On the contrary I deny the fundamental existence of such a permanent gap. We are faced only with an unanalysed fact, and it should rather be suspected — as I believe a glance at reality teaches us — that it is a consequence of interest on capital, which is to be explained quite differently, than that it is a primary fact independently explaining interest. Individuals may value means of production less than products because they must pay interest on the way from the former to the latter, but they do not perforce pay interest because they value the former less than the latter on other grounds. This is very important. Here I only wish to draw attention to the fact that the difficulty against which the whole of my exposition must fight is especially great in the case of interest — the difficulty, namely, that outside of certain fundamentals we have become accustomed to simply accepting a series of unanalysed facts, and instead of penetrating more deeply into the interior of things, to considering many things as elements which are complex combinations. Once this habit is acquired we proceed to further analysis only with reluctance; we are always inclined to point to such facts as to living objections. Abstinence is such a fact. The assertion that capital value is simply the capitalised value of the return is another. And because in making this assertion one always takes one's stand upon experience, the latter does not offer a sufficiently emphatic contradiction. For the time being, however, we must still retain this conception of the “gap.”

A few remarks are now necessary to formulate precisely the process of computation (Einrechnungsvorgang). Hitherto we have always spoken of the process of imputation and have traced it back from its anchoring ground in the value of the product to the services of labor and land. It might now seem that the imputation could take still another step, that it might lead the value stream still further back, namely to the labor-power and to the land themselves. Since there is no reason in an exchange economy to become conscious of a value of labor-power as such, and since if there were the same would hold true of it as for land, we shall confine ourselves to the latter, and respecting labor-power merely emphasise again that it would only present a special problem if we regarded it (which we do not) as a product of the means of subsistence of the laborer and his family. Now, one might first of all conceive the services of land as the product of land and the latter itself as the true original means of production to which imputation must sweep the value of its product. This would be logically false.8 For land is not an independent commodity, separate from its own services, but merely a bundle of these services. Therefore it is better not to speak of imputation at all in this case. For imputation involves the transference of value to goods of continually higher orders. It so operates that nowhere is a piece of value left hanging. In determining the value of land, however, something else is involved, namely the derivation of its value from the given values of the elements of which it “consists” economically, which were determined by imputation. Here it is better to speak of computation (Einrechnung).

In the case of every good, whether a consumption or a production good, these two processes are to be distinguished. Only its services have definite values, determined 9 directly by the scale of wants or indirectly by imputation, from which its value must be derived. But while the latter process is extremely simple in the case of produced goods, and through the necessity of their reproduction, which arises sooner or later, is reduced to fixed and known rules, in the case of land it is complicated by the fact that an unlimited series of uses inhere in land, which reproduce themselves automatically and in principle without cost.10 Hence the question arises, on account of which we have embarked upon this discussion: must not the value of land be infinitely great and so rent as a net income disappear through computation? I answer this question in a different way from Böhm-Bawerk.11

First, even if the value of land were infinitely great I should still describe rent as a net income. For the source of the return could not then be exhausted by consuming it and a continuous stream of goods to the landowner would be explained. The mere summation of net returns can never abrogate their character as net returns. Only imputation, never computation, annihilates a net return. Secondly, in real life, of course, the price of a piece of land is never infinitely great. However, my conception should not be reproached with leading to this infinite value, that is to an absurd result. It is not my conception that is false but the fundamental idea of the prevailing theory of capitalisation, namely that the value of income-yielding property is formed merely by the summation of appropriately discounted returns. On the contrary the determination of this value is a special, fairly complicated problem, which will be studied in this chapter. In this as in every case of valuation it is necessary to look at the concrete purpose in view. There is no rigid rule of addition here, since value quantities are mostly not simply additive. Within the normal course of the circular flow there is no reason at all to be aware of the value of land as such. It is different with a machine: every product must have a definite total value, since it is necessary in deciding the question of its reproduction. And the rule of addition applies here too. Competition enforces it. If a machine could be had for less than it produced, a profit would be made, which would necessarily raise the demand for and the price of machines; if it cost more than its employment yielded, a loss would result, which would lower the demand and the price. Land, on the other hand, is not sold in the normal circular flow, but only its uses. Therefore only their values and not the value of land as such are elements in economic planning. And the processes of the normal circular flow can teach us nothing about the determination of the value of land. Only development creates the value of land; it “capitalizes” rent, “mobilises” land. In an economic system without development the value of land would not exist at all as a general economic phenomenon. A glance at reality confirms this. For the only occasion on which there is any sense in being aware of the value of land is upon the sale of it. And actually this hardly occurs at economic stages in which economic reality most nearly approaches the conception of the circular flow. The market for trading in land is a phenomenon of development, and can only be understood from the facts of development in which alone we can find a key to this problem. For the time being we still know nothing about it. Thus, so far, we can say that our conception does not lead to an infinite value but in general to no value, that the values of the services of land are not to be related to any other values and hence are net returns. In case it is objected that incentives to sale must nevertheless arise, it must be said that these incentives must necessarily be sporadic and that personal conditions, like distress, dissipation, non-economic aims, and the like, must be deciding. Nothing else can be stated at this juncture.

Wherever the rule of addition yields an infinite value we thus speak of a net income just as in the case of wages. For our sole concern here is that a permanent stream of goods flows to an individual and that he is not required to pass them on. And the computation which yields an infinite result, far from excluding the possibility of such a stream of goods, is a symptom of its existence. This is in fact an essential element in understanding the theory of interest which is to be expounded.

§ 3. There is still a second method of escaping the “dilemma of interest.” The question of how a permanent surplus over the values of the services of labor and land is possible may also be answered by pointing to a brake on the latter. If there were such a brake then the possibility of a permanent value surplus would undoubtedly be proved, and to the circumstance which brings it about would have to be ascribed — at least from the “private” standpoint — value productivity in the fullest sense. It — or the commodity in which it is embodied — would yield a net income. A special and independent value surplus would occur in every economic process. Interest would then not be an element of cost in the real sense; it would owe its existence to a discrepancy between costs and the value or price of the product; it would be a real surplus over costs.

Such a case occurs in an exchange economy when a product is monopolised — monopolies of original productive factors do not interest us here because it is clear from the outset that interest cannot be based upon them. The monopoly position actually operates as a brake and brings the monopolist a permanent net income. We regard monopoly revenue as a net income with the same right and for the same reasons as we do rent. In this case too, the rule of addition would give an infinite result. And here also this would not deprive the revenue of the character of a net income. Why the value of the monopoly — say of a perpetual patent — is not infinite, however, does not interest us at this point; the answer will appear later. Finally, here too the determination of the value of the monopoly is a special problem, and in solving it we must not forget that in the normal circular flow no motive to form such a value exists, hence the gain is not to be related to any other magnitude. However all this may be, the monopolist can at any rate never say: “I make no profit because I ascribe an extremely high value to my monopoly.” This is sufficiently certain.

In discussing Lauderdale's theory of interest Böhm-Bawerk also comments upon the case in which a labor-saving and hence profit-yielding machine is monopolised. He emphasises rightly that this machine will be so dear that no profit, or only the minimum which will just induce people to purchase or hire it, will be connected with its employment. So much is certain. Yet a profit is undoubtedly connected with its production, which is as permanent as the patent. It might be said that the monopoly position is for the monopolist something analogous to a productive factor. Imputation takes place with reference to the “services” of this quasi-factor of production just as with reference to other factors. The machine as such is not a source of surplus value, nor are its means of production, but the monopoly makes it possible to obtain a surplus value with the machine or its means of production. Obviously nothing is changed if we allow producer and user to coincide in one person.

Hence we have a net income sui generis. If what is called interest were the same as this, all would be well. Our three questions would be satisfactorily answered. There would be a source of surplus value the existence of which would be explained by the theory of monopoly; there would also be a reason for the assignment of a return to monopolists; and finally the fact that neither imputation nor competition annihilates the return would be explained. However, such monopoly positions do not occur regularly and numerously enough for this explanation to be accepted, and moreover interest exists without them.12

Another case in which one might speak of a permanent and regular lagging of the value of the services of labor and land behind the value of the product would exist if future goods were systematically and in principle valued less than present goods. The reader knows already that this is not accepted here, but it is necessary to mention the case once more. While in all the cases treated so far a permanent source of income resulted simply from a permanent and — at least from the “private” standpoint — productive service, this case would involve something different, namely a movement in values themselves. While previously the explanation lay in the determination of the value of some productive service sui generis, here it would lie in the determination of the value of the services of labor and land on the one hand and of consumption goods on the other hand. Here there would be a surplus of the value of the product above the value of the means of production, in a narrower and truer sense than in the case of monopoly. And “surplus over costs” would ipso facto signify a net return and surplus above the “capital value” of the produced means of production. Hence it would be proved ipso facto that the return would neither disappear nor be absorbed by the process of computation. For the full value of a future product cannot be imputed and computed if, at the moment when the imputation and the determination of the value of the means of production are to be undertaken, it appears not at its real magnitude but smaller. The possibility of a permanent stream of goods would thus undoubtedly be proved, whether or not it was the interest which we observe in real life. Our first question would be answered: a source of value from which interest can flow would exist. The second question, namely why the stream of goods flows to those particular individuals, would obviously not be difficult to answer. And the third, why the return does not disappear, by far the thorniest part of the interest problem, would be superfluous. Since the value surplus would have been explained by reason of non-imputation, there would be no sense in asking why it is not imputed.

Hence if the mere passing of time had a primary effect upon valuation, and if what reality shows us to be its influence were not merely an unanalysed fact which fundamentally rests in turn upon the existence of interest, which is again to be explained on other grounds, this line of argument would be in itself quite satisfactory, even though in my opinion it brings us into many a conflict with the actual course of the economic process. Purely logically it would be free from objections. But the passing of time has not this independent primary effect. And even the growth in the value of many goods in the course of time proves nothing. Since this fact is especially prominent and has played a certain rôle in the literature of the subject, a few words may be devoted to it.

