Chapter XLIII: Section CLXXXVI

HISTORY OF THE RATE OF INTEREST.--CAUSES OF A HIGH RATE IN THRIVING COMMERCIAL NATIONS.

There are, however, even where a people's economy is in a flourishing condition, many obstacles which cause the decline of the rate of interest to take a retrogressive course, or which at least may delay it for a time.

To this category belong all the modifications of a nation's economy alluded to in § 183.[186-1] Among them, therefore, is every extension of the limits of productive land. Let us suppose a nation which, its capital and labor remaining the same in every respect, should suddenly double its territory. The less productive places where investments were made in the old province are now abandoned, and labor and capital emigrate to the new. The result is, of course, an increase of the aggregate national income, and, at the same time, a decrease of rent. (§ 157.) Hence, the interest on capital and the wages of labor, taken together, must greatly increase. Which of these two branches shall profit most and longest by the increase will depend upon whether capital or the number of workmen increases most rapidly.[186-2] A similar effect must be produced when, by changes or modifications in the commercial situation, in the tariff, etc., a nation is enabled to obtain the means of subsistence at cheaper rates from more fertile and less settled countries.[186-3]

The introduction of better methods of production has very different immediate consequences, according as these methods affect the commodities which minister to the wants peculiar to workmen as a class, or do not. Let us suppose, as a first case, that the cost of ordinary clothing is reduced one half by reason of newly discovered material, better machines, etc. As in the case of the whole people, so also in that of the owners of capital as consumers, there is, in consequence, an addition to their enjoyment of life. Their interest as well as their capital, compared with clothing material, would have become more valuable. But the relation between capital and interest, that is, the rate of interest, could not be directly changed. (Compare _infra_, note 3.) Only when the working class employ their materially increased wages to increase population; when in consequence hereof, their wages, estimated in money, again decline beyond what it was before; when, therefore, the price of a given quantity of labor declines, does the rate of interest rise, although a portion of that which the workmen have lost may be added to rent on account of the increased population?[186-4] [186-5] If the applicability of the new method of production is confined to articles of luxury used by the upper classes, for instance to fine lace, the rate of interest usual in the country will be affected thereby only to the extent that through the medium of commerce such products are exchanged with foreign nations against commodities consumed by the working classes. But there are very few improvements in production which have not led to a greater cheapness of those things which satisfy the wants of the working class; and this is especially clear in the improvements in the means of transportation so usual in our day.

However, the increase of fixed capital, such as machines, railroads, etc., once they are completed, may, at first, cause a depression of the rate of wages, as well as an enhancement of the rate of interest; the former from the fact that a number of workmen is thereby, at least temporarily, thrown out of employment; the latter because the conversion of so much circulating into fixed capital must diminish the supply of the former.[186-6]

A second class of obstacles consists in the diminution of the supply of capital. War, for instance, always causes such a destruction of capital, and at the same time for the most part renders the reproduction of capital more difficult to such a degree that the rate of interest is wont to rise greatly.[186-7] Something similar is true of other great catastrophes and of extravagance on a large scale.[186-8] Every state loan, whether intended for direct consumption or to procure capital for use (_Nutzkapitalien)_, decreases the supply of circulating capital which most directly determines the market rate of interest.[186-9] [186-10]

[Footnote 186-1: _Wolkoff_ very well shows that the economic
progress of mankind is effected partly by the improvement of
production, and partly by saving. The former increases the
rate of interest, the latter lowers it. (Lectures, 182, 189.
Compare _supra_, § 45.)]

[Footnote 186-2: Thus the rate of interest in Russia rose,
after Catherine II. had conquered the provinces situated on
the Black Sea. (_Storch_, Handbuch, II, 34.) The same is
still more strikingly apparent in the judicious planting of
agricultural colonies.]

