Ludwig von Mises Institute

Interest

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Interest is the ratio in the mutual valuation of present goods against future goods.[1]

History[edit]

On Mesopotamian clay tablets are recorded repayments of commodities that had been loaned. The lending system of ancient Babylon was evidently quite sophisticated. Debts were transferable, hence should be paid to the bearer rather than a named creditor. Clay receipts or drafts were issued to those who deposited grain or other commodities at royal palaces or temples. Borrowers were expected to pay interest (a concept which was probably derived from the natural increase of a herd of livestock), at rates that were often as high as 20 percent. Mathematical exercises from the reign of Hammurabi (1792-1750 BC) suggest that something like compound interest could be charged on long-term loans.

In the Middle Ages, lending money at interest was a sin for Christians. Usurers, people who lent money at interest, had been excommunicated by the Third Lateran Council in 1179. Even arguing that usury was not a sin had been condemned as heresy by the Council of Vienna in 1311-12. Christian usurers had to make restitution to the Church before they could be buried on hallowed ground. They were especially detested by the Franciscan and Dominican orders, founded in 1206 and 1216.

In medieval Venice, Jews had been providing commercial credit. They did their business in front of the building once known as the Banco Rosso, sitting behind their tables - their tavule - and on their benches, their banci. Jews, too, were not supposed to lend at interest. But there was a convenient get-out clause in the Old Testament book of Deuteronomy: 'Unto a stranger thou mayest lend upon usury; but unto thy brother thou shalt not lend upon usury.' In other words, a Jew might legitimately lend to a Christian, though not to another Jew. Jews had been expelled from Spain in 1492. They sought refuge in the Ottoman Empire and from its ports they then established trading relationships with Venice. At first the city's government was reluctant to accept them, but it soon became apparent that they might prove a useful source of money and financial services, since they could be taxed as well as borrowed from.[2]

Composition of interest[edit]

Originary interest is the ratio of the value assigned to want-satisfaction in the immediate future and the value assigned to want-satisfaction in remoter periods of the future. It manifests itself in the discount of future goods against present goods. It is a ratio of prices, not a price in itself. There prevails a tendency toward the equalization of this ratio for all commodities. In the imaginary construction of the evenly rotating economy, the rate of originary interest is the same for all commodities. [1]

The granting of credit is necessarily always an entrepreneurial speculation which can result in failure and the loss of a part or of the total amount lent. Every interest stipulated and paid in loans includes not only originary interest but also entrepreneurial profit.[3]

The purchasing power of money can change and so affect credit contract. A price premium can be introduced to amend this problem. It can be negative when it reflects an anticipated rise in the purchasing power of money, i.e., a drop in prices, and positive when it reflects an anticipated drop in the purchasing power of money, i.e., a rise in prices, as is frequently the case when inflation is anticipated.


However, in a changing economy, there is no uniform rate of originary interest; there only prevails a tendency toward the establishment of such uniformity. Before the final state of originary interest is attained, new changes in the data emerge which divert anew the movement of interest rates toward a new final state. Where everything is unceasingly in flux, no neutral rate of interest can be established.

In the world of reality all prices are fluctuating and acting men are forced to take full account of these changes. Entrepreneurs embark upon business ventures and capitalists change their investments only because they anticipate such changes and want to profit from them. The market economy is essentially characterized as a social system in which there prevails an incessant urge toward improvement. The most provident and enterprising individuals are driven to earn profit by readjusting again and again the arrangement of production activities so as to fill in the best possible way the needs of the consumers, both those needs of which the consumers themselves are already aware and those latent needs of the satisfaction of which they have not yet thought themselves. These speculative ventures of the promoters revolutionize afresh each day the structure of prices and thereby also the height of the gross market rate of interest. [4]

Interest is not a price[edit]

Originary interest is not a price determined on the market by the interplay of the demand for and the supply of capital goods. Its height does not depend on the extent of this demand and supply. It is rather the rate of originary interest that determines both the demand for and the supply of capital and capital goods. It determines how much of the available supply of goods is to be devoted to consumption in the immediate future and how much to provision for remoter periods of the future.