There are two kinds of such increase in value. First, the services — actual or potential — of a good may alter automatically in the course of time and the value of the good increase. A young forest and a stock of wine are examples frequently cited. What happens in such cases? Now both forest and wine certainly become more valuable goods by natural processes which demand time. However, they only grow into the higher value physically; economically this higher value already exists in the small trees of the young forest and in the wine newly cellared, because it depends upon them. These small trees and this wine must therefore so far — from the standpoint of the facts with which we are already acquainted — be exactly as valuable as the timber fit for felling and the matured wine. In so far as wood and wine may also be sold to consumers before they are quite ripe, their owners will ask themselves which of two alternatives will yield the greater return per economic period: allowing time for further ripening or selling now and producing anew. They will choose the alternative which yields the greater return, and they will value accordingly the trees and wine and the necessary services of labor and land from the very beginning. In reality this is not so. For the forest and wine continually increase in value pari passu as they approach maturity. This is due, however, fundamentally to material and personal risk, especially the risk of life, and to the fact that interest already exists, a fact which under certain conditions makes time an element of cost, as we shall soon see. If it were not for these factors there would be no such increase in value. If it is decided to let the forest and wine ripen longer than was originally intended, that can only be because it has been discovered that it is more advantageous to do so. There then occurs a new method of employing the forest and the wine, which must obviously result at the time of the decision in a rise in value. But there is in general no real, continuous growth of value with the passing of time as a primary and independent phenomenon.

Secondly, it often happens that the services of a good remain absolutely the same physically but yet in the course of time increase in value. This can only be attributable to the appearance of a new demand, and is a phenomenon of development. It is easy to see how this case is to be regarded. If the increase in demand is not foreseen, then there is a gain, but not one which constitutes a permanent increase in value. If on the contrary it is foreseen, then it must be imputed from the very beginning to the good concerned, so that again there is no increase in value. If in reality it nevertheless appears that there is, we shall explain it in the same way as in the case of the improvement of physical qualities.

§ 4. We have exhausted the most important lines of thought which might have led us out of the dilemma of interest, and with a negative result. Hence we find ourselves driven back again to those surplus values of which we have already spoken repeatedly and which we can consider as net surpluses with a clear conscience, namely surpluses of the value of products above the value of the quantities of production goods embodied in them. They owe their existence to some special circumstance which raises the value of products above the equilibrium value that the commodities in question would have in the circular flow. The character of such surpluses as a net return and as the source of a flow of goods is thereby ipso facto established just as much as it would be in the case of systematic undervaluation of future goods.

Circumstances which raise the value of a product above that of its means of production, so that with the help of the latter a profit can be made, also occur in an economy without development. Errors and windfalls, unintentional and unexpected deviations of results from expectations, conditions of distress and accidental superabundance — these and many other circumstances may produce surpluses, but this kind of deviation of actual values from normal values, and at the same time from the values of the means of production used, is of little importance. We turn to those surplus values which owe their existence to development, and which are much more interesting. We have already divided them into two main groups. The one embraces those surplus values which development carries with it of necessity, in the creation of which development consists in a sense, and which are explained by the choice of new, more advantageous, uses of producers' goods, whose values were previously determined according to other, less advantageous, uses. The second group embraces those surplus values which are based upon repercussions of development, that is upon increases, actual or anticipated, of the demand for certain goods which development brings about.

To repeat, all these surplus values are — as Böhm-Bawerk would also admit — true and real surpluses in every conceivable sense, and have nothing to fear either from the Scylla of computation or from the Charybdis of the list of costs. All streams of goods which flow to individuals under any other title than wages, rent, and monopoly revenue must directly or indirectly be due to them. Let us recall, however, the proposition already derived, that competition and the working of the general laws of valuation tend to eliminate all surpluses above costs.13 For example, if a business suddenly and unexpectedly requires machines of a certain kind the value of the latter will rise and the possessor of such machines will be assured of the surplus value, in whole or in part. But if the new demand is foreseen then it must be assumed that more of such machines have already been produced and are now supplied by competing producers. Then either no special profit will be realised at all or, if production cannot be appropriately extended, the surplus will be imputed to the natural and original productive factors, and surrendered to their owners, in accordance with well known rules. Even if the new demand is not anticipated, the economic system will finally be adjusted to it, and no permanent surplus value will be associated with the machines.

§ 5. We can now formulate five propositions of our theory of interest which follow almost automatically from the first elementary conclusion that interest is a value phenomenon and an element in price — we have this much in common with every scientific theory of interest — and which will have to be completed later by a sixth proposition.

First, interest flows essentially from the surplus values just considered. It can flow from nothing else since there are no other surpluses in the normal course of economic life. Of course this is only true for what we have called productive interest in the narrowest sense, which does not include “consumptive-productive interest.”14 For in so far as interest is only a parasite in the body of wages and rent it has clearly nothing to do directly with these surplus values. But the large, regularly flowing stream of goods on which the capitalist class lives and which flows to it in every economic period from the proceeds of production — this can only come from our surplus values. These points will be examined more closely later. Moreover, there is one surplus value which is not of this kind, namely monopoly revenue. Our thesis therefore assumes that the typical source of interest is not in monopoly revenue. This, however, as I have already said, should be sufficiently clear. Thus without development, with the qualifications mentioned, there would be no interest; it is a part of the great waves which development causes in the sea of economic values. Our thesis rests first of all upon the negative proof that the determination of value in the circular flow excludes the phenomenon of interest; this proof in turn rests first upon direct knowledge of the process which determines values and secondly upon the untenableness of various attempts to establish decisive differences between the values of products and of means of production in an economy without development. Then we have added the positive proof that such a difference in value does occur in development. The thesis will lose much of its strangeness in the course of the following discussion. It may be emphasised here at once, however, that it is not nearly so far from an unprejudiced treatment of reality as it might seem, for industrial development is certainly at least the chief source of the interest form of income.15

Secondly, surplus values in development fall, as we have seen, into two groups — entrepreneurial profit and those values which represent the “repercussions of development.” It is clear that interest cannot attach itself to the latter. We can assert this so easily because the process of creating this kind of surplus is quite clear, so that we can see immediately what is and is not there. Let us consider the example of a tradesman who, in consequence of the establishment of factories in his village, receives more than equilibrium income for a time. Thus he makes a definite profit. This profit cannot itself be interest, for it is not permanent and is soon wiped out by competition. But neither does interest flow from it — assuming that the tradesman has done nothing more in the acquisition of it than simply stand in his shop and charge higher prices to his customers — for absolutely nothing further happens to it: the tradesman pockets it and uses it as he pleases. The whole process leaves no room for the phenomenon of interest. Therefore interest must flow from entrepreneurial profit. This is an indirect conclusion to which I attach, of course, only secondary importance as compared with the other facts which support this thesis. Development, then — in some way — sweeps a part of profit to the capitalist. Interest acts as a tax upon profit.

Thirdly, however, it is obvious that neither the whole profit nor even a part of it can be directly and immediately interest, because it is only temporary. And analogously we see at once that interest does not adhere to any class of concrete goods. All surplus values adhering to concrete goods must be by nature temporary, and even though such surpluses constantly arise in an economic system in full development — so much so that it requires deeper analysis to recognise the ephemerality of any one of them — yet they cannot immediately form a permanent income. Since interest is permanent it cannot be understood simply as a surplus value from concrete goods. Although it flows from a definite class of surplus values no surplus value per se is interest.

These three propositions, that interest as a great social phenomenon is a product of development,16 that it flows from profit, and that it does not adhere to concrete goods, are the basis of our theory of interest. The admission of them puts an end to all the continually repeated attempts to find an element of value in concrete goods corresponding to interest,17 and thereby concentrates work on the problem of interest within quite a small field.

§ 6. It is now time to get the significant question more firmly in our grasp. The main question, the solution of which settles by far the most important point in the interest problem, now runs: how is this permanent stream of interest, flowing always to the same capital, extracted from the transitory, ever-changing profits? This statement of the question embodies the results so far attained and is independent of the direction in which we continue. If it is answered satisfactorily, then the interest problem is solved in a way that satisfies all the demands which Böhm-Bawerk's analysis has proved to be indispensable and — whatever its defects may otherwise be — it is not exposed to the objections fatal to previous theories.

We proceed with our fourth thesis, which differs totally from the usual theories, with the exception of the exploitation theory, and which has the weight of the most competent authority against it: in a communistic or non-exchange society in general there would be no interest as an independent value phenomenon. Obviously no interest would be paid. Obviously there would still exist the value phenomena from which interest flows in an exchange economy. But as a special value phenomenon, as an economic quantity, even as a concept, interest would not exist there; it is dependent upon the organisation of an exchange economy. Let us formulate this still more precisely. Wages and rent also would not be paid in a purely communist organisation. But the services of labor and land would still exist there, they would be valued, and their values would be a fundamental element in the economic plan. Nothing of this holds good for interest. The agent for which interest is paid simply would not exist in a communist economy. Hence it could not be the object of a valuation. And consequently there could not be a net return corresponding to the interest form of income. Thus interest is indeed an economic category — not created directly by non-economic forces — but one which only arises in an exchange economy.

Why is there no interest in a communist society, although there is in an exchange economy? This question leads us to our fifth thesis. It opens to us a first view of the nature of the suction apparatus that draws a permanent stream of goods from profits. The capitalist certainly has something to do with production. And technically, production is always the same process under whatever organisation it may occur. Technically it always requires goods and nothing but goods. Hence no difference can exist here. But elsewhere there is a difference. The entrepreneur's relation to his production goods in an exchange economy is essentially different from that of the central organ in a non-exchange community. The latter has the disposal of them directly, the former must first of all procure them by hire or purchase.

