355

APPENDIX.

APPENDIX A.- VOL. I. p. 164.

Upon the Causes which determine the Rate of Interest. Extracted from a Publication by the Author, entitled "Considerations on the State of the Currency." 1826.

THE rate of interest may be defined to be that proportional sum which the lender is content to receive, and the borrower to pay, annually, or for any longer or shorter period, for the use of a certain amount of monied capital*, without any consideration for trouble in the collection of the income, or for risk as to the punctual repayment of the interest or principal at stipulated periods. Whatever is received by the owner of a monied capital for the loan of it, beyond that rate, ought to be considered in the light of a remuneration for risk or trouble.

In this view, the rate of interest is the measure of the net profit on capital. All returns beyond this, on the employment of capital, are resolvable into compensations under distinct heads, for risk, trouble, or skill, or for advantages of situation or connexion. When the owner of a capital

In

*To distinguish, with perfect accuracy, between monied capital and currency, is a matter of some difficulty, and, perhaps, would require a detailed analysis of every species of mercantile transaction. ordinary discourse, both monied capital and currency are called money, and the market for monied or disposable capital is called the moneymarket, and hence much confusion arises from the use of the word money, where monied capital is meant. M. Say notices this distinction between money and disposable capital, and the errors to which the confounding of the two terms together has given rise, in his excellent and justly celebrated work Traité d'Economie Politique, p. 112. et seq.

employs it actively in reproduction, he does not come under the head of those capitalists, the proportion of whom, to the number of borrowers, determines the rate of interest. It is only that class of capitals, the owners of which are unwilling or unable to employ their money actively themselves, which has any immediate influence on the rate of interest.

This is the description of capitals which M. Say calls Capitaux disponibles.

The possessors of disposable monied capitals, who operate on the rate of interest as lenders, may be classed under the following heads:

1. Persons, or bodies of persons, trustees, or others, who are precluded by legal or other disability from investing any money which they have to lay out, in any security that is attended with either risk or trouble. Banks, whether corporate, or consisting of private individuals, in as far as they conduct their business according to correct banking principles, may be reckoned under this head. It is perfectly possible that, within certain limits, an increasing proportion of national monied income may be accumulated in the hands of persons or bodies coming under this description, to such an amount that, if the borrowers who have securities to offer, which involve neither risk nor trouble to the lenders, be limited to a certain number, the rate of interest upon such securities may be depressed in almost any degree.* It is clear, in this point of view, that a fall in the rate of interest on the best securities is no criterion of the returns to capital actively employed, which involves the necessity of risk, trouble, and skill. If, by any financial operation, brought about without any intermediate disturbance of property, as, for instance, by an effective sinking fund, our national debt were reduced to one or two hundred millions, it is not inconceivable that any perpetual annuities offered by government, within that amount, would fetch fifty years' purchase, or, in other words, that the rate of interest, all other things remaining the same, would, on such securities, be reduced as low as 2 per cent. per annum.

*It is on this account that an increased issue of Bank of England and other bank notes, in the way of loans to government, or of discount on mercantile bills, contributes to reduce the rate of interest, when there is no corresponding increase of borrowers having the most undoubted security to offer.

A state of war, on the other hand, may easily be supposed to raise the rate of interest by creating a supply of that description of security to a larger amount, and more rapidly, than could be absorbed by the accumulations of the class coming under this head. A rise in the rate of interest is, therefore, a condition for obtaining the requisite funds from the other classes of persons possessing monied capitals.

Hence it may be seen why the rate of interest, as measured by securities involving no risk or trouble, should be lower in peace than in war, without resorting to any difference in the rate of profits, to account for that difference in the rate of interest.

2. Persons who are willing to take some trouble, with little, if any risk, and who invest their monied capitals in mortgages, ground-rents, or in loans on goods and other securities involving the necessity of superintendence, and more or less of trouble and exertion in collecting the annual interest. In proportion to the difficulty of obtaining good securities of this kind, except at a reduced rate of interest, this class would be liable to merge into the next class which will be mentioned.

