in the process of production. Loan interest represents
simply contract interest, and is the amount paid to the
lender by the borrower for the use of capital. In the
ordinary treatment of interest, loan interest is considered
rather than economic interest. The loan interest may be
greater than economic interest, but in the long run it tends
to approximate it when the two elements of risk and com-
mission are left out. The chief difference between eco-
nomic interest and loan interest lies in the variation in
loan interest caused by the favorable or unfavorable con-
dition of the loan. Thus, current rates for short loans gen-
erally vary greatly from current rates for long loans. But
there is a normal rate to which the variations of current
rates usually tend in a community, which comes very nearly
176 ECONOMICS.
the economic interest, just as contract wages or contract
rent tends to conform to economic wages and economic
rent, respectively. The essential fact in interest does not
necessitate a loan, for interest arises from the use of
capital even when it is used by its owner. The man who
engages in business for himself and allows in his accounts
a record of the interest on his own capital, not only ob-
serves a good business principle, but also approximates
an economic truth. He usually records the current rate,
but recognizes the income that naturally arises from
capital.
Development of Theories of Interest.
There have been very many theories respecting interest
advanced by the people of ancient time, as well as by dif-
ferent economists. This fact, however, does not interfere
with a true theory of interest. All interest was called
usury by the people of the middle ages. And indeed the
Bible calls interest usury, and speaks decidedly against
the man who takes usury. When the Hebrew writers
urged against the charge of interest, the economic life
was entirely different from what it is at the present day.
Capital was then loaned for the purpose of relieving
distress, without thought of putting it in business for the
purpose of earning a large return to the borrower. Aris-
totle held that money was a barren thing; that it could
not beget money, and therefore that it was wrong to
charge interest. In the first place, his mistake was in
supposing interest was charged on money instead of on
capital, of which money was only a single form. In the
second place, the modern processes of economic produc-
tion had not yet appeared.
Aristotle says that the most hateful of all ways of
ECONOMICS. 177
earning money is usury, which makes a gain out of the
money itself without the natural use of it. " For money,"
he says, "was intended to be used in exchange, but not
to increase interest. And this term usury, which means
the birth of money from money, is applied to the breeding
of money because the offspring resembles the parent.
Wherefore, of all modes of making money this is the most
unnatural." But Aristotle with all of his wisdom and
learning could have known nothing of the industrial
revolution, of division of labor in its extended form, of
power manufacture and the consequent modern uses of
capital, and therefore could have well assumed that a
thing might be quite unnatural in his day which is quite
natural in our day. Although he was the most learned
of the ancients, he could not be expected to have antici-
pated a science which had not yet been created; nor could
other pagan writers, who held that money is by nature in-
capable of bearing fruits, that the lender's gain therefore
cannot come from the peculiar power of money, and that
it can only come from a defrauding of the borrower, know
of future development of industry through capital. But
Athens, and Rome herself, as civilization grew more com-
plex, found the charging of interest to be an inevitable
result of complexity of business relations, notwithstand-
ing the learning of Aristotle.
In the middle ages the writers and ecclesiastics treated
the subject more thoroughly; and at the close of this
period, when political economy was gradually developing,
many of them finally acknowledged the right of interest
to exist, a conclusion reached through their philosophy,
12
178
ECONOMICS.
for they counted the practices of the world all wrong and
could not learn of them. The old canonists of the twelfth
and subsequent centuries tried to argue against the pay-
ment of interest as an abhorrent thing. Thus Gonzalez
Tellez wrote : " So then as money breeds no money, it is
contrary to nature to take anything beyond the sum lent,
and it may with propriety be said that it is taken from
industry than from money, for money does not breed, as
Aristotle has related.' 7
Covarruvias, another of the canonists, wrote : " The
fourth ground is that money brings forth no fruit itself,
nor gives birth to anything. On this account it is inad-
missible and unfair to take anything over and above the
lent sum for the use of the same, since this is not so
much taken from money, which brings forth no fruit,
as from the industry of another."
And again Vaconius Vacuna : " Therefore he who gets
fruit from that money, whether it be pieces of money
or anything else, gets it from a thing which does not
belong to him, and it is accordingly all the same as if
he were to steal it."
Thomas Aquinas considered the element of time in
interest, and held that he who charged interest charged
for time, which belonged alike to all, and a thing of
which no one could make a monopoly without robbery.
There were four points in the doctrine of the canonists 2
viz. :
1. Loan interest is simply an income which the lender
draws by fraud or force from the borrower. 2. The lender
is paid in interest for fruit which barren money cannot
bear. 3. The lender sells a use which does not exist, or
ECONOMICS.