If entrepreneurs were in a position to commandeer the producers' goods which they need to carry their new plans into effect, there would still be entrepreneurs' profit, but no part of it would have to be paid out by them as interest. Nor would there be any motive for them to consider part of it as interest on the “capital” they expend. On the contrary, the whole of what they make over and above costs would be “profits” to them and nothing else. It is only because other people have command of the necessary producers' goods that entrepreneurs must call in the capitalist to help them to remove the obstacle which private property in means of production or the right to dispose freely of one's personal services puts in their way. No such help is wanted in producing within the circular flow, for firms already running can be, and in principle are, currently financed by previous receipts, which stream to them without the intervention of any distinct capitalistic agency. Hence nothing essential is obscured in the picture of the circular flow, if it is assumed that the means with which production is carried on consist of the products of preceding periods; but in the case of new combinations, entrepreneurs have no such products with which to procure means of production. Here, then, the function of capital comes in, and it becomes evident that nothing corresponding to it can exist either in a communist or even in a noncommunist but “stationary” society.

§ 7. I should like to direct the reader's attention to the fact that our conception of the interest problem involves something different from the usual conception. Although this is really obvious it will nevertheless not be superfluous to elucidate the point still more.

For this purpose I shall start from the usual distinction between interest on loans and “original” interest on capital. It reaches back to the beginning of investigations into the nature of interest, and has become one of the foundation stones of the theory. Speculation about the interest problem started as a matter of course with interest on consumptive loans. First of all, it is in the nature of things that it should start with interest on such loans because this stands out as an independent branch of income distinguished by many clear features. It is always easier to grasp conceptually a branch of income which is also externally distinguished than one which must first be cleared of an admixture of other elements — therefore rent was first clearly recognised in England where it not only existed but was also as a general rule paid separately. But interest on consumptive loans was also the starting point because it was the most important and best known form in ancient times and in the Middle Ages. Interest on productive loans was not wanting, it is true; but in classical antiquity it operated in a world which did not philosophise, while the world which did philosophise only observed economic things fleetingly and only paid attention to the interest which was to be observed in their sphere. And also later, the elements of a capitalist economy which existed were familiar only to a circle which was a world in itself and neither pondered nor wrote. The church father, the canonist, or the philosopher dependent upon the church and Aristotle — all of them only thought of interest on consumptive loans, which made itself noticeable within their horizon and indeed in a very unpleasant manner. From their contempt for the bleeding of the necessitous and the exploiting of the thoughtless or profligate, from their reaction against the pressure exerted by the usurer, arose their hostility to charging interest, and this explains the various prohibitions of interest.

Another conception grew up from observation of business life, as the capitalist economy gathered strength. It would be an exaggeration to say that interest on productive loans was positively a discovery of later authors. But in effect the emphasis upon this came to much the same as a discovery. It immediately made clear that the old conception simply ignored one part, and indeed what now was by far the most important part, of the phenomenon, and at the same time that the debtor by no means always becomes poorer by borrowing. This took the edge off the fundamental reason for the hostility to interest and led scientifically a step further. The whole English literature on interest up to Adam Smith's time is filled with the idea that a loan often leads the borrower to business profit. In the place of the weak debtor there appears in the mind of the theorist a strong debtor, in the place of the piteous crowds of distressed poor and thoughtless landowners there appears a figure of another breed, the entrepreneur — not quite clearly and boldly defined, it is true, but still plain enough. And this is the point which the theory here expounded takes up. But productive interest is still interest on loans for this group of theorists. Entrepreneurial profit is recognised as its source. However, from this it no more follows that entrepreneurial profit is simply interest than it follows that the total receipts of production are wages because these total receipts are the source of wages. If anything definite at all can be said in view of the shortness of these writers' arguments about interest, it is that they did not confound interest and profit in the least or view them as identical in character. They perceived, on the contrary, as is seen from Hume,18 the difference between the two, and were far from seeing in profit nothing more than interest on one's own capital. They explain profit in a manner which is not at all applicable to interest on loans as such, but only to another kind of profit which is the source of interest on loans.19 All these authors traced interest back to business profit as its source, but did not say that the latter itself is again only a case and indeed the principal case of interest. Their “profit” may not be translated by interest even when it occurs in the phrase “profit of capital.” They did not solve the interest problem. But it would not be correct to say that they merely traced back one derived form, interest on loans, to the original and real interest, without explaining the latter. They merely failed to prove why the creditor with his capital is in a position to exact this share of profit, why the capital market always decides in his favor. Furthermore, the central problem upon the solution of which insight into the interest phenomenon depends, certainly lies in business profit; not, however, because business profit is itself true interest, but because its existence is a prerequisite of the payment of productive interest. Finally, the entrepreneur is certainly the most important person in the whole matter; not, however, because he is the true, original, typical interest receiver, but because he is the typical interest payer.

In the case of Adam Smith we may still perceive a trace of the view according to which profit and interest do not simply coincide. Only with Ricardo and his epigoni are the two plainly synonymous. Not till then did theory come to see in business profit in general the only problem, and in fact the interest problem; not till then did the question, why does the entrepreneur obtain a business profit, become the interest problem; and finally not till then is the meaning of the English authors correctly rendered if their “profit” is translated by “profit on capital” (Kapitalgewinn) or “primary interest” (ursprunglicher Zins). This constitutes by no means merely the harmless substitution of interest on one's own capital for contractual interest on borrowed capital, but a new assertion, namely that the entrepreneur's profit is essentially interest on capital. The following facts must have contributed to what from our standpoint clearly appears as a deviation from the right path.

First of all, this statement of the question is extraordinarily obvious. Contractual agricultural rent is certainly only a consequence of the “original” phenomenon, namely of that part of the product which is “imputable” to land. It is nothing more than the latter itself, the net return of agriculture from the landlord's point of view. Contractual wages are only the consequence of the economic productivity of labor; they are simply the net return of production from the worker's point of view. Why should it be otherwise in the case of interest? Without special reason it will not be taken to be so. The conclusion, that corresponding to contractual interest there is an original interest and that the latter is just as much the typical income of the entrepreneur as rent is the typical income of the landlord, appears to be perfectly natural, almost self-evident. In practice the entrepreneur allows for interest on his own capital — this appears as an incontestable sanction if such is necessary at all.

The surplus of the value of products over their costs, then, is really the fundamental phenomenon upon which interest is also dependent. And it arises in the hands of the entrepreneur. Is it to be wondered at that only this problem was seen and that it was hoped that everything was settled with the solution of it? Economists had just wrested themselves free of mercantilist superficialities and become accustomed to looking at the concrete goods which lay behind the money veil. It was emphasised that capital consists of concrete goods, and the tendency was to constitute this capital a special productive factor. This standpoint, once taken up, leads directly to considering interest as an element in the price of stocks of goods, and hence it has simply been identified with what the entrepreneur obtains by means of these stocks. Because interest undoubtedly came from profit, and thus represented a part of profit, the latter or at any rate the better part of it became interest unawares, quite automatically at the moment when interest was connected with the concrete goods which the entrepreneur makes use of in production. That wages do not similarly become interest, because interest may be paid out of them, is a reflection that is remoter than one would think.

The unsatisfactory analysis of the entrepreneurial function contributed powerfully to make this view general. It is perhaps not quite correct to say that entrepreneur and capitalist were simply lumped together. But in any case one started from the observation that the entrepreneur can only make his profit with the aid of capital in the sense of a stock of goods, and placed an emphasis upon this observation which it does not deserve. One saw — and this was quite natural — in the employment of capital the characteristic function of the entrepreneur and distinguished him by it from the worker. He was regarded in principle as the employer of capital, the user of production goods, just as the capitalist was regarded as the provider of some kind of goods. The above statement of the question then readily suggests itself; it must appear simply as a more precise and more profound statement of the question concerning interest on loans.

This must obviously have had grave consequences for the interest problem. There was interest on loans because there was original interest and the latter arose in the hands of entrepreneurs. Thereby the whole apparatus for the solution of the problem was focussed on the entrepreneur. Now this led to a great number of false scents. Many attempts at explanation like the exploitation theory and some labor theories — as explanations of interest — became possible for the first time. For only when interest is linked with the entrepreneur can the idea arise of explaining it by his labor service or by labor contained in production goods or by the price struggle between entrepreneur and workers. Other attempts, such for example as all productivity theories, even though not made possible were nevertheless made essentially more obvious by this way of formulating the interest problem. It made a sound theory of entrepreneurs and capitalists impossible; it made the recognition of a special entrepreneurial profit difficult, and ruined the explanation of it from the outset. But by far the worst consequence of this interpretation was the creation of a problem that became a kind of economic perpetuum mobile.

Interest is, as experience teaches, a permanent income. It originates in the hands of the entrepreneur. Consequently a permanent income sui generis originates in the hands of the entrepreneur. And the question confronting the traditional theory of interest is: from where does it come? For more than a century theorists have been attacking this impossible, indeed meaningless, question.

Our position is entirely different. If traditional theory links up contractual interest with entrepreneurs' profits, it only traces the problem to what it believes to be its fundamental case, and has, after having done so, still to perform the main part of the task. If we succeed in linking up interest with entrepreneurs' profits, we shall have solved the whole problem, because entrepreneurs' profits themselves are not another case of interest, but something different from it which has been explained already. The statement that “there is interest on loans because there is a business profit” is only valuable as a more precise statement of the question for the prevailing theory; while for us it already has explanatory value. The question, but whence comes the business profit? which contains for the prevailing theory a summons to do its chief work, is for us settled. For us there remains only the question: how does interest arise from entrepreneurial profit?

It was necessary to draw the reader's attention especially to this different and narrower statement of the question in our interest problem because the objection that nothing more is done here than the reduction of interest to business profits, which theory accomplished long ago, would be particularly annoying. Thus the repeated emphasis upon things which the reader might easily have said himself is well justified. Now we shall proceed to the sixth and last proposition in our theory of interest.

