WEBVTT NOTE XX. Interest, Credit Expansion, and the Trade Cycle 1 00:00:00.000 --> 00:00:06.000 CHAPTER 20 INTEREST, CREDIT EXPANSION AND THE TRADE CYCLE 2 00:00:06.000 --> 00:00:10.000 1. THE PROBLEMS 3 00:00:10.000 --> 00:00:18.000 In the market economy in which all acts of interpersonal exchange are performed by the intermediary of money, 4 00:00:18.000 --> 00:00:25.000 the category of originary interest manifests itself primarily in the interest on money loans. 5 00:00:25.000 --> 00:00:35.000 It has been pointed out already that in the imaginary construction of the evenly rotating economy, the rate of originary interest is uniform. 6 00:00:35.000 --> 00:00:39.000 There prevails in the whole system only one rate of interest. 7 00:00:39.000 --> 00:00:50.000 The rate of interest on loans coincides with the rate of originary interest as manifested in the ratio between prices of present and of future goods. 8 00:00:50.000 --> 00:00:54.000 We may call this rate the neutral rate of interest. 9 00:00:54.000 --> 00:01:04.000 The evenly rotating economy presupposes neutral money. As money can never be neutral, special problems arise. 10 00:01:04.000 --> 00:01:17.000 If the money relation, that is, the ratio between the demand for and the supply of money for cash holding, changes, all prices of goods and services are affected. 11 00:01:17.000 --> 00:01:25.500 These changes, however, do not affect the prices of the various goods and services at the same time and to the same extent. 12 00:01:25.500 --> 00:01:35.500 The resulting modifications in the wealth and income of various individuals can also alter the data determining the height of originary interest. 13 00:01:35.500 --> 00:01:45.000 The final state of the rate of originary interest to the establishment of which the system tends after the appearance of changes in the money relation 14 00:01:45.000 --> 00:01:51.360 is no longer that final state toward which it had tended before, thus the driving force 15 00:01:51.360 --> 00:01:57.520 of money has the power to bring about lasting changes in the final rate of originary interest 16 00:01:57.520 --> 00:02:00.440 and neutral interest. 17 00:02:00.440 --> 00:02:05.480 Then there is a second, even more momentous problem, which of course may also be looked 18 00:02:05.480 --> 00:02:11.800 upon as another aspect of the same problem. Changes in the money relation may under certain 19 00:02:11.800 --> 00:02:17.360 American Circumstances first affect the loan market in which the demand for and supply 20 00:02:17.360 --> 00:02:24.680 of loans influences the market rate of interest on loans, which we may call the gross money, 21 00:02:24.680 --> 00:02:27.760 or market rate of interest. 22 00:02:27.760 --> 00:02:34.560 Can such changes in the gross money rate cause the net rate of interest included in it to 23 00:02:34.560 --> 00:02:41.760 deviate lastingly from the height which corresponds to the rate of originary interest, that is, 24 00:02:41.760 --> 00:02:52.760 Can Events on the Loan Market Partially or Totally Eliminate Originary Interest? 25 00:02:52.760 --> 00:02:57.760 No economist will hesitate to answer these questions in the negative. 26 00:02:57.760 --> 00:03:00.760 But then a further problem arises. 27 00:03:00.760 --> 00:03:09.760 How does the interplay of the market factors readjust the gross money rate to the height conditioned by the rate of originary interest? 28 00:03:09.760 --> 00:03:30.760 These are great problems. These were the problems economists tried to solve in discussing banking, fiduciary media and circulation credit, credit expansion, gratuitousness or non-gratuitousness of credit, the cyclical movements of trade and all other problems of indirect exchange. 29 00:03:31.760 --> 00:03:37.760 2. The Entrepreneurial Component in the Gross Market Rate of Interest 30 00:03:37.760 --> 00:03:49.760 The market rates of interest on loans are not pure interest rates. Among the components contributing to their determination, there are also elements which are not interest. 31 00:03:49.760 --> 00:04:00.760 The money lender is always an entrepreneur. Every grant of credit is a speculative entrepreneurial venture, the success or failure of which is uncertain. 