179
which in reality belongs to the borrower. 4. The lender
sells time, which belongs to the borrower just as much
as it does to the lender and to all men. In every sense
interest appears as a " parasitic profit extorted or filched
from the defrauded borrower." These illogical and unjust
arguments appear very crude to us to-day, who have so
long been accustomed to the payment of interest. Yet they
serve to illustrate the truth that former ages had their
vagaries and visionary theories as well as this, considered
in the light of dogmatic teaching. During the sixteenth
and down through the eighteenth centuries the arguments
against interest gradually subsided. The world went on
practicing the use of interest without taking heed to the
sayings of the philosophers. Sometimes in recent years
people revive the old controversy in a new way, apparently
not conscious of the exploded theories of former days.
Among modern economists there have been a variety of
views set forth, some of them of entirely opposite char-
acter. Thus, James Mill and McCulloch held that in-
terest was nothing but the wages of labor stored up in
capital, and as all capital was originally formed of
labor, that the interest on the capital corresponded to the
wages of labor. The explanation of the origin of capital
and its service in production would indicate that this
is not only a confusion of terms, but also hints at that
which is not true. It was held by Turgot and supported
by Henry George, that interest derived its reason to be
on acount of live capital which brought forth a return
without accompanying labor. Thus, land, animals, bees
and wine would yield a return without labor. From this
as a starting-point, they held that other capital should have
180 ECONOMICS.
the same return. This traces interest to a natural source.
More recently Menger, J. B. Say and Hermann held
that capital brought forth interest because of its especially
favorable investment, which yielded a return over and
above its normal productivity. Other writers have tried
to show that capital has some peculiar power of increasing
so that interest will grow out of it under all circumstances
but these people overlook the idea of time, of risk, and of
abstinence or the special diversion of capital into certain
channels. While abstinence is not the cause of interest,
it is indispensable to the formation of interest, becauses
through it capital is placed in a condition of service.
Another very erroneous idea is that interest is robbery]
that the product ought all to go to labor, but a robber seizes
that which belongs rightly to others and calls it interest.
These writers, among whom are Marx and Rodbertus,
hold that there is no rational cause for interest. If told
that because a man owns property he has a right to
pay for the same, the followers of these writers have
asserted that man has no right to private property, and
they cry out with Proudhon, that "property is robbery."
But they claim if labor had received its share of the
net earnings there would be no capital accumulated in
the hands of those who do not labor. But this does not
say that the capital would not have its existence, and that
the laborers who would own it could not charge interest
or at least have a right to it. In fact, this is the real
case, for the laborers of this life are the capitalists ; they
are the ones who save and who obtain a return from their
savings. In reality, granting two points, that a man has
the right of property and that the laborer has the right of
wages, I have no more right to ask a man to allow me
ECONOMICS.
181
to use his capital without a return than I have to ask
him to work for me without a return in wages. How
absurd for me to say to a man r "You are stronger than
I, and as I have work to be done which will greatly
benefit me, if you will come to work for me I shall have
a better living, a finer house and more leisure; and for
this service I propose to pay you nothing, because you
have no right to charge me for such services." Would
it not be equally absurd for me to say, "You have a thou-
sand dollars and I have none; let me take your money^
as I know a profitable investment where I can make a
large return in a short time " ? And you say, " What
will you give me for the use of this money ? " I say,
" Nothing ; you do not need it and I do." How absurd
such a proposition would be!
Interest a Premium on Exchange.
In his admirable work on Capital and Interest, Boehm-
Bawerk gives a careful review of all theories, and finally
advances his own, which seems to throw much light upon
the subject. He holds that a loan is an exchange of
present goods against future goods. On account of the
ordinary desires of man to value present things more than
future ones, a lump of capital is worth more to-day than
its future valuation for a year from to-day. Hence if
present commodities command a premium over future
ones, it is to be observed that a sum of present wealth
is to be had only at the price of a greater one in future.
This premium is the net interest. This places all loans
on a purely exchange basis, and makes interest the differ-
ence in the price of a commodity of to-day from the same
commodity a year from to-day. It is a simple business
way of estimating interest, and disposes effectually of
182
ECONOMICS.
the theories which have been advanced to show that money
is barren, or that money is fruitful in itself, or that in-
terest is robbery. That is, you have a horse which I ask
you to loan me for a year. To-day the horse is worth $100.
But I will not agree to give you a hundred dollars for
the horse a year from to-day, because, supposing that
he will be in good condition then as now, a year's service
has gone. Hence if I borrow the horse for a year I must
return something besides the horse to make an even trade.
It is the same with the hundred dollars being worth more
money to-day than it will be a year from to-day, I agree
to pay that difference, which is $8 or $6, as the case may
be. This is called interest, and may be paid now or a
year from now. This interest is usually calculated in a
given rate on the principal, which is sometimes mislead-
ing.
Bate on Loans.
The rate on loans varies slightly during a long period
of time. There is a steady decline in interest as society
becomes more stable and business investments more per-
manent. But the rates vary in different countries as well.