§ 8. The surplus which forms the basis of interest, being a value surplus, can only emerge in a value expression. Therefore in an exchange economy it can only be expressed in the comparison of two money sums. This is self-evident, and prima facie completely uncontroversial. In particular, no comparison of quantities of goods can in itself assert anything about the existence of a value surplus. Wherever quantities of goods are spoken of in such a connection, they appear only as symbols of values. In practice the value expression is used and interest is represented in the money form alone. In any case we must accept this fact, but we can interpret it very variously. We might come to the conclusion that this appearance of interest in the form of money is merely dependent upon the necessity of a standard of value, and has nothing to do with the nature of interest. This is the prevailing view. According to it, money serves as the form of expression and nothing else, while interest on the contrary arises in goods of some kind as a surplus of the goods themselves. We take this view too in the case of entrepreneurial profit. A measure of value is also necessary to express it, and the money representation is therefore made use of as a matter of expediency. But in spite of this the nature of entrepreneurial profit has nothing at all to do with money.

Unquestionably it is extraordinarily tempting in the case of interest also to try to turn away from the element of money as quickly as possible and to carry the explanation of interest into the region where values and returns arise, namely in the realm of the production of goods. However, we cannot turn aside. It is true that in every case, corresponding to money interest, that is to the premium on purchasing power, there is a premium on goods of some kind. It is true that goods and not “money” are needed to produce in the technical sense. But if we conclude from this that money is only an intermediate link, merely of technical importance, and set about substituting for it the goods which are obtained with it and for which therefore in the last analysis interest is paid, we at once lose the ground from under our feet. Or more correctly expressed: we can indeed take a step or even a few steps away from the money basis into the world of commodities. But the road suddenly ends because these premiums on commodities are not permanent — and then we see at once that this road was wrong, for an essential characteristic of interest is that it is permanent. Therefore it is impossible to pierce the money veil in order to get to the premiums on concrete goods. If one penetrates through it one penetrates into a void.20

Thus we cannot move away from the money basis of interest. This constitutes an indirect proof that a second interpretation of the significance of the money form in which interest encounters us is to be preferred, namely the interpretation that this money form is not shell but kernel. Obviously such a proof alone would not justify far-reaching inferences. But it fits into our earlier arguments on the subject of credit and capital, by virtue of which we can understand the rôle played by purchasing power here. Hence as a result we can now state our sixth proposition: interest is an element in the price of purchasing power regarded as a means of control over production goods.

This proposition of course does not ascribe to purchasing power any productive rôle. Yet most people reject it a limine in spite of the fact that interest fluctuates in the money market with the supply of and demand for money, which undoubtedly points to our interpretation.21 Another point may be added at once. That one gets wet when it rains is no more self-evident to the businessman than that interest falls when credit facilities increase, other things being equal. In reality, if a government were to print paper money and to lend it to entrepreneurs, would not interest fall? And would not the state be able to receive interest for it? Does not the connection of interest with rates of exchange and gold movements speak plainly enough? It is an extremely wide and significant range of everyday observations that supports us here.

Nevertheless, only a few significant theorists introduced these facts into the discussion of the interest phenomenon. Sidgwick represents an interpretation in which I perceive, with Böhm-Bawerk, essentially an abstinence theory. But before the sedes materiae, the chapter on interest, he treats of interest in the chapter on the value of money, and here he brings it into relation with money and recognises the influence of the creation of purchasing power upon interest in the statement: “ … We have to consider, that the banker to a great extent produces the money he lends … and that he may easily afford to sell the use of this commodity at a price materially less than the rate of interest on capital generally.”22 This statement contains several points over which we cannot rejoice. Furthermore, it provides no thoroughgoing foundation for the process. Finally, no further conclusions for the theory of interest are drawn. Yet it is a step in our direction, obviously made with reference to Macleod. Davenport applies himself much more to the subject; but his analysis also comes to nothing. He rides quite nicely and willingly up to the fence but then refuses to take it. The prevailing theories completely neglect the element of money — they leave it to the financial writers as a technical matter without theoretical interest. This attitude is so general that it must rest upon an element of truth and in any case is in need of explanation.

Least may be said for the attempt to deny the statistical connection between the interest rate and the quantity of money. R. Georges Lévy23 has compared the interest rate with the production of gold and, as was to be expected, found that no significant correlation exists. Neglecting the fact that the statistical method employed was defective, it does not justify the conclusion that the quantity of money and the interest rate have nothing to do with one another. In the first place, an exact time correlation is not to be expected. Then the supply of gold, even of the banks, is not simply proportional to the volume of credit granted — and only the granting of credit is significant for the rate of interest. Finally, the whole production of gold does not flow to the entrepreneur.

Nor does the inductive refutation attempted by Irving Fisher (Rate of Interest, p. 319 ff.) affect our argument. Yearly averages prove absolutely nothing as against the observations which may be made in the details of everyday dealings in money. Also, he compared the circulation of money per capita with the interest rate and thereby made the comparison completely irrelevant.

But of course economists of the eighteenth century had every reason to emphasise that interest is ultimately paid for goods. They had to fight not only mercantilistic but all sorts of other errors, both of businessmen and philosophers, and in so doing they did in fact establish valuable truths and expose a long list of popular fallacies. Law, Locke, Montesquieu, and others were undoubtedly quite wrong in making the rate of interest simply depend on the quantity of money, and Adam Smith was right in pointing out24 that an increase in the quantity of money will caeteris paribus raise prices, and that, at a higher level, the same relation between return and capital which ruled before will tend to reestablish itself. Even the immediate effect of an increase of money in circulation would be to raise the rate of interest rather than to reduce it. For anticipation of such an increase must have that effect,25 and in any case the demand for credit will be stimulated by the rise in prices. But all this, while it explains and to some extent justifies the aversion which most of our highest authorities display against any “monetary” theory of interest, yet has nothing whatever to do with our proposition.

We can also discover other elements of truth in the point of view “hostile to monetary explanations.”26 Businessmen and financial writers often emphasise the importance of discount policy and the monetary system in a wrong way. The fact that the central banks can influence the interest rate no more proves that interest is the price of purchasing power than the fact that the state can fix prices proves that prices in general are explicable by governmental action. The interest rate can no doubt be influenced by the attention paid to the state of the currency, but the theoretical significance of this fact does not in itself go far. It is a case of influencing a price for motives which lie outside the market. The view that by the monetary system and by discount policy a country's interest rate can be kept lower than that of other countries, and that such a policy stimulates economic development, is nothing but a pre-scientific prejudice. The organisation of a money market is of course just as capable of improvement as that of a labor market, but nothing in the fundamental processes can be altered by this.

§ 9. Our problem now reduces to the simple question: what are the conditions for the emergence of a premium on present over future purchasing power? Why is it that if I lend a certain number of units of purchasing power, I can stipulate for the return of a greater number of such units at some future date?

This is obviously a market phenomenon. The market we have to study is the money market. And it is a price-determining process which we have to investigate. Every individual loan transaction is a real exchange. At first it seems strange, perhaps, that a commodity is as it were exchanged for itself. After Böhm-Bawerk's arguments on this point,27 however, it is not necessary to go into it in detail: the exchange of present for future is no more an exchange of like for like, and therefore meaningless, than the exchange of something in one place for something in another place. Just as purchasing power in one place may be exchanged for that in another, so present can also be exchanged for future purchasing power. The analogy between loan transactions and exchange arbitrage is obvious, and may be recommended to the reader's attention.

If we succeed in proving that under certain circumstances — let us say at once in the case of development — present purchasing power must regularly be at a premium over future purchasing power in the money market, then the possibility of a permanent flow of goods to the possessors of purchasing power is theoretically explained. The capitalist can then obtain a permanent income which behaves in every respect as if it arose in the circular flow, although its sources are individually not permanent and although they are the results of development. And no imputation or computation can alter anything in the character of this stream of goods as a net return.

We can now state directly how high the total value of an interminable annuity must be. It must be the sum which, if lent at interest, will yield a return equal to the annuity, for if it were less, lenders would compete to buy the annuity, and if it were more, potential buyers would rather lend their money at interest than buy it. This is the real rule of “ capitalisation “ which already presupposes the existence of a rate of interest. From this it follows again that the valuation of permanent returns cannot take away the character of net incomes from them.

Therefore we answer all three questions of which the interest problem consists if we solve the problem of the premium on present purchasing power. The proof of a permanent flow of goods to capitalists, from which no deduction is to be made and which is not to be passed on to other individuals, completely settles the matter and explains ipso facto that this flow also represents a gain, that it is a net return. We shall now proceed to produce this proof and enfold step by step our explanation of the many-sided problem of interest.

§ 10. It has been said already that even in the circular flow cases may and will arise in which people will be ready to borrow even on the condition of having to pay back a larger sum than they receive. Whatever the motive — temporary distress, expectation of a future increase in income, weakness of will, or foresight — such people will be able to express their valuation of present purchasing power in terms of future purchasing power, which determines their demand curve for the former in the ordinary way. On the other hand, there may be, and generally will be, people ready to meet this demand provided they get a premium which more than compensates them for the disturbance which the lending of sums held for definite purposes must entail. Therefore we can also construct supply curves, and it is hardly necessary to show in detail how a price — a determined premium — will emerge in this market.

But transactions of this kind could not normally be of any great importance and, above all, they would not be necessary elements in the conduct of business. Lending and borrowing can become part of the normal routine of industry and commerce, and interest can economically and socially acquire the importance that it actually has, only if the control of present purchasing power means more future purchasing power to the borrower. As the prospect of business profit is the pivot on which the valuation of sums of present purchasing power actually turns, we shall now put aside for the moment all other factors which may give rise to interest even where there is no development.

