Some Notes on Interest

Sydney S. Gilchrist

[Reprinted from Progress, May, 1978]

One must distinguish between two meanings of interest.

A. Some economists, including some Georgists (and George himself if I recall aright) define interest as the return on capital investment (that is true capital, being "stored labour", or goods which are used to facilitate the production of other goods or satisfactions, i.e. tools, factories, houses, theatres, railways etc. but not including privileges such as licences or titles or quotas or protection). I prefer that the return from capital investment should be called just that - "return from real capital investment" - (not interest, nor profit, which is an emotive word not necessarily related to true capital).

B. The other meaning of interest is the market value (from both buyer and seller views) of the benefit of having something now and paying more for it in the future, or alternatively of giving up something now in order to get more satisfaction in the future.

On one side it is the satisfaction of getting something without waiting; on the other, payment for waiting. The essence of interest is time. In addition, there is the element of risk. If you can get something which gives you satisfaction now, definitely you do get that satisfaction, but if you have to either (a) save up steadily for years to buy the item, you risk all sorts of things - sickness, death, debasement of currency, etc; and (b) similarly if you lend, you risk not being paid back or you may die or you are repaid in debased currency.

There will always be a market between people who want to get something now and pay more over the future, and those who lend.

Reasons for Borrowing

There are three main reasons why people borrow.

(1) To spend the money on things which they want to immediately consume - such as to pay for a big wedding for a daughter, or to pay for a short holiday. That is borrowing for immediate consumption.

(2) To spend the money on something which may yield satisfaction over a more extended period in the form of capital goods. This can be a car or a house which yields satisfactions for a number of years. Or it can be the purchase of capital goods (a factory) which yield a return which also yields satisfactions over a period; I call this borrowing for capital investment.

(3) To spend the money on purchase of privilege which will yield satisfaction into the future (land titles, licences, milk quotas, etc.) This is borrowing for investment hi government-granted privilege - mainly land titles.

Three Functions

The point I wish to make is that interest on money can be used for any of the above three functions, and of course there are many borrowings which may include two or even three. If you borrow to invest in a property or factory you are borrowing to provide both capital and "privilege". There is also only a vague line between "capital" and "consumption". Some goods give satisfaction for only a day or a week, others perhaps several months, others have possibilities of giving a yield satisfaction over much longer. When you buy a car you are buying the expected satisfaction flow over a number of years; in the case of a house, for many years. Sometimes people talk as if there was only one interest rate.

In fact, there are many interest rates ranging from say, savings bank interest 3-1/2% up to the most severe usury on some personal loans. There is a market for all these interest rates, and they differ according to the risks which vary, and to time. The market of course depends on the number of people who are seeking the various types of loans with varying amounts of security, and the numbers who have money to lend and what risks they wish to take. And the market supplies in each affect each other.

Now my point is that if you could not or did not need to borrow money in order to get privileged titles or licences, then there would be no market for loans in that regard.

But there still would remain those wanting to borrow or lend in regard to consumption or capital. As to whether interest would rise or fall is a moot point, which does not matter, because it will still be a fair market payment based on supply and demand without the interference of privilege (we hope).

Possible Effects: Much lending comes from the "wealthy", and this means from those who have a large amount of land rent (privilege) income. If this source is dried up, then money for lending will have to come from those who save from real capital returns, or from the results of labour. So there may be less money offered for lending; so the interest might go up. On the other hand, you can say that because people (home builders or other investors) will not have to borrow to buy land there will be much less demand for borrowing.

Capital and consumption are bigger risks than land privilege, which has been low-risk and well-secured. Higher risks mean higher interest!

Or you may find that everyone is fully employed and so prosperous that they can save up quickly for the things they want.

Capital Equipment

However, there will always need to be a large amount of capital equipment in houses, shops, factories, tools, vehicles, etc. Someone has to plan and produce these well ahead of the actual usage, and there will be time and risk factors which must be rewarded if these capital goods or even consumption goods are produced. There will be lots of things in stock; how do the people who make goods get paid if goods are not bought for say a year or so before they are purchased for actual consumption? How is the shearer paid if it takes a year or more before the wool goes to Europe and finally is worn by someone? Clearly there will still be a whole range of interest rates, depending on risks and waiting times, and individuals' desires and preferences. What does it matter if interest is high or low, so long as it is determined by a free market? You can then decide if you want to be a saver, lender, or alternatively a borrower/investor in capital or consumption.

There will always be people with enterprise and ideas, which they may not be able to finance and who will seek finance. And there will always be those willing to lend or invest for their old age (assuming we don't get a perfect welfare state).

Let's stop saying interest rates will rise or fall. Let's just say that site taxes reduce the purchase price of land and the builder of a house or factory will not have to pay interest for financing the purchase of land. By the way, if you don't need to buy land you'll probably borrow more to buy a bigger house, and pay just as much interest or more if it is poorer security.