CAPITALIZATION AND INTEREST § 1. Interest subsequent to time-price. 1 2. Origin and definition of the term,tnterest. § 3. Interest versus income, or gross versus net in terest. A 4. Concealed rate of interest. § 5. Commercial paper. 1 6. Mercantile cash discounts. § 7. Long-time loans. I 8. Special markets for money loans. 1 9. Capitalization, the clue to the general interest rate. § 10. Time-series of incomes, monetary and non-monetary. 1 11. Present dollars and what they can buy. § 12. Blending of the invest ment premiums into a common rate. * 13. Indicative nature of the in terest rate.
§ 1. Interest subsequent to time-price. There remains to consider that form of a price for time which is most prom inent in the thoughts of men in the business world, which therefore often is the only form that is recognized—namely, interest on a loan of money, or on credit expressed in terms of money. The buying and selling of anything for a price expressed arithmetically was very unusual until some form of money came into use; and this was particularly true of the sale of timeliness in a barter economy. The loaning of money occurred in the commercial cities of ancient times, but for a long period, in the Middle Ages, was very unusual. The practice again became common in commercial cities of Europe about the fifteenth and sixteenth centuries. The deepest thinkers from Aristotle (p.c. 384-322) to Thomas Aquinas (1224-1274 A.D.) could see nothing in a money-loan but its superficial money-aspect, nothing of its underlying economic nature, and they studied the problZm only as one of morals. When, despite all the disapproval of philo sophic moralists of church and state, the practice of money loans had become common in commercial circles in cities, the 300 earlier economists began to attempt an explanation of the phenomena. A prevailing rate of premium on money-loans appeared only where money was in use, and therefore at first was deemed to be peculiarly connected with the quantity of money in the country. This idea still widely persists, is indeed the naïve theory of every mind until it is corrected by some economic thought. Some economists began to see that the rate of interest on money-loans was somehow a reflec tion of the general state of wealth of the community, and was not in the long run dependent on the quantity of money in the community. Behind the problem of the rate on con tractual loans was seen to be a more fundamental economic problem of value. The explanation of the problem was, how ever, still begun in the market for contractual loans, the so called money market. We, having studied the nature of time preference and of capitalization, are in a position from which to view money-loans in a different way, and to see them in their true character as merely forms in which time-preference sometimes appears in an economy where money is in general use and borrowing is common in commercial affairs.
§ 2. Origin and definition of the term interest. The term interest,I applied in the Middle Ages to a payment for the use of a money loan, was first a substitute for the word usury. It was intended, by indicating that the lender had something involved in the business, to soften the general op position of the church and of public opinion to such agreements.
The word interest will be here defined in its original meaning, still almost universal in business circles, to wit : Interest is the amount paid and received according to a con 1 The economists of the eighteenth, and early part of the nineteenth, century gradually broadened the term to include any income attributable to those goods generally bought and sold in terms of money. Later the term was extended to include, tho never consistently, a large part of the problem of time-value, the nature of which was beginning to be seen.
tract for credit given in terms of money. Credit is the post ponement of the right of either party in an exchange to require immediate delivery of the price agreed upon. The creditor puts faith (credence) in the promise of the debtor. The rate of interest is the percentage that the interest (usu ally for one year) makes of the principal. The principal is the amount loaned expressed in dollars as a capital sum esti mated apart from the interest. Interest, in this sense, always is a price, and not simply an individual's estimate. "Its amount is always stipulated by a contract between persons (expressed or implied, as either the customary amount or the legal amount specified by statute law). The interest contract may not illogically be looked upon as a special case of the rent contract, the thing rented being a stated amount of money (the standard of deferred payments or things acceptable to the lender as of equal value) and the rent (interest) being a smaller amount of money. Interest is payable at stipu lated periods until the money loaned is returned. The ex pression of the interest as a percentage (rate of interest) is of great practical convenience, permitting as it does payment of parts of the principal and for partial periods of a year without alteration of the contract. Moreover, the expression of interest as a rate per cent of the principal gives to the interest problem an aspect very different from any presented by the rent § 3. Interest versus income, or gross versus net income. The sum paid as interest on a 1and the rate specified contain other elements than a pure t me-price. This is recog nized constantly in practice and must be observed in theory.