Now within the circular flow and in a market which is in equilibrium it is impossible with a given money sum to obtain a greater money sum. However I employ a hundred monetary units' worth of resources (including management) within the generally known and customary possibilities, I can obtain no greater receipts from them than exactly a hundred monetary units. To whichever of the existing possibilities of production I may apply any hundred monetary units I shall always receive for the product not more — possibly less, however — than a hundred monetary units. For that is precisely the characteristic of the equilibrium position, that it represents the “best” combination — under the given conditions in the widest sense — of the productive forces. The value of the monetary unit is in this sense necessarily at par, for ex hypothesi all arbitrage gains have already been made and are therefore excluded. If I buy the services of labor and land with the hundred monetary units, and with these carry out the most lucrative production, I shall find that I can market the product for exactly a hundred monetary units. It was precisely with regard to these most lucrative possibilities of employment that the values and prices of the means of production were established, and this most lucrative employment also determines the value of purchasing power in our sense.

Only in the course of development is the matter different. Only then can I obtain a higher return for my product, that is, if I carry out a new combination of the productive forces which I bought for a hundred monetary units and succeed in putting a new product of higher value on the market. For the prices of the means of production were not determined with regard to this employment, but only with regard to the previous uses. Here, then, the possession of a sum of money is the means of obtaining a bigger sum. On this account, and to this extent, a present sum will be normally valued more highly than a future sum. Therefore present sums of money — so to speak as potentially bigger sums — will have a value premium, which will also lead to a price premium. And in this lies the explanation of interest. In development the giving and taking of credit become an essential part of the economic process. There, the phenomena appear which have been described by the expressions “relative scarcity of capital” and “the lagging of the supply of capital behind the demand” and so forth. Only if and because the social stream of goods becomes broader and richer does interest stand out with such sharpness and bring us finally so very much under its influence that long analytical effort is required to perceive that it does not always appear where men act economically.

§ 11. Let us now look more closely into the process of the formation of interest. After what has been said this means that we shall examine more closely the method of determining the price of purchasing power. To this end let us confine ourselves first of all strictly to the case which we recognised as the fundamental one, and to which the argument of the earlier chapters was also directed, namely to the case of exchange between entrepreneurs and capitalists. Later we shall pursue the most important ramifications of the interest phenomenon.

Under our present assumptions, the only people who have a higher estimation for present as against future purchasing power are the entrepreneurs. Only they are the bearers of that market movement in favor of present money, of that demand which raises the price of money above par as we define it.

Capitalists on the supply side confront entrepreneurs on the demand side. Let us start with the assumption that the necessary means of payment for carrying out new combinations must be withdrawn from the circular flow and that there is no creation of credit means of payment. Furthermore, since we are considering an economy without results of previous development, there are no great reservoirs of idle purchasing power, for these are, as was shown above, only created by development. A capitalist would thus be one who is ready under certain conditions to transfer a definite sum to the entrepreneur by withdrawing it from its customary uses, that is by restricting his expenditure either in production or in consumption. We still assume that the quantity of money in the system does not increase in any other way, for example through gold discoveries.

Exchange will develop between entrepreneurs and possessors of money and will proceed just as in any other case. We have definite demand and supply curves for all the exchanging individuals. The entrepreneur's demand is determined by the profit which he can make with the help of a certain money sum by exploiting the possibilities hovering before him. We shall follow the practice of assuming these demand curves to be continuous just as we do in the case of other goods, although a very small loan, say of a few monetary units, will be of little use to the entrepreneur, and at certain points, namely where important innovations become possible, the individual demand curves will in fact be discontinuous. Beyond a certain point, namely beyond the sum which is necessary to the carrying out of all the plans which the entrepreneur has thought of at all, his demand will fall sharply, perhaps absolutely to zero. However, in considering the whole economic process, that is in considering very many entrepreneurs, these circumstances lose much of their importance. Therefore we shall imagine that the entrepreneur is able to attach determined quantities of entrepreneurial profit to the individual monetary units from zero to the limit for practical purposes, in the same way as every individual attaches certain values to the successive units of any good.

Any normal individual's valuation of his stock of money per economic period follows from the subjective exchange value of any unit, as was explained in the first chapter. The same rules are also valid for an increase in money beyond this accustomed stock. From this there results a definite utility curve for every individual, and from this again, according to well known principles, a definite curve of the potential supplies on the money market.28 And now we have to describe the “price struggle” between entrepreneurs and potential suppliers of money.

Let us assume as a starting point that upon our money market, which might be regarded as similar to a stock exchange, someone offers a certain price for purchasing power by way of experiment. Under our present assumptions this price would have to be very high, since the lender would have to disturb severely all his private and business arrangements. Suppose then that this price of present purchasing power expressed in future purchasing power is 140 for one year. With a premium of 40 per cent only those entrepreneurs could exercise an effective demand who hoped to make an entrepreneurial profit of at least 40 per cent, or more correctly of over 40 per cent; all others would be excluded. Assume that a certain number of the former existed. According to the principle “better to exchange with small advantage than not to exchange at all,”29 these entrepreneurs will really be ready to pay this interest rate for a certain quantity of purchasing power. On the other side of the market there will likewise be lenders who will not exchange even at this rate. Assuming again that a number of people considered this compensation to be adequate, they would ponder the question of how much they should lend. The 40 per cent is only a sufficient compensation for a certain sum; for everyone there is a limit beyond which the magnitude of the sacrifice in the present economic period must exceed the magnitude of the increase in utility in the next. But the loan must also be actually so big that an increase would result in a surplus of disadvantage, for as long as it is smaller the lending of further monetary units at that rate would afford a surplus of advantage which, according to general principles, no individual can forego.

Supply and demand, therefore, are unequivocally determined in every such case of a “tentative” price. If they were by accident equally great, then the price would stand, in our case, a rate of interest of 40 per cent. If the entrepreneurs, however, can use more money at this rate than is supplied, they will outbid one another, whereupon some will drop out and new lenders will appear until equilibrium is attained. If the entrepreneurs cannot use as much money as is supplied at this rate, then the lenders will underbid one another, whereupon some of them will drop out and new entrepreneurs will appear until equilibrium is attained. Thus in the exchange struggle on the money market a definite price for purchasing power will be established just as on any other market. And since, as a rule, both parties value present more highly than future money — the entrepreneur because present money signifies more future money for him, the lender because under our assumptions present money makes possible the orderly course of his economic activity while future money is merely added to his income — the price will practically always be above par.

The result of our discussion up to this point may be expressed in terms of the marginal theory, just as in the case of any price-determining process. On the one hand interest will be equal to the profit of the “last entrepreneur,” who is simply the one who anticipates from carrying out his project a profit which just makes the interest payment possible. If we rank entrepreneurs — with due regard to the element of variation in risk — in a row according to the size of the profits which they hope to make, so that the “borrowing capacity” of the entrepreneurs falls the further we advance in the row, and if we think of this array as continuous, then there must always be at least one entrepreneur whose profit exactly equals the interest and who stands between those who make bigger profits and those who are excluded from exchanging on the money market because their profit is smaller than the interest to be paid. In practice the “last” or “marginal” entrepreneur must also retain a small surplus, but there will be at times entrepreneurs for whom this surplus is so small that they can only exercise a demand for purchasing power at the actually ruling interest and not at a higher rate by however small an amount. These are in the position which corresponds to the theoretical marginal entrepreneur. We can say, then, that interest must in every case be equal to the smallest entrepreneurial profit that will be actually realised. With this statement we approach again the usual interpretation.

On the other hand interest must also be equal to the value estimate of a last or marginal capitalist for his money. The concept of such a marginal capitalist is attained mutatis mutandis in just the same way as that of the marginal entrepreneur. It can easily be seen that from this standpoint interest must be equal to the valuation of the last lender, and further, that the latter must also be equal to the valuation of the last entrepreneur. It is also obvious how this result could be developed further — it has already been done often in economic literature. Only one point must still be mentioned. The last lender's valuation rests upon the importance which he attaches to the habitual course of his economic life; and this may be expressed by saying that the loan involves a sacrifice, and indeed for the marginal capitalist a “marginal sacrifice,” that corresponds to the valuation of the increase in income by the receipt of interest. Then interest is also equal to the greatest or marginal sacrifice that must be made in order to satisfy the existing demand for money at a given rate of interest. And with this we approach the method of expression of the abstinence theory.

§ 12. Interest would have to be determined in this way if industrial development were actually financed with the resources of the circular flow. However, we observe that interest is also paid for purchasing power created ad hoc, namely for credit means of payment. This leads us back to the results which were developed in the second and third chapters of this book, and it is time to introduce them here. We saw there that in a capitalist society, industrial development could in principle be carried out solely with credit means of payment. We now adopt this conception. Let it be remembered once more that the great reservoirs of money which actually exist arise as a consequence of development and must therefore be left out of account at first.

By the introduction of this element our previous picture of reality is altered but is not made unusable in its main features. What we said about the demand side of the money market remains provisionally unaltered. Now as before, the demand comes from the entrepreneurs and indeed in the same way as in the case just considered. Only on the side of supply is there much alteration. Supply is now put upon another basis; a new source of purchasing power, of a different nature, appears, which does not exist in the circular flow. The supply also comes from different people now, from differently defined “capitalists,” whom we call “bankers” in conformity with what was said earlier. The exchange, to which interest owes its origin in this case and which, according to our interpretation, is also typical of all other exchanges concerning money in modern society, takes place between entrepreneur and banker.

Hence we shall have grasped the fundamental case in the phenomenon of interest if we can give the conditions governing the supply of credit means of payment. We know already by what forces this supply is regulated: first with regard to possible failures by entrepreneurs, and secondly with regard to the possible depreciation of the credit means of payment. We can eliminate the first element from our consideration. For this purpose we only need to consider an addition for risk, which is known empirically, as included once for all in the “par price of the loan.” This means that if it is known from experience that one per cent of loans is irrecoverable then we shall say that the banker receives the same sum that he lent if he actually receives an additional 1.01 per cent approximately from all debts which are not bad. And there is, of course, an element of wages for the professional activity of the banker, which we also neglect. The size of the supply will then only be determined by the second element, that is with regard to the necessity of avoiding a difference in value between the newly created and the existing purchasing power. We must show that the value- and price-determining process also creates a premium on the newly created purchasing power.