In England interest is lower than in Boston, and it is
lower in Boston than in Kansas City. The chief causes
of this are, first, the amount of available capital seeking
employment in older countries; and, second, the element
of risk. People do not like to take the risk of loaning
money in new and unsettled countries, or in lands far
away from home. In the former case they will do so if
the interest is large enough to tempt them to take the
risk; in the latter case, if interest is sufficient to cover
risks and agents' commissions, they may make loans. I
said that the rate of interest continually decreases, although
ECONOMICS. 183
the process is a slow one if we exclude the element of
risk, which may cause a sudden change in the interest at
any time. Thus, in early times in Kansas, money was
loaned at the rate of eighteen per cent., and it was not long
ago that current rates were twelve and thirteen per cent.
Now, the usual rate is eight per cent, at banks, while first-
mortgage loans are six and seven per cent, in eastern
Kansas, and four-per-cent. school bonds sell readily at
a premium ; while banks charge ten per cent, on short-time
loans. In 1876 in California one and one-half and two
per cent, per month were common charges in many parts
of the State, while one per cent, per month was a fair
average in San Francisco. The great cause of this decline
is in the fact that large amounts of capital have accumu-
lated in London and in the large cities of the eastern
part of our nation, which are seeking investment. And
on the other hand, the West, having become more
stable than formerly there is less risk engendered. The
yearly average of interest in London for the last twenty
years has been less than four per cent. ; it exceeded that
amount but one year. In 1888 the British debt was
funded at two and three-fourths and two and one-half
per cent., and it is not uncommon to charge only two and
two and one-half per cent, for money in London. People
are glad to get four to five per cent, in New England
on gilt-edged security. It is difficult to loan money at
five and one-half per cent, in Kansas City on first-class
security. Other things being equal, the rate of interest
will depend on the amount of available capital seeking
employment; or in other words, upon the demand and
supply. But other things are not always equal. For
example, in times of panic and unsettled business there
184
ECONOMICS.
may be plenty of money with interest low, or at certain
stages there may be plenty of money and interest high]
but where a large amount of money seeks honest and
legitimate investment it must have an effect in lowering
interest. The rate of interest will vary, secondarily, ac-
cording to the desire of people to enter new business, and
it is also somewhat dependent upon the character of the
borrowing community. If the latter has a record of pay-
ing debts promptly and without failure, more favorable
terms of interest may be had; while if there are doubts
as to its solvency, the rates of interest are higher.
Effect of Cheap Money on Interest.
Some people, and even some economic writers, have
been mistaken as to the effect of a cheaper money on in-
terest. If the purchasing power of money could be reduced
one-half it would not cheapen interest, as an inflated cur-
rency has no perceptible influence on interest. For if the
interest is paid by a given per cent., the same proportion of
the cheap money will go to pay the debt. In another way,
however, inflation frequently leads to speculation, and
this brings on a higher rate of interest. If, however, a
debt is contracted in one form of money and the interest
made payable in another, dearer form of money, then
interest will be increased directly by inflation.
Legislation and Interest.
One of the most difficult points to consider in relation
to interest is the result of legislation on interest. Can
a single State reduce the rate of interest by passing a
law to reduce it below the current, commercial rate ? The
general tendency of all legislation to reduce interest is
to make it more difficult for the borrower. However, there
ECONOMICS.
185
are some things to be observed in connection with this
general assertion. So long as a State can by the power
of legislation change the custom or habits of the people,
there is some governmental power in the reduction of in-
terest. Suppose the current rate based upon the supply
and demand in a given State should be eight per cent,
and suppose the legislature should suddenly pass a law
that no more than five per cent, should be charged, and
fix a heavy penalty for disobeying the law. Two things
will occur: first, money will seek other countries for an
investment and the current rate will rise; second, the
law will be evaded, if not violated, and those persons who
borrow money will suffer. However, if in this given
State people have been charging a large interest through
long custom and lenders have a sort of monopoly on loan
funds, laws may be passed asserting, for example, that six
per cent, is the proper rate of interest; this measure will
have a large influence in the reduction of interest, if there
be a considerable amount of home capital. For the bor-
rower will borrow less money, rather than to take it at
a price which is declared exorbitant. And lenders, rather
than have their money idle and rather than have it leave
the State for a higher rate, will loan at a lower rate. Like-
wise, lenders will slowly adjust themselves to the new
rate, simply because their attention has been called to
the fact. In some Eastern States the rate has been fixed
for years at six per cent. In these States, in country towns
and country places at least, no one thinks of charging
more. It is not the law so much as custom, education, and
I may say religion, that keeps the rate below this maxi-
mum. On the other hand, without any collusion the banks
of a small town may demand a certain rate because they
186
ECONOMICS.
have always charged a certain rate, and thus refuse to take
less. People who must have money will pay the charges
rather than go without; but the same custom is observed
to a large extent in merchandise in a small town, because
it is slow to feel the rise and fall in the general market.