[Footnote 186-3: Abolition of the English corn laws! Foreign
commerce when very advantageous, always adds to the
well-being of the people; to the rate of interest, however,
only to the extent that articles which are calculated to
satisfy the wants of the working class become cheaper in
consequence; and this in turn lowers the rate of wages. Let
us suppose that a country had hitherto purchased yearly
10,000 barrels of wine for $1,000,000. It might now happen
that, in consequence of an advantageous commercial treaty,
for instance, the 10,000 barrels might be obtained for
$500,000. If, after this, wine-drinkers want to spend
$1,000,000 for wine as they did before, they of course
double their consumption of wine, but the rate of interest
remains unchanged. If, on the other hand, they leave their
consumption of wine where it was before and apply the saved
half million to effect an increased demand for home
products, the capital required for this production is set
free at the same time. Hence, the relation between the
supply and demand for capital has not changed, abstraction
made of certain difficulties in the transaction. Compare
_Ricardo_, Principles, ch. 7, rectifying _Adam Smith_,
Wealth of Nat., I, ch. 9.]

[Footnote 186-4: An increase in the rate of interest caused
by a diminution in the rate of wages does not last long.
Capital now increases more rapidly, and the increase is
accompanied by an increased demand for labor. If, in the
mean time, workmen have become accustomed to a lower
standard of life, the increasing wages are followed by an
increase of population: then the necessity of having
recourse to the cultivation of land of a worse quality is an
additional cause of a decreasing rate of interest. (Edinb.
Rev., March, 1824, 26.)]

[Footnote 186-5: According to this, it is easy to tell what
influence the increasing skill or activity of the working
class (for instance by a decrease in the number of holidays,
coöperation of wife and child) must have. Where there has
been no accompanying and corresponding elevation of the
standard of life, and of the want of the class, the gain
soon falls to the lot of the capitalists or landowners.]

[Footnote 186-6: See the very clear but not entirely
complete discussion in _John Stuart Mill_, Principles, IV,
ch. 3 ff. When new railways, machines, etc., before they are
complete, simultaneously increase the rate of interest and
the rate of wages, and even sometimes rent, although they do
not immediately increase the national income in any way, the
phenomena are to be explained, not by a distribution of
income, but as the result of an advance of capital made.]

[Footnote 186-7: Compare _supra_, § 184. The rise of the
rate of interest in Basil, between 1370 and 1393, _Arnold_
(loc. cit.) accounts for by the wars and defeats of the
upper German cities. Similarly in Zürich, 1457. (_Joh.
Müller_, Schweizer Geschichte, IV, 211.) During the time
immediately following the Spanish war of succession, the
_usuriers les flus modérés_ in France got 12-15 per cent. a
year. (_Dutot_, Réflexions, 1866.) In Russia the rate of
interest, after the war of 1805-15, rose by 4-5 per cent.
(_Storch_, Handbuch, 35 seq.) Per contra, _Nebenius_, Oeff.
Credit., 70 seq.]

[Footnote 186-8: Thus the Hamburg conflagration, combined
with the bad harvests of 1841, raised the rate of interest
in Mecklenburg for a long series of years. Similarly in
Würtemburg, the many bad harvests from 1845 to 1853, which
are said to have caused a deficiency of 50,000,000 florins.
(Tübinger Zeitschr., 1856, 568.)]

[Footnote 186-9: In bad times, state loans are usually
effected at a disproportionally high rate of interest. This
also operates momentarily on the general rate of interest,
to the injury of persons engaged in business enterprises;
who, by the very fact of the withdrawal of so much capital,
become involved in an unfavorable competition. In the long
run, indeed, the high or low rates of interest paid by
national debts, in so far as the creditor cannot demand
reimbursement, has no influence on the rate of interest
usual in the country. Such debts as cannot be declared due
assume the character of stationary capital, the value in
exchange of which is determined by their yearly return,
capitalized at the rate of interest usual in the country.
(_Hermann_, Staatswirthschaftliche Untersuch., 223.)]

[Footnote 186-10: The coöperation of most of the causes
above mentioned raised the English rate of interest which
had sunk to 3 per cent. to an average of 5, from about 1760
to 1816. Thus _Gauss_, in a manuscript work which I have
used, relates that the fund for the support of professors'
widows in Göttingen was, in 1794, expected to pay only 3 per
cent. In 1799, the trustees observed that their capital
could often be safely invested at 4 per cent.; somewhat
later the rate of interest rose to 5 per cent., at which
point it remained for years. About 1843 ff. the rate of
interest in old Bavaria was only 4 per cent.; in more highly
cultured Rhenish Bavaria, 5 per cent.]