In the case previously treated it was not wholly impossible that negative interest should occur. It might possibly occur in that case if the demand for money for new enterprises were smaller than the offers by those people to whom a “favor would be done” in temporarily taking charge of their money. Here, however, this is excluded. The banker who received back less than he gave would suffer a loss; he would have to cover the deficiency, since he would not be able completely to meet the claims upon him. Therefore in this case interest cannot fall below zero.

But it will in general be above zero, because entrepreneurs' demand for purchasing power is distinguished in one important respect from the ordinary demand for goods. Demand in the circular flow must always be supported by an actual supply of goods or else it is not “effective.” The entrepreneur's demand for purchasing power, however, in contrast to his demand for the concrete goods which he needs, is not subject to this condition.

On the contrary, it is only restricted by the much less stringent condition that the entrepreneur will be able later on to repay the loan with interest. Since, even if there were no interest, the entrepreneur would only demand credit in the event of his being able to make a profit with the help of the loan — for otherwise he would have no economic incentive to produce — we can also say that the entrepreneur's demand is subject to the condition or is effective upon the condition that he can make a profit with the loan. This leads to the relation between supply and demand. In any kind of economic situation whatever, the number of possible innovations is practically unlimited, as was explained in the second chapter. Even the richest economic system is not absolutely perfect and cannot be so. Improvements can always be made, and the striving after improvements is always limited by the given conditions and not by the perfection of what exists. Every step forward opens new prospects. Every improvement leads further away from the appearance of absolute perfection. The possibility of profit, therefore, and with it the “potential demand,” have no definite limit. Consequently the demand with interest at zero would always be greater than the supply, which is always limited. However, these possibilities of profit are powerless and unreal if they are not supported by the entrepreneur's personality. So far we only know that profit-yielding innovations are “possible” in economic life; we do not even know whether they will always be taken up by concrete individuals in such measure that the demand for purchasing power with interest at zero is always greater than the supply. We may go still further. The fact that economic systems without development may exist teaches us that individuals who are capable and inclined to carry out such innovations may even not exist at all. May it not be concluded from this that such individuals may also possibly exist in such a small number that the supply of purchasing power is not exhausted, instead of being insufficient for the satisfaction of all? There would be no creation of purchasing power at all and the total supply of credit means of payment would simply disappear30 if no demand for purchasing power, or only an insignificant one, existed. But if any entrepreneurs' demand for credit exists at all, then it is impossible for it to be smaller than the supply with interest at zero. For the appearance of one entrepreneur facilitates the appearance of others. In the sixth chapter it will be shown that the obstacles with which innovations are confronted become smaller the more a community gets accustomed to the appearance of such innovations, and that in particular the technical difficulties in founding new enterprises become smaller because connections with foreign markets, credit forms, and so on, when once created, benefit the epigoni of the pioneers. Therefore the greater the number of people who have already successfully founded new businesses, the less difficult it becomes to act as an entrepreneur. It is a matter of experience that successes in this sphere, as in all others, draw an ever-increasing number of people in their wake, hence that continually more people proceed to carry out new combinations. The demand for capital of itself continually engenders new demand. And therefore on the money market there is a limited effective supply, however big it may be, as against an effective demand which has no definite limit at all.

This must raise interest above zero. As soon as it comes into existence many entrepreneurs are eliminated, and as it rises more and more of them disappear. For although possibilities of profit are practically unlimited, they differ in size and most of them are of course only small. The appearance of interest again increases the supply which is not absolutely fixed, but interest must and will nevertheless continue to exist. A price struggle is started on the money market, which we shall not describe again, and under the influence of all elements of the economic system a definite price for purchasing power is established which must contain interest.

§ 13. We have now to connect the empirical facts, which we have so far excluded, with the fundamental principle relating to interest. First we must enumerate all those sources of existing, in contrast to newly created, purchasing power which actually feed the great money-market reservoir; and secondly we must show how interest spreads from its quite narrow basis over the whole exchange economy, permeates as it were the whole economic system, so that interest seems to occupy much more room than one would expect from our theory. Only if the whole area of the interest problem in these two directions can be exhaustively explored from our point of view can we consider our problem as solved.

The first task presents no difficulty. First of all, every concrete phase of development begins, as was said before, with a heritage from earlier phases. A reservoir of purchasing power may already be formed by the elements which the pre-capitalist exchange economy has created, and hence there will always be greater or lesser quantities of purchasing power in the economic system which are at the disposal of new enterprises either permanently or for a certain time. Moreover, when the capitalist development is in motion an ever-increasing stream of disposable purchasing power flows to the money market. We shall distinguish three branches of it. First, by far the largest part of entrepreneurial profit is employed in this way; the profit will be “invested.” Here it is in principle quite immaterial whether an entrepreneur invests his profit in his own business or whether the sum in question comes on the market. Secondly, in the case of the retirement of entrepreneurs or perhaps of their heirs from active business life, if this leads to the liquidation of the enterprise, greater or lesser sums then become free without other sums always and necessarily at the same time becoming tied up. Thirdly and finally, those profits which development so to speak sweeps to other people than entrepreneurs, and which are based upon “repercussions of development,” will to a greater or lesser extent come directly or indirectly into the money market. Let us notice here that this process is accessory in still another sense than in the sense that this sum only owes its existence to development: it is the fact that interest exists, the possibility of receiving interest for this sum of money, that draws disposable purchasing power to the money market. The acquisition of interest is the only motive that leads its possessor to offer it — if there were no interest the purchasing power would be hoarded or spent on goods.

It is similar in the case of another element. We saw that the significance of saving in an economic system without development31 would be relatively very small, and that what is usually meant by the size of the savings of a modern nation is nothing but the sum of those profits from development which never become elements of income. Now the importance of saving in the real sense might not be large enough, even in a system with development, to play a decisive part for industrial requirements, but for the fact that a new kind of saving — and indeed of “real” saving — appears which is absent in a system without development. The fact that one may be assured of a permanent income by lending a sum of money acts as a new motive to saving. It is conceivable that, just because a sum saved increases automatically and consequently its marginal utility sinks, less will sometimes be saved than if no interest were received. For the most part, however, the existence of interest, which opens up a new method of employing the money saved, leads clearly to a considerable increase in saving activity — which of course does not mean that every rise in interest must result in a proportional increase or any increase at all in saving. From this it follows that the saving which is actually observable is in part a consequence of the existing interest; and here also there is an “accessory stream of purchasing power” coming into the money market.

A third source which supplies the money market is money which is idle for a longer or shorter time and which is also lent if interest can be obtained for it. It consists of momentarily disposable business capital and so forth. The banks collect these sums and a highly developed technique enables every monetary unit, even if it is held ready for an impending expenditure, to contribute to increasing the supply of purchasing power. Still another fact belongs here. We saw that the nature of credit means of payment and the explanation of their existence must not be sought in the effort to economise metal money. Of course, credit means of payment cause less metal money to be used than would have to be used if the same transactions had to be carried out with metal money alone. But these transactions only arose with the help of credit means of payment, and as against the money requirement which would have developed in the same time if there had been no credit means of payment, no “economy” in money so far occurs. Yet we must now recognize that, apart from the credit means of payment which development brings into existence, further transactions which were perhaps carried out previously by means of metal money are settled with credit by the banks under the pressure of the desire to increase the quantity of interest-bearing purchasing power; that is, credit means of payment are likewise created by banking technique, consequently a still further increase in the disposable quantity of money results from this source.

All these elements increase the supply on the money market and lower interest far below the level at which it would be if they were not present. They would very soon reduce it to zero if development did not continually create new possibilities of employment. Whenever development stagnates, the banker hardly knows what to do with the disposable funds, and often it becomes doubtful whether the price of money contains more than the capital sum plus a premium for risk and compensation for labor. Then especially, and particularly on the money markets of very rich nations, the element of creation of purchasing power often recedes into the background, and the impression can easily be formed, so dear to economic theory as well as to banking practice, that the banker is nothing more than a middleman between borrowers and lenders. From this conception it is only a step simply to substitute for the lender's money the concrete goods which the entrepreneur needs, or even the concrete goods needed by those who transfer the necessary means of production to the entrepreneur.

It may be remarked further that there are cases, as Böhm-Bawerk has already emphasised, in which interest is only demanded and paid because it is possible to demand and pay it. Interest on bank balances is an example. No one transfers his purchasing power to the bank with the intention of investing his capital in this way. On the contrary, money is deposited only in so far as it is desirable to have a supply of purchasing power available for business or private reasons. This would happen even if something had to be paid for it. But actually the depositor receives, in most countries, a kind of share in the interest which the sums in question yield in the banker's hands. And when once this has become usual people will not be inclined to leave a balance at a bank which does not pay interest. Here interest accrues to the depositor without anything being done on his part. Now this phenomenon reaches very far into all economic life. The fact that every particle of purchasing power can obtain interest puts a premium on it, whatever purpose it may serve. Thus interest forces its way into the business of people who have not themselves anything to do with new combinations. Every unit of purchasing power has to fight as it were against the current that attempts to draw it into the money market. Furthermore, it is obvious that in all cases in which anyone needs credit for any reason at all, the loan transaction — state loans and so forth — will be linked with the fundamental phenomenon.

§ 14. In this way the interest phenomenon extends gradually over the whole economic system, and therefore it presents a much wider front to the observer than one would suspect from its innermost nature. Hence, time itself becomes in a certain sense an element of cost, as has already been indicated. This consequent phenomenon, which the prevailing doctrine accepts as the fundamental fact, explains — and at the same time justifies — the discrepancy between it and our interpretation. But we have still a further step to take, namely to explain the fact that interest finally becomes a form of expression for all returns with the exception of wages.

