Additional Comments
on the Theory of Interest

Raymond V. McNally

[A response to comments made by C.H. Kendal.
Reprinted from Land and Freedom, July-August 1937]

Mr. C. H. Kendal's letter on interest in your May-June issue appears to me to have been the result of some sort of a telepathic divination on his part, for he has presented an excellent example of just the thing I warned against in my article. Mere assertions and appeals to ethics do not prove interest. This fact must first be realized before we can hope to solve such a problem. Mr. Kendal's position on this question is typical of the confusion that invariably attends discussions on interest, for he has offered two entirely different theories to account for the phenomenon of interest the Productivity theory and the Use theory.

He gives us an illustration in which five men with capital, group A, can produce 40x per man, and five men without capital, group B, can produce only lOx per man. The excess of 30x he declares is interest, but not the slightest proof is offered to support this assertion. In the absence of such proof, it may be stated with equal assurance that the entire 40x is wages. Failing to perceive the relationship between value and interest, he overlooks the fact that in order to prove interest, it must be shown that the 40x less the replacement value of the capital possesses more value than the lOx. We must keep in mind that interest, in the economic sense, is considered to be the increase that accrues, not to any particular capital, but to generic capital. In this matter, we are not concerned with capital as a physical concept but as a value concept. Therefore, we cannot regard interest so much as a quantity of goods as an increase in value. As a matter of fact, in the very next paragraph Mr. Kendal admits that the entire product of 40x less "the mortality of the capital" is wages, indicating either that he does not after all consider 30x as interest or that he indentifies interest with wages. He is correct in drawing a distinction between quantity or natural interest and the rate of interest, but because he has not proved interest, he is unable to show any direct relation between the two in his next illustration.

He assumes now that both groups of labor use capital so that each man receives 40x, and there being no borrowing demand and no lending supply, the rate of interest is zero. But one man becomes ill and cannot use his tool (capital). The supply of capital exceeding the demand, the rate is still zero. Another man, however, breaks his tool. He can either make a new tool or borrow that belonging to the sick man. Now there is a lender and a borrower, and here Mr. Kendal comes np against an obstacle, for he is unable to determine what the borrower will pay the lender. He will not pay 30x, the excess over what he could obtain is he used no tool, nor in fact any part of it, for he is free to make his own tool and obtain the entire 30x for himself. Realizing, therefore, that he cannot show what the borrower will pay by attributing interest to the productivity of cap- ital, Mr. Kendal shifts his allegiance from the Productivity theory to the Use theory. But here he falls up against another obstacle because he is unable to give any economic reason whatsoever why the borrower will pay interest for the use of the tool. Consequently, he appeals to the moral element with which economic science is not concerned with this statement: "... equity demands compensation for its use (legally enjoyment in time), plus 'capital write-offs,' viz., mortality items wear and tear, etc. A free lending "would be charity, not equity." Nor does he attempt to justify these moral assertions. On the contrary, it may be asserted with equal assurance that equity demands no such thing, for even though the sick man received no interest on his capital, he would gain by lending. His tool suffers from natural deterioration, and if he did not lend it, he would receive no compensation for this deterioration. Thus, it is to his advantage to lend even though he received no extra payment as interest, for he would be fully compensated by receiving payment for the deterioration plus wear and tear. Can equity demand more than this? Apparently Mr. Kendal assumes that two kinds of uses attach to the loan of capital, but the use of capital is the same thing as its consumption, and the compensation for this use is not interest but either another tool equally as good or a sum equivalent to its replacement value. (See the discussion of the Use theory in my article in the May-June issue.)

If there is such a thing as interest, then when the supply of capital is just sufficient to satisfy the demand, a payment of interest should pass from the borrower to the lender. But in the illustration given here, it is not proved that any such payment is due. Therefore, it is meaningless to say that the supply and demand of capital determines the rate of interest. If there is a shortage of capital that is, the demand exceeds the supply the borrower may have to pay a premium in order to obtain capital, but this is not interest. However, the tendency is for the supply of capital to increase in proportion to the demand, and so this premium would be paid only in exceptional cases. Now, the question might be properly asked: Why does one borrow capital? Surely, it is not in order to obtain the power which resides in it to increase one's efficiency, because one is free to accumulate or to produce capital himself. Therefore, one borrows for the sake of convenience, but any payment for this is not interest. The lender, however, requires compensation for the risk involved in the employment of his capital and demands a payment in proportion to the risk. But this is merely an equalization of profits and losses an element of business cost and not an economic concept and disappears when production in the aggregate is considered. It may be called commercial interest but is not economic interest, because the latter is regarded as an addition to the sum total of wealth.

Mr. Kendal's concluding statement is very curious, inasmuch as the latter part of it seems to contradict the first part; and because it suggests a serious lack of harmony between the moral law and economic laws, it leads one to suspect that he has not been discussing interest at all, but something else. I quote; "Under equitable conditions interest is inevitable and while under such conditions equity would demand a rate of interest on borrowings, the supply of capital would be such that, in all probability, the rate would approximate zero."

Although he has claimed that interest is natural and just, in effect he is saying here that under equitable conditions, the capitalist would receive little or no interest for the loan of his capital. This implies then that today the income of the capitalist as such is the product of inequitable conditions, and that loan interest, rather than being in any way connected with quantity interest, is due to an unnatural restriction of the supply of capital a monopoly payment forced from labor, in other words and that, therefore, it is both unnatural and unjust an admission that should gladden the heart of any socialist. But if there is such a thing as interest, and if it is just, then under equitable conditions, the rate should be higher than it is now, for while the supply of capital would be greater, the demand for it would also be greater.

All of this is evidence of the difficulties one gets into when he tries to locate something that does not exist. The very nature of capital precludes the attributing of the phenomenon that is called interest to any absolute cause.