Capital value is not primary
2. There are two modes of approach to the problem of interest: one from the side of income (rents); the other, from the side of the bearer (capital). The rate of interest expresses a relation between two values, the value of the income and the value of the sum loaned, whether it consists of money or of other wealth expressed in terms of money; But which of these values is primary in a study of the causes of value? Which is the base from which the other is derived by multiplying at the rate expressing their ratio? The answer to this question cannot be a matter of indifference to the economic theorist. Universally heretofore the study of interest has been approached from the side of capital. A capital sum was said to be invested and to earn a certain interest, that is, per cent., of that sum. The usage of speaking of the investment of capital as a sum given, and of "interest on capital" predisposes the mind to this view.
Expected rents are primary, and capital value is the "years' purchase"
But the approach from the side of income has been shown to be in some important cases the historical origin of the rate of interest, and we need but reconsider reasoning that has gone before to see that this is the logical order in all cases. Rent, or income, is a link in the chain of value, connecting gratification or psychic income, consumption goods, rent or usufruct value, and finally capital value. To one keeping in mind the logical cause of value, it becomes inconceivable that capital value could precede income, a view possible only when a fragment of the problem is seen. This being true, the mere mention of a capital sum implies the interest problem, and assumes the interest rate. The capital is of that amount because the anticipated incomes, discounted at some rate, equal that sum. The capital sum is a certain number of years' purchase of the series of rents which can be secured by the use of wealth in various industries. The owner of a number of dollars (or of an amount of other wealth expressed in dollars) has open to him various investments. The value of any wealth is due to the possibility of deriving incomes from it. If, however, the expected income fails to be realized, the capital loses its value, or it is revalued on the basis of the new rents. The investment is then said to be a losing one. Thus, at each stage in the valuation of capital, before it is invested and at every moment thereafter when the valuation is readjusted to the rents realized or expected, rents are logically primary, the source from which the capital sum is derived.
The rate of capitalization of rents is not fixed merely in commerce
3. The capitalization of comparatively safe permanent incomes from real estate contains within itself all the factors for the independent determination of the interest rate, and is not to be explained merely by reference to "the prevailing rate of interest" in other investments. The value of land usually is explained simply as the capitalizing of its rents at "the prevailing rate of interest." The rate is assumed to be fixed by conditions in manufacturing and commerce, and if five per cent, can be gotten there the capitalist would never buy land unless investment in it were made equally attractive. The cause of the rate thus is supposed to rest outside the transaction itself, the exchange of land for other capital seeking investment. The economic student is safe in assuming always that explanations of this sort are fallacious. The cause of value in any one exchange or any one industry is not thus to be juggled and shifted into another industry. It is true that the values of goods are so wonderfully interrelated by substitution that as the price of fresh beef will affect that of salt mackerel, so the capitalization rate of machinery affects that of land; but the influence is not from one side only, it is mutual. When anything has value, it must have in itself an independent cause of value.
The exchange of any present and future rents results in a rate of time discount
It can not be otherwise in the particular problem of value called capitalization. The first task of scientific study is to state clearly the nature of the problem. In this case it is seen to be the exchange of a present sum of wealth for a series of future rents. Whenever there are income-bearers and buyers and sellers of them, there are the conditions required for the determination of the market rate at which those future incomes shall be discounted. Manufactures and commerce have no peculiar relation to this process. By a flight of scientific imagination we might assume that the stock of indirect agents in the world consisted only of natural food producers, and that this stock and its yield were absolutely unchangeable by man's will or efforts. Each man in such case would have to stand with hands tied, and take the fruits as they matured. Even in such a case there would be capitalization and a rate of discount on future rents. The fruit-tree (that is, the whole future series of fruits) would bear a certain relation to one year's yield; the field would bear a certain relation to its crop. Wherever there are buyers and sellers of more or less durable agents of it matters not what kind or origin, there are present the elements and causes for the fixing of a rate of time discount.
Capitalization of a perpetual uniform series of rents;
4. In practical business may be seen innumerable instances of the capitalization of both permanent and limited series of incomes. The simplest case is the capitalization of an unvarying and supposedly perpetual series of rents. Whatever the rate of time discount prevailing, rents infinitely distant become infinitesimally small when discount is compounded. The present rent is worth most, next year's less, and so on in a decreasing series.