In practice we speak of land as yielding interest, likewise of a patent or of any other good which yields a monopoly revenue. We even speak of interest-bearing in the case of a non-permanent return; we say, for example, that a sum of money employed in speculation, even a commodity employed in speculation, has yielded interest. Does not this contradict our interpretation? Does it not show that interest is an income from the possession of goods, that it is in an altogether different category than it would be according to our interpretation?

This method of expressing returns has borne definite fruit in theory amongst American economists. The impetus came from Professor Clark. He called the return from concrete producers' goods rent; the same return conceived as a result of the enduring economic fund of productive power — which he calls “capital” — interest. Here, then, interest appears merely as a special aspect of the returns and no longer as an independent part of the national income stream. Professor Fetter32 has developed the same idea still more strongly and in a somewhat different way. But here we are interested most of all in Professor Fisher's theory, expounded in his work The Rate of Interest. Professor Fisher explains the fact of interest simply by the underestimation of the future satisfaction of wants; most recently 33 he has expressed his theory in the statement: “Interest is impatience crystallised into a market rate.” Accordingly he connects interest with all goods separated in time from final consumption. And since all returns to the latter can be “capitalised,” consequently expressed in the form of interest, interest is not a part but the whole of the income stream: wages are interest on human capital, rent is interest on capital in the form of land, and every other return is interest on produced capital. Every income is value product discounted according to the rate of the undervaluation of future satisfactions. It is clear that we cannot accept this theory because we do not even recognise the existence of the fundamental element in it. It is just as clear that for Fisher this element becomes a central factor in economic life, which must be brought in to explain nearly every economic phenomenon.

The fundamental principle that comes into consideration here, and that should lead us to understand the universal practice of expressing returns in the form of interest, is the following. According to our interpretation concrete goods are never capital. Yet anyone who possesses concrete goods can, in a system which is conceived to be in full development, obtain capital by selling them. In this sense the concrete goods might be called “potential capital”; at least they are so from the standpoint of their possessor, who can exchange them for capital. In this connection, however, only land and monopoly positions34 come into consideration, for two reasons. First, it is clear that one cannot sell one's labor-power as such, if we neglect the case of slavery. But there are no stocks of consumption goods and produced means of production in the sense asserted by the prevailing doctrine — so in principle we come back immediately to land and monopolies. And secondly, only land and monopoly positions are directly income-bearing. Since capital is also income-bearing, its owner would not exchange it for goods which yield no net income — or only if such a price reduction is conceded to him that he can realise a profit with the goods in the current economic period and then reinvest his capital uninjured; but in this case the seller would suffer a loss to which he would only make up his mind in abnormal conditions, especially in distress, as will be shown immediately.

The possessors of “natural agents” and monopolists thus have every reason, if there is development, to compare their income with the return on the capital which they could obtain by selling their natural agents or their monopoly, since such sale might possibly be advantageous. And capitalists have reason to compare their income from interest with the rent or permanent monopoly revenue which they can obtain with their capital. Now how high will be the price of such sources of income? No capitalist, in so far as he takes the acquisitive standpoint, can value a piece of land higher than the sum of money which yields as much interest as the former does rent. No capitalist can, with the same qualification, value a piece of land any lower. If the piece of land cost more it would — neglecting obvious secondary elements — be unmarketable: no capitalist would buy it. If it cost less, competition would arise among the capitalists which would raise its price to that level. No landowner who is not in distress will be inclined to give up his land for a lesser sum than that which yields him as much in interest as his piece of land yields in pure rent. But he will also not be able to get a bigger sum for it, because a large quantity of land would immediately be offered to the capitalist who was ready to give it. Thus the “capital value” of permanent sources of income is unequivocally determined. The well known circumstances which cause either more or less to be paid in most cases do not affect the principle.

In this solution of the problem of capitalisation the central and fundamental factor is interest on purchasing power. The return to every other permanent source of income is compared with this, and according to it — as a consequence of the existence of interest — its price is so fixed by the competitive mechanism that in conceiving the return of potential capital as real interest no practical error is made. In reality, therefore, every permanent return is connected with interest; but only externally, only in so far as the magnitude to which it is related is determined by the level of interest. It is not interest; the contrary method of expression in practice is merely brachylogy. And it is not directly dependent upon interest as would be the case if the nature of interest were correctly characterised by the expression “time discount.”

Our result may also be extended to non-permanent net returns, for example to quasi-rents. It is not difficult to see that under free competition a temporary net return will be sold and bought for that sum of money which, if invested at interest at the moment of the conclusion of the business, would accumulate to the same sum by the time the net return ceased as all the net returns would if they were lent as they accrued. Here also in practice the buyer's capital will be spoken of as yielding interest — and with the same right as in the case of permanent returns — although the buyer no longer has his capital, and has changed from a capitalist into a rent receiver. And what sum will the owner of say a blast furnace be able to obtain for it if it is not the bearer of a permanent — perhaps monopolistic — or temporary net return, but is a business of the circular flow, that is — abstracting from rent, which we shall neglect here — profitless? Now no capitalist will “invest” his capital in such a business. The transaction, if it is to take place at all, must yield him not only the replacement of his capital after the plant is worn out, but also a net return during its lifetime corresponding to the interest which he could otherwise draw. Consequently, if the buyer has no other design for the furnace than simply to collect its returns in the circular flow, that is if it is not called upon to play a part in a new combination, it must be sold at a price lower than cost. The seller must make up his mind to a loss, for only so could the buyer obtain a profit equal to the interest which he could otherwise obtain with the purchase money.

In all these cases the businessman's interpretation and expression are not correct. But in all these cases the incorrectness has no practical consequences, and it is quite clear why the businessman makes use of this inadequate interpretation. In the modern economic system the rate of interest is such a ruling factor, interest is so much the barometer of the whole economic situation, that regard to it is necessary in the case of practically every economic action and it enters into every economic deliberation. It leads to the phenomenon observed by theory from time immemorial, that all returns in the economic system, seen from a certain aspect, tend to equality.

§ 15. The elliptical expression of the practical man, which is always implied in speaking of interest on concrete goods, has certainly led theory astray. But now I want to show that the theoretical error which always lies in this extension of the idea of interest beyond its real basis may also bring practical errors in its train.

The “interest aspect” of returns is a harmless view to take in the case of permanent returns, that is rents and permanent monopoly revenues, but not in other cases. Let us consider first of all our example of the furnace in order to show this. Under our assumptions the buyer of the furnace receives enough during its lifetime to recover his purchase money and interest besides — which we shall assume he spends as income. Now if all economic conditions remain unchanged, when it is worn out he can build another furnace,35 of exactly the same kind as the old and at the same costs as the old. But if these costs are higher than originally, the individual in question must add something to his amortisation fund in order to cover them. And henceforth the furnace would accordingly no longer yield him a net return. Now if the buyer of the furnace perceived these conditions clearly he would not undertake the construction, but would invest the sum recovered elsewhere. If he did not perceive them, if he allowed himself to be deceived by the interest aspect, then he would be the loser, although the seller on his part might also have been the loser and the buyer at the time rightly believed that he had made a good bargain. At first sight the case seems bewildering. But I shall not add another word of explanation because the matter must be clear to the reader who gives it the appropriate attention. Such cases are not rare in practice, and are consequences of the habit of attaching permanent net returns to goods which do not yield them. Of course other errors can also lead to such disappointments. On the other hand the disappointments may fail to materialise in consequence of particularly favorable circumstances. But I believe that everyone must find sufficient proofs in his experience for what has been said.

The case is similar if net returns really exist but are not permanent, if for example a business still yields a few instalments of entrepreneurial profit or temporary monopoly revenues or quasirents. If one nevertheless speaks of such things as interest-bearing it does no harm as long as one is aware of the temporary character of these returns. But at the moment when one explains them as interest the temptation is obvious to regard them as permanent; indeed, sometimes the expression is already a symptom of this error. And then of course one experiences the most unpleasant surprises. This interest has a way of diminishing obstinately, even of suddenly coming to an end. The businessman in this event complains of bad times, to be sure, and cries out for protective tariffs, government assistance, and so forth, or considers himself as the victim of a special misfortune or — with more reason — as the victim of new competition. Such occurrences are very frequent, and they substantiate our interpretation strikingly. Yet they obviously hark back to the fundamental error which leads in practice to false steps and bitter disappointments, in theory to those explanations of interest which we are criticising.

The statement is often heard that somebody's business “yields” say 30 per cent. Of course this is not simply interest. In most cases the result is arrived at by not counting the entrepreneur's activity as an outlay and consequently not including the payment for it under costs. If this is not the explanation then the return cannot be permanent. Business experience completely substantiates this conclusion of our interpretation. For what business “yields interest” permanently? It is true, the businessman often does not realise this temporary character of the return, and makes the most diverse hypotheses about its continual dwindling. And the buyer is very often lured by the expectation that such a return will be maintained — at the most he recognises that the experience of the previous owner may have something to do with its size. Then he automatically applies the interest formula instead of the correct method of calculation. If he does this strictly, that is if he “capitalises” the return at the current rate of interest, then failure will follow. The return of every business ceases after a time; every business, if it remains unchanged, soon falls into insignificance.