The prevalence, however, of habits of prudence, and the consequently increasing proportion of the national income accumulating in the hands of this, as well as of the first class, would enable persons possessing skill for the active employment of capital, or enjoying advantages of situation or connexion, and offering sufficient security, to retain a larger portion of the returns, as a compensation for their risk, trouble, and skill. Supposing the whole returns to capital to remain the same, a diminishing proportion might go as the net profit to the monied capitalist, and an increasing one to mercantile, manufacturing, farming, or other professional skill. These returns, beyond the mere interest of money, and beyond what may arise from rent or the monopoly of situation, connexion, &c., M. Say classes under the head of profits industriels, as contra-distinguished from profits de capitaux; a distinction which our economists might adopt with advantage.

3. Persons who, in order to obtain a higher rate of interest, or a higher price for the use of their monied capitals, are willing to run an extra degree of risk in the investment of them, but without bestowing personal labour,

or possessing any technical knowledge or skill, to qualify them for the active management of such investment.

This is a class, the extent of which could not have been adequately conceived till the experience of late years, in which the success of foreign loans, and mining schemes of the most hazardous nature, proves how many persons there were in this country, who, having some property, were willing to embark it in enterprises of more or less hazard, provided that such enterprises promised on the face of them to yield more than the common rate of interest, without requiring labour or skill. In proportion as the funds of this class have been absorbed in successive payments to the loans and schemes, they must have been withdrawn from the competition with the two first classes of lenders, and this new mode of investment must, consequently, have operated thus far in preventing a fall, if not in occasioning a rise, in the rate of interest on the best securities in this country. At the same time that the progressive reduction in the rate of interest, on the best securities, must have detached many monied capitalists from the two first classes, and brought them into the third. There can be no doubt, therefore, that the fall in the rate of interest, an artificial one as it now appears, was, in some degree, a necessary condition of the success of those loans and schemes to the extent to which they were carried.

The three classes of persons here enumerated as being lenders of monied capital, include those who, being actively engaged in trade, manufactures, or farming, accumulate more than they can re-invest in their own occupation, with the prospect of getting the ordinary rate of interest, after allowing for a remuneration for their labour and risk.

A material consideration to be here borne in mind is, that it is only as long as those capitals are floating, or disposable, that they operate on the rate of interest. When once they are invested, whether for a long or a short time, they are out of the competition of lendable capitals, and cease to affect, directly, the rate of interest. Thus, if I have invested my monied capital in the discount of bills, however undoubted in point of security, and at however short a date, that sum is withdrawn from the amount of floating or disposable capital. I may, indeed, if I have a sudden occasion to require so much money for immediate

use, get the bills re-discounted for me; but, then, this sum must be withdrawn from the amount of floating or disposable capital in other quarters.

These being the principal heads under which the lenders of monied capitals may be classed, constituting one of the conditions on which the rate of interest depends, viz., the supply, it remains to consider what is the description of the borrowers, who constitute the demand. These may be classed as follows:

1. Persons who have the prospect of being able to employ a capital beyond their own funds, in such a manner as to afford a return adequate to remunerate them for their trouble, and skill, and risk, after replacing the amount advanced, together with the sum stipulated for the use of it.

2. Persons who, having embarked the whole of the capital which they possessed, and having entered into engagements which require larger advances, and afford smaller returns than they had anticipated, call for a further sum, of such an amount as their securities or credit enable them to obtain, in order to make up for the deficiency or temporary absence of the returns which they had reckoned upon.

3. Persons who have occasion to borrow, in order to supply the means of unproductive expenditure beyond their income. This head includes a great number of borrowers, having various kinds of securities. It embraces not only those who are proprietors of lands and houses, which admit of being mortgaged, or who have personal security to offer, but the government, which may mortgage the revenues of the state. Under this head may be considered the agents of foreign governments, who may raise loans in this country, or, in more general terms, may offer foreign government securities, which hold out adequate temptation for investment on the part of capitalists in this country.

It is only by a classification of particulars like these, that the causes of variation in the current rate of interest can be extricated from the confusion in which they are involved by the attempts which have been made, in discussions purely scientific, to account for all such variations by the supposition of corresponding alterations in the rate of profit.

The simplest way, as it strikes me, on all such occasions