People do not save and accumulate capital because there is interest. Interest is neither the impetus to saving nor the reward or the compensation granted for abstaining from immediate consumption. It is the ratio in the mutual valuation of present goods as against future goods.

The loan market does not determine the rate of interest. It adjusts the rate of interest on loans to the rate of originary interest as manifested in the discount of future goods.

Originary interest is not "the price paid for the services of capital." The higher productivity of more time-consuming, roundabout methods of production, which is referred to by Böhm-Bawerk and by some later economists in the explanation of interest, does not explain the phenomenon. It is, on the contrary, the phenomenon of originary interest that explains why less time-consuming methods of production are resorted to in spite of the fact that more time-consuming methods would render a higher output per unit of input.[1]

Interest and Land[edit]

The phenomenon of originary interest also explains why pieces of usable land can be sold and bought at finite prices. If the future services which a piece of land can render were to be valued in the same way in which its present services are valued, no finite price would be high enough to impel its owner to sell it. Land could neither be bought nor sold against definite amounts of money, nor bartered against goods which can render only a finite number of services. Pieces of land would be bartered only against other pieces of land. A superstructure that can yield during a period of ten years an annual revenue of one hundred dollars would be priced (apart from the soil on which it is built) at the beginning of this period at one thousand dollars, at the beginning of the second year at nine hundred dollars, and so on.[1]

Zero interest[edit]

Originary interest is a category of human action. It is operative in any valuation of external things and can never disappear. If one day people started to believe like at the close of the first millennium of the Christian era, that the ultimate end of all earthly things was impending, men would stop providing for future secular wants. The factors of production would in their eyes become useless and worthless. The discount of future goods as against present goods would not vanish. It would, on the contrary, increase beyond all measure.

On the other hand, the fading away of originary interest would mean that people do not care at all for want-satisfaction in nearer periods of the future. It would mean that they prefer to an apple available today, tomorrow, in one year or in ten years, two apples available in a thousand or ten thousand years. We cannot even think of a world in which originary interest would not exist as an inexorable element in every kind of action. Whether there is or is not division of labor and social cooperation and whether society is organized on the basis of private or of public control of the means of production, originary interest is always present. In a socialist commonwealth its role would not differ from that in the market economy.

As long as the world is not transformed into a land of Cockaigne, men are faced with scarcity and must act and economize; they are forced to choose between satisfaction in nearer and in remoter periods of the future because neither for the former nor for the latter can full contentment be attained.

There are always goods the procurement of which we must forego because the way that leads to their production is too long and would prevent us from satisfying more urgent needs. The fact that we do not provide more amply for the future is the outcome of a weighing of satisfaction in nearer periods of the future against satisfaction in remoter periods of the future. The ratio which is the outcome of this valuation is originary interest.[1]

See Also[edit]

References[edit]

  1. 1.0 1.1 1.2 1.3 1.4 Ludwig von Mises. "XIX. INTEREST: Originary Interest", Human Action, online version, referenced 2010-05-11.
  2. Niall Ferguson. The Ascent of Money, Chapter 1, p. 31, 35-37. Published 2008, ISBN 9780141035482. Referenced 2012-06-08.
  3. Ludwig von Mises. "XIX. INTEREST: Originary Interest in the Changing Economy", Human Action, online version, referenced 2010-05-11.
  4. Ludwig von Mises. "3. The Price Premium as a Component of the Gross Market Rate of Interest", Human Action, online version, referenced 2010-05-11.

Bibliography[edit]

  • 1986, Ingo Pellengahr, "Austrians Versus Austrians II, Functionalist Versus Essentialist Theories of Interest", In: Malte Faber, dir., Studies in Austrian Capital Theory, Investment and Time. Berlin: Springer-Verlag
  • 1996, Ingo Pellengahr, The Austrian Subjectivist Theory of Interest: An Investigation into the History of Thought, Frankfurt/M., Berlin, Bern, New York, Paris, Wien


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