The individual industrial business is not a permanent source of any other income than wages and rent. The individual who is most inclined to overlook this in daily practice, and to suffer the unpleasant experience indicated above, is the typical shareholder. It might be thought that an objection against our theory of interest could be forged out of the “fact” that a shareholder may draw a permanent net income even without periodically changing his investment. According to our view the capitalist would first have to lend his capital to one entrepreneur and after a certain time to another, since the first cannot be permanently in the position to pay interest. Since we characterised the shareholders as mere contributors of money, and yet they draw a permanent income out of one and the same enterprise, the objection would seem to be very strong. But precisely the case of the shareholder — and of every creditor who throws in his lot permanently with an enterprise — shows how true our interpretation is to reality. For this “fact” is very doubtful. Do companies live eternally and do they pay dividends forever? Certainly there are such, but broadly only two groups of them. First there are branches of industry, some railways for example, which have, if not a perpetual, yet an assured monopoly for a long time. Here the shareholder simply receives monopoly revenue. Then there are kinds of enterprises which by nature and programme are continually doing new things and are really nothing but forms for continual new enterprises. Here the aims alter incessantly and the leading personalities also change, so that it is in the nature of the thing that people of considerable ability always appear in the leading positions. New profits are always arising, and if the shareholder loses his return this is not really necessary but just a misfortune to be explained by the individual case. But neglecting these two categories, that is if a company simply operates a definite business without a monopoly position, there is, at the most, rent of natural agents as a permanent income, and nothing more. Now experience confirms this strikingly, although in practice competition does not act promptly and hence enterprises remain in possession of surpluses for a considerable time. No industrial company of the type indicated gratifies its shareholders with a constant shower of gold; on the contrary it soon declines into a stage that has the most lamentable similarity with the drying up of a spring. Hence repayment of capital is frequently concealed in dividends, even though the wearing out of machines and so forth is ever so conscientiously taken care of by depreciation accounts. Quite rightly, therefore, much more than wear and tear is frequently written off and many companies strive to write off the whole capital as soon as possible. For the time comes for each when the business as such is really valueless, that is when its returns only just cover costs. So there is no such thing as a lasting income from interest out of one and the same business, as anyone who does not believe it and acts accordingly may learn to his cost. Hence the receipt of dividends by shareholders does not tell against our interpretation — quite the reverse!

§ 16. How far this theory will prove an efficient instrument in the analysis of statistical material and in the investigation of the questions which arise in relation to interest still remains to be seen. It certainly seems to bring the facts of money, credit, and banking into closer touch with pure theory than other interpretations do. The author hopes to be able to submit the results of some work on these lines in a book to be published in the near future, in which such problems as, for example, the relation between gold reserves and interest, the influence of the monetary system upon interest, the differences between interest rates of different countries, and the correlation between rates of exchange and interest will be discussed.

Our argument should also explain the movement in time of the rate of interest. It is from this class of facts that verification of the fundamental idea might primarily be expected. If the interest of business life — what it is usual to call “productive interest” — has its roots in entrepreneurial profit, both should move closely together. As a matter of fact, this is true of short period fluctuations. In longer periods we may still observe some relation between the prevalence of new combinations and interest, but there are so many elements to be taken account of, and “other things” remain so imperfectly equal as soon as we go beyond the span of say a decade, that verification becomes extremely complicated. It is then not only necessary to allow for government borrowing, migration of capital, and movements of the general level of prices, but there are also more delicate questions, which cannot be entered upon here.

There is nothing in our theory to support the old view — which with many people from the classical economists onwards has acquired the force of a dogma — that interest must of necessity display a secular tendency to fall. It may be shown, however, that the impression to that effect, which seems so strongly to suggest itself, is largely due to the element of risk, which accounts for medieval figures; and that the real rate of interest does not display any clear secular trend, that its history rather verifies our interpretation than disavows it.

These remarks must suffice. However incomplete our arguments may be, and however much more precise formulation and however much modification they may require, I believe the reader will nevertheless find in them some of the elements for understanding that part of economic phenomena which has hitherto presented most difficulties. I have only one thing to add: I wished to explain the interest phenomenon but not to justify it. Interest is not, like profit for example, a direct fruit of development in the sense of a prize for its achievements. It is on the contrary rather a brake — in an exchange economy a necessary brake — on development, a kind of “tax on entrepreneurial profit.” Certainly this is not sufficient to condemn it, even if one includes condemnation or approbation of things in the tasks of our science. Against the condemnatory verdict we can assert the importance of the function of this “ephor of the economic system,” and we may conclude that interest only takes away something from the entrepreneur which would otherwise accrue to him, and not from other classes — neglecting the cases of consumptive and of “ productive-consumptive credit.” Yet this fact, together with the fact that the interest phenomenon is not a necessary element in all economic organisations, will always result in the critic of social conditions finding more to object to in interest than in anything else. Therefore it is important to state that interest is only the consequence of a special method of carrying out new combinations, and that this method can be much more easily changed than the other fundamental institutions of the competitive system.


Notes

1 This must be emphasised so much because outside of a narrow circle of specialists even the critical part of Böhm-Bawerk's contribution has not yet been fully absorbed. But I presuppose a knowledge of it. The following relates to it at all points, and whoever still maintains the self-evidence of interest and does not see the decisive problem must find the following unnecessarily tortuous, much of it incomprehensible, even false. In Böhm-Bawerk's work, however, the reader can find everything necessary and references to almost all the literature. General knowledge of it is necessary. Finally, I do not wish to repeat what I have already said: cf. Wesen, bk. III.

2 Cf. Böhm-Bawerk, for example on Say, 1, 142. Böhm-Bawerk's method of expression is, however, already influenced there by the fact that he has a definite theory of interest in mind.

3 Cf. Böhm-Bawerk, 1, 230.

4 Cf. the concluding considerations of Böhm-Bawerk, 1, 606 f.

5 Cf. Böhm-Bawerk, 1, 132, on the concept of physical and value productivity of produced means of production.

6 Cf. Böhm-Bawerk's remarks, for example on Say and Roesler.

7 To the machine, the value of its products is imputed; to the services of labor and land necessary to the production of the machine, the value of the latter is imputed. Consequently the services already have the value of the final product, and if they become a machine the latter simply takes their place. In this sense we say that the machine “receives” the value of the productive services. It is to be hoped that I am not misunderstood as deriving its value from its costs.

8 Cf. Böhm-Bawerk, Rechte und Verhältnisse vom Standpunkte der Volkswirtschaftlichen Güterlehre. Also his observations on the “use” theories of interest, which are likewise applicable to our case. At the same time I may observe that I exclude the fundamental idea of the use theory of interest from my consideration because I have nothing to add to Böhm-Bawerk's arguments.

9 Strictly speaking this method of expression is suited only to the case of a non-exchange economy. In an exchange economy the value of means of production is nowhere felt as indirect use value. Nevertheless, here also the conception of them as potential products gives the principle for the formation of their value. And a more correct method of expression only leads to the same result.

10 The case of self-reproduction of the services of land is distinguishable from the case of the increase of a herd of cattle by the fact that one can allow the latter to increase in such a way that the value of a beast finally falls to its cost in labor and land. The services of land reproduce themselves automatically only by the same amount in every economic period. They are, it is true, not incapable of increase, but their increase involves costs.

11 Cf. Kapital und Kapitalzins, vol. II.

12 Yet a very elaborate attempt has been made in this direction: cf. Otto Conrad, Lohn und Rente. All other suggestions of this kind of explanation of interest are not of the rank of an elaborated theory.

13 Cf. the argument of Chapter IV.

14 Cf. Wesen, bk. III, ch. iii; also Chapter III, Part 1, in the present work. Example: if a factory is destroyed by accident and if it is rebuilt by means of a loan, then the interest on this loan is what we mean by “consumptive-productive.”

15 Only the regularity of interest supports the preconception that it must be explained “statically”; but we do account for this regularity.

16 Cf. Wesen, bk. III, ch. iii.

17 From this two practical results follow at once. First, the so-called primitive trading interest is not interest. In so far as it is not monopoly revenue or wages it must be entrepreneurial profit — also only temporary. Secondly, rental is not interest. Rental is partial purchase and can include no element of interest in the circular flow. The net income from a house could only be ground rent — and wages of “superintendence.” How an element of interest can, in development, enter into the rental will be seen automatically from our argument. The fact that already existing interest on capital makes time an element of costs is especially important.

18 Petty, Locke, and Steuart might also be quoted.

19 This explains the disharmony actually exhibited upon a first glance into Locke's theory, as Böhm-Bawerk emphasises. (Cf. Kapital und Kapitalzins, 2 ed., 1, 52.)

20 Here I shall not enter further into the expedients “stock of consumption goods “ and “stock of accumulated services of labor and land.”

21 Cf. Marshall's remarks before the Commission on the Depression of Trade. In the discussion of the relation between the quantity of money and commodity prices he says, speaking of an increase in the quantity of money: “I should say it would act at once upon Lombard Street, and make people inclined to lend more; it would swell deposits and book credits and so enable people to increase their speculation… .” One who says this (and who could deny it?) cannot reject our interpretation lightly.

22 Principles of Political Economy, 3 ed., p. 251.

23 Journal des Economistes (1899).

24 Cf. his short and pregnant argument in bk. II, ch. iv, of the Wealth of Nations.

25 Cf. Fisher, Rate of Interest, p. 78.

26 For example its justifiable scorn of the causal connection between interest and the quantity of money in the following form: if more money exists then the value of money falls — and for this less valuable money less interest is paid. In this, of course, there is no redeeming feature. I have not discussed this interpretation at all in the text, but I believe that it has contributed largely to frightening off economists once for all from this nexus between money and interest.

27 Cf. Kapital, vol. II.

28 Cf. for details Wesen, bk. II. Here we are not concerned with an elaborate exposition of the theory of prices.

29 Cf. Böhm-Bawerk, Kapital, vol. II.

30 To avoid misunderstandings it may be remarked that it would be possible for exchanges in the circular flow to be effected with the help of credit means of payment. These would circulate without interest and at par. But in order that there may be an incentive to create more credit means of payment interest is certainly necessary.

31 Cf. Chapter II.

32 Cf. my article “Die neuere Wirtschaftstheorie in den Vereinigten Staaten,” Schmoller's Jahrbuch (1910).

33 Sceientia, Rivista di Scienza (1911).

34 Though I use this method of expression I do not mean to cast doubt upon the fundamental fact that monopoly positions are not “goods,” as will easily be seen.

35 The reader will easily see that the argument is not changed if we assume that the buyer, who wishes to continue to work the furnace, does not let it perish and build it anew, but preserves it permanently by repairs.