§ II. THE MOTIVE FOR PAYING INTEREST
Money borrowed to buy consumption goods
1. Interest for loans to obtain consumption goods is paid because they are felt to have greater importance at the moment than an equal amount (either of goods or of money) will have in the future. A sudden stress of misfortune may impart to a thing at the moment far more than its usual value. One standing face to face with starvation cannot be worse off a year hence; often there is good ground to hope that if the present misfortune can be relieved, the future better fortune will make it possible to repay a loan with interest. In other cases, the object of a loan of consumption goods is to increase the future earning-power of the borrower. When the student borrows money that represents to him food, clothing, text-books, tuition, and other expenses incidental to a course in college, the expenditure is intended to increase the effectiveness of the worker. When he borrows he has little earning-power, but with that faith in himself which makes the young American so interesting, he pictures himself four years later, sheepskin in hand, drawing a munificent salary with which he can easily satisfy the most exacting Shylock. Such an expenditure is sometimes called "an investment of capital," but it should be called a consumption loan—nevertheless in many cases a loan wisely made. To call this an investment of capital is to confuse man, the end of production, with material means.
Sometimes this higher estimate of the present good is unwise, viewed in the light of wider experience. Goods that meet momentary desire make an exaggerated appeal to untrained minds. The child, the spendthrift, the savage, cannot properly estimate the relative values of present and future. The improvident sometimes lightly agree to pay an exorbitant interest for an immediate consumption loan, making a ruinous difference between present and future gratifications.
Money borrowed to buy indirect agents
2. Interest on indirect agents is paid as a more or less indirect means of securing gratification. This can be clearly seen when durable agents are hired that produce gratification directly. A carriage bought with borrowed capital and used for the pleasure of the borrower is expected to afford a utility greater than that to be gotten by the amount of the interest in any other way. A spade bought with borrowed capital and used to cultivate the owner's garden is expected to add products of greater value than the interest.
But how is it in case the agent is used to gratify persons other than the owner? The music-teacher who buys a piano on credit expects to increase his earnings by a sum greater than the interest he has to pay. If the addition to his earnings exceeds the interest charge, it is because he has found a use for the borrowed capital greater than that on the basis of which it was capitalized in the market. The amount of the interest is secured through the pleasures and services the piano affords to the patrons of the teacher. In the most complex cases of the borrowing and use of indirect agents, there is ultimately this same basis for the interest: enjoyment afforded by the use of capital in the particular period. To the borrower, what the capital makes possible is an addition to his income as great as, or greater than, the prevailing interest. Most loans in our society are now of this sort. Money is borrowed to invest in business, to get better machinery or a larger stock; with this capital is secured a better or larger product, and the product finally being sold at a profit, the business man is at a point where he can satisfy his wants without encroaching on his capital. Logically, therefore, the consumer of the product pays the interest in the price, and the final consumer's enjoyment must be deemed the logical source of the money interest. The borrower's motive for paying interest on these indirect goods evidently is his hope of profit through realizing a greater money rent than he has contracted to pay for their use.
The special case of money borrowed to pay debts
3. The money market in which short-time loans are made is peculiar in that the money frequently is borrowed to pay debts, not for investment. In beginning the discussion of interest, it always is remarked that it is not money, but capital, that is borrowed and loaned. This caution against the superficial errors that so easily beset the popular discussion of interest is much needed, but it is well to note a peculiar case which is apparently in contradiction to this statement. The usual method by which money is loaned in the great industrial centers is called discount, which is the exchange of a certain sum of money for a note or other credit paper of a larger amount, the interest thus being taken out in advance. Much borrowing in the form of discount is for the same purpose as other borrowing—to acquire control of more productive agents, to embark on new enterprises. The peculiarity of the discount money-market is that an unusual number of loans are made to meet contracts that have already been made. There is always a great mass of outstanding obligations, and merchants are compelled to renew these loans on penalty of bankruptcy. This market for short-time loans is not connected closely with the general market for loanable capital. When the need is for ready money, other concrete capital cannot flow in to meet it. This special money demand, therefore, in time of greater or less stress, may fluctuate rapidly, and the interest rate be temporarily higher or lower than the rate on long-time loans. This case is similar to that where two markets, as a retail and a wholesale one, exist side by side, but slowly exerting a mutual influence.