Custom rules to a considerable extent, although these are
really exceptions to the general law. Legislation for the
reduction of the rate of interest has generally proved to
be a dangerous thing for the borrower. A law fixing
a maximum rate is very valuable in cases where no rate
is mentioned in contracts, or where a judgment for interest
is rendered. It also to a certain extent prevents extor-
tion in certain cases. This is absolutely essential in all
well-regulated countries.
Interest as an Economic Factor in Distribution.
While it has been stated that land and labor are the
two essential factors in production, and precede capital
in logical order, it is also known that when capital is
once created it enters into production and claims its own
reward in interest. Interest must always be satisfied
wherever capital is used in production. The wages of
labor and the rent on land are not more certain than the
interest on capital. In the process of production many
people go into business who are not capable of manage-
ment, and interest finally absorbs their earnings and the
result is they must quit business. But this does not mili-
tate against interest as a natural factor in distribution.
Capital is a necessity in modern production, and its just
reward is interest, which must be paid.
References: Clark, J. B., Capital and Its Earnings; Boehm-
Bawerk, Eugene von, Capital and Interest; Ely, R. T., Outlines
of Economics; Cassell, G., Nature and Necessity of Interest.
ECONOMICS. 187
CHAPTEK Y.
PROFITS.
Gross Profits.
Some classify all the returns of industry as profits, in-
cluding rent for the use of land, interest on capital, and
profits of management; but it is profits of management
that concern us in the present analysis. Gross profits
must be distinguished from the profits of the entrepreneur
or manager, which are called pure profits. If we would
consider any given business we should find that there must
be a replacement of the amount of capital used out of
the entire receipts of the year ; that the interest on capital
must be paid, and also a certain sum in the form of a pay-
ment for risk must be set aside to tide over bad years ; and
that the wages of superintendence must also be paid. If
there is anything left out of the returns for a single year
we call it pure profits, which goes to the manager of the
business.
Pure Profits.
If we consider normal industry we shall see the division
of the net product into the different shares accruing to
landlord, capitalist, and laborer; we shall observe that
industrial enterprises go on from year to year working on
this basis. The managers of business may receive nothing
more than the wages of superintendence. So long as they
receive this, business will continue. If they fall short of
this, business will cease. But there are certain concerns
more favorably situated or better managed than others,
183
ECONOMICS.
which yield a surplus of profits over and above the pay-
ment of the ordinary expenses of business. This surplus
of pure profits accrues on account of excessive skill of
management. It has sometimes been called the rent of
superior characteristics. It more naturally falls into this
category than any other. Yet according to most writers
it is called profits, and we follow the rule to avoid con-
fusion. Business ability or the quality of management
makes the return of profits uncertain and indefinite.
Nevertheless it is true that all businesses can be arranged
in a group, passing all the way from no-profitt industry
to that of a large return.
Competition and Fronts.
Competition also destroys pure profits, or tends to re-
duce them. The person who obtains some means of pro-
ducing cheaply, or has obtained a desirable location, or by
skill in advertising has succeeded in making a large profit,
cannot continue long before others discover his secret and
enter the same field. Hence in any given industry profits
continue to decrease gradually; and the older the country
the more rapidly they decrease. Hence there is a tendency
to level down profits.
The Managing Class.
The power of the managing class in business is very
great. An observation of the number of failures in busi-
ness of any sort or description is evidence of the need of
skill to conduct business properly and with profit. Thou-
sands, presuming upon a skill they did not possess, have
wrecked their business and dragged others down with them.
In discussing the labor problem, or the problem of capital,
not sufficient importance has been given to the managers
ECONOMICS.
189
of business, who are the true employers of labor; nor
sufficient credit for their part in productive enterprises.
Without them the wheels of industry would stop; the
modern process of production includes them as essential
factors.
Profits and Bent.
As was stated above, the law of profits is to a certain
extent governed by the same law as that of rent. The
power to command profits must rest upon exceptional op-
portunities and exceptional abilities which combined
make profits possible. There are a large number of people
who are doing business for the sake of profits who obtain
no return. All that their business pays is the wages of
labor, interest on capital, and wages of superintendence,
together with other expenses such as rent, taxes, insurance,
etc. Pure profits do not emerge in the transaction. The
result is that these businesses will continue to run until
a fall in price or depression in trade causes them to close.
Other businesses in the same line, on account of favorable
location, the prestige of business through trade-marks,,
advertising, and other means, or through superior skill of
management, yield a return in pure profits. It is easy to
observe that the principle here is the same as that of rent.
The chief difference is that profits arise from very uncer-
tain conditions. There is less regularity in the appearance
of profits than in the appearance of rent, nevertheless