Responding to Critics
on the Subject of Interest Theory

Raymond V. McNally

[Reprinted from Land and Freedom, November-December 1937]

I note some comments in the July-August issue on my article ("What Is Interest?") which I think demand a reply.

D. L. Thompson states that if I am right in my opinion that what is termed "interest" is merely "compensation for risk," interest rates should be higher, as he believes "the element of risk has steadily increased since the last industrial breakdown." I am afraid, however, that such a belief is not substantiated either by fact or in theory. Anyone who has made a study of business cycles knows that the element of risk is greatest immediately prior to an industrial crisis, when speculation has driven values upward to the breaking point, and is lowest during the period between crises. It is the wise man who invests during this interim. Your readers will doubtless recall the fact that commercial interest rates just prior to the 1929 debacle were at a record height and gradually shaded off as a new equilibrium was being established. A few years ago at the low point of the depression, after the terrific liquidation of 1932 (when business failures were more numerous than in any other year), interest rates were at the lowest level one-eighth per cent on call loans. Since that time they have been slowly hardening, corresponding with the increase in the hazards of doing business not, as Mr. Thompson contends, since the "last industrial breakdown," but since the low point of the depression. They will continue to rise, for the risk element increases as we creep nearer to the next crisis. The great activity recently in the building industry is a sure indication that men with capital regard conditions now to be more secure than they were just prior to or immediately after 1929.

As for Mr. Thompson's claim that the element of time accounts for "interest," I would like to refer him again to my article, for he has made no attempt to meet the arguments that I set up against this particular idea. And as his error appears to be due to his having confused use value with economic value, I suggest also that he read the very enlightening chapters on value in Henry George's The Science of Political Economy.

Turning now to the letter written by Henry P. Sage, I find him claiming that the cause of "interest" is the service rendered by the lender to the borrower which enables the latter to "overcome the disutility of time" and is not the increased power that labor receives from capital. But although he has made a valiant effort to keep clear of the Productivity theory, he cannot help falling into it when he tries to measure this disutility or inconvenience. He offers the illustration of a man who, rather than spend a year accumulating capital, prefers to borrow $500 so he can work his farm immediately At the end of the year, he is able not only to pay back the principal with "interest" but to have for himself stock and tools and several hundred dollars in cash. Now, Mr. Sage wants us to believe that when this farmer applies capital to land, he can earn more than he could at some other occupation without capital. But this is rather doubtful economics, for such a condition is impossible. If a man could increase his income merely by using capital, a flock of competitors would be attracted to his occupation who would drive his income down to what it was working without capital. And if he borrowed capital in order to obtain an advantage over working without capital and contracted to pay for that advantage, he would soon find himself bankrupt. Practical experience supports this statement, for 90 per cent of those who enter business for themselves eventually fail, largely because of incompetence. Capital can give nothing to labor that labor does not already have in itself. A savage, for instance, would be helpless with a machine in his hands. A man does not use capital to increase his efficiency, but rather he is first efficient and that is why he uses capital. In other words, using capital is the conventional mode of producing wealth, and the man in the illustration is compelled by competition to employ capital on this type of farm if he is to remain in the market. This may be difficult to perceive, for we are so accustomed to the schoolboy formula that "capital aids labor to produce wealth." Mr. Sage's belief that labor gains from the use of capital is based on the assumption that, as an alternative to borrowing, one must engage in an inferior occupation in order to accumulate capital, as though capital had the power to determine one's ability or the productiveness of any occupation. Such a notion is socialistic and contrary to fact. This assumption is the pitfall of all productivity theorists. It is labor only that determines the character of industry. Capital merely represents the method of labor or the direction that labor takes in production.

When we come to understand the true nature of capital, we shall see that one borrows instead of accumulating capital oneself, not to gain an advantage over working without capital, but because of the convenience of having it at a particular time. All that can be afforded in return for this convenience is compensation for risk, for one's income as a laborer, other things being equal, is determined entirely by one's own efforts.