In both the instances cited, the adjustment has been made thru a, recurrence to the normal demand and supply of real capital, which has been temporarily disturbed by the changes affecting price and by the consequent modification in the use of capital. To put it in another way, since capital is acquired thru the medium of mone2,,, changes in money supply interfere with the adjustment of the demand and the supply of capital, as. well as with the replacement process that (Toes on all the time.
Variations in the rate of interest are effected by the rapidity of the replacement process, and by the use to which the capital fund is put in creating capital goods. In the bookkeeping of the business community a part of the earnings of capital goods is set aside to replace those goods when replacement becomes necessary. Some capital is destroyed in a single use, as in the case of coal. Other capital, in fixed forms, typified by buildings and machinery, is used a long time before it is necessary to replace it, but in the case of every product something must be set aside as a part of the original cost.
8. Replacement of products of capital give their owners funds or credits which can be used to restore the original wornout 'capital, or to produce other capital. The rate of interest depends upon the capital in existence, and is one of the most important factors in the problem, but the continuance of the capital of the land depends upon the replacement process. For example, the capital invested in car riage works is in a number of important concerns not being replaced. As the products are turned into cash, the owners, instead of using their mobile funds to make repairs, to buy new machinery, and to keep up the plants, are turning them into new industries. The lenders of money are not willing to let their funds go into an industry of this kind, which offers so little promise.
9. The business of a promoter is to formulate the proposition and then to get the funds by which the capital for the enterprise can be pur chased. He advertises and circularizes, solicits and persuades, until the people who have credit funds, bank deposits and money, exchange their general pur chasing power for paper certificates of ownership. This mobility of the capital fund works toward an ad justment of rates in different industries.
10. Marginal the final analysis, it is the marginal value of capital that determines the rate of interest. The reasoning in regard to the marginal worker applies to the marginal amounts of capital also. With variations in demand and changes in machinery, organizations and supply of capital, the marginal results of capital as well as of labor are continually modified. Many instances are to be found in which productive capital, working in con junction with labor, earns high returns. Generally, however, capital must accept the return that can be paid for the use of the least productive capital. The supply of capital being forthcoming at that remunera tion, the rate paid for capital is determined by the relation of the productivity, expressed in dollars, to the amount of capital employed. This is, and must
be, the current rate.
If the supply of capital were affected by the intro duction of savings from abroad that can be put into capital goods, the rate of productivity would be changed and the interest rate modified. The problem of interest comes to every business man as an indi vidual question, but it is also a community problem, for the determining factors are broad, economic forces that have to do with the real productive agencies of the nation.
11. Effect of high or low the lender wants to know about his loan is, Can I be sure of getting the interest? There are many people who invest part of their money in railroad bonds and part in real estate mortgages. If the railroad interest rates fall while farm rates remain unchanged, some of the people will direct their new investments to farms instead of railroads, thus increasing the supply of farm loans and diminishing that of railroad loans. If the process were completely carried out we should have an equalization of the rates of interest in different lines and the establishment of one general rate of interest fi)r capital as a whole. This process of shift ing from the fields of the lower to those of the higher rates of interest takes place all the time, tho judgment and conservatism tend to hold the movement in check-. According to the view that the interest rate tends to indicate the marginal productivity of capital, there ought to be a steady tendency toward an equal rate, in so far as there is no interference because of monop oly conditions. A.11.,e• The problem of &insurance is affected in all its phases by the rate of interest. If the rate of interest falls the necessity for higher premiums appears, since the insurance funds must earn a rate sufficient to meet the obligations assumed. The man looking for an annuity by which to protect his later years with a suitable income, finds the interest rates determining the amount he must pay for the annuity. In other instances similar results are to be seen. The man who hopes to leave his family a sum large enough to furnish an adequate income is confronted by the dilemma of either lowering his estimate of the income, or mate rially increasing the capital fund if the rate of interest falls in high-grade activities. Up to a certain point the lower rate might stimulate increased accumula tions in some groups, but in others it would encourage immediate consumption.
Occasionally legislative bodies attempt to fix the interest rate by law. The effort is futile, for capital, being governed by economic principles, must have a certain rate of interest. Allowance is made for risk and possibility of loss, in accordance with the general judgment, and the legislative act merely prevents the borrower from placing his funds to the best advan tage. Heavy taxation on securities, mortgages and notes brings evasion of taxes ; and a higher rate of interest for the borrower is the outcome, because of the fear which the lender has of discovery or seizure of his property.