32 00:04:00.760 --> 00:04:08.760 The lender is always faced with the possibility that he may lose a part or the whole of the principal lent. 33 00:04:08.760 --> 00:04:16.760 His appraisal of this danger determines his conduct in bargaining with the prospective debtor about the terms of the contract. 34 00:04:16.760 --> 00:04:25.760 There can never be perfect safety, either in money lending or in other classes of credit transactions and deferred payments. 35 00:04:25.760 --> 00:04:33.220 Payments. Debtors, guarantors and warrantors may become insolvent. Collateral and mortgages 36 00:04:33.220 --> 00:04:40.080 may become worthless. The creditor is always a virtual partner of the debtor, or a virtual 37 00:04:40.080 --> 00:04:46.160 owner of the pledged and mortgaged property. He can be affected by changes in the market 38 00:04:46.160 --> 00:04:52.560 data concerning them. He has linked his fate with that of the debtor, or with the changes 39 00:04:52.560 --> 00:05:07.560 Capital as such does not bear interest. It must be well employed and invested not only in order to yield interest, but also lest it disappear entirely. 40 00:05:07.560 --> 00:05:20.560 The dictum, money cannot beget money, is meaningful in this sense, which of course differs radically from the sense which ancient and medieval philosophers attached to it. 41 00:05:20.560 --> 00:05:27.060 Gross interest can be reaped only by creditors who have been successful in their lending. 42 00:05:27.060 --> 00:05:32.640 If they earn any net interest at all, it is included in a yield which contains more than 43 00:05:32.640 --> 00:05:35.060 merely net interest. 44 00:05:35.060 --> 00:05:41.200 Net interest is a magnitude which only analytical thinking can extract from the gross proceeds 45 00:05:41.200 --> 00:05:43.080 of the creditor. 46 00:05:43.080 --> 00:05:48.480 The entrepreneurial component included in the creditor's gross proceeds is determined 47 00:05:48.480 --> 00:05:54.080 and by all those factors which are operative in every entrepreneurial venture. 48 00:05:54.080 --> 00:05:59.760 It is, moreover, co-determined by the legal and institutional setting. 49 00:05:59.760 --> 00:06:05.280 The contracts which place the debtor and his fortune, or the collateral, as a buffer between 50 00:06:05.280 --> 00:06:11.000 the creditor and the disastrous consequences of malinvestment of the capital lent, are 51 00:06:11.000 --> 00:06:14.760 conditioned by laws and institutions. 52 00:06:14.760 --> 00:06:21.260 The creditor is less exposed to loss and failure than the debtor only in so far as this legal 53 00:06:21.260 --> 00:06:27.600 and institutional framework makes it possible for him to enforce his claims against refractory 54 00:06:27.600 --> 00:06:29.480 debtors. 55 00:06:29.480 --> 00:06:35.160 There is, however, no need for economics to enter into a detailed scrutiny of the legal 56 00:06:35.160 --> 00:06:41.640 aspects involved in bonds and debentures, preferred stock, mortgages and other kinds 57 00:06:41.640 --> 00:06:44.520 of credit transactions. 58 00:06:44.520 --> 00:06:51.220 The entrepreneurial component is present in all species of loans. It is customary to distinguish 59 00:06:51.220 --> 00:06:57.620 between consumption or personal loans on the one hand and productive or business loans 60 00:06:57.620 --> 00:07:03.520 on the other. The characteristic mark of the former class is that it enables the borrower 61 00:07:03.520 --> 00:07:11.200 to spend expected future proceeds. In acquiring a claim to a share in these future proceeds, 62 00:07:11.200 --> 00:07:16.680 The lender becomes an entrepreneur, as in acquiring a claim to a share in the future 63 00:07:16.680 --> 00:07:19.160 proceeds of a business. 64 00:07:19.160 --> 00:07:24.360 The particular uncertainty of the outcome of his lending consists in the uncertainty 65 00:07:24.360 --> 00:07:27.620 about these future proceeds. 66 00:07:27.620 --> 00:07:33.640 It is furthermore customary to distinguish between private and public loans, that is, 67 00:07:33.640 --> 00:07:37.300 loans to governments and subdivisions of governments. 68 00:07:37.300 --> 00:07:44.340 The particular uncertainty inherent in such loans concerns the life of secular power. 69 00:07:44.340 --> 00:07:49.020 Empires may crumble, and governments may be overthrown by revolutionaries, who are not 70 00:07:49.020 --> 00:07:55.320 prepared to assume responsibility for the debts contracted by their predecessors. 71 00:07:55.320 --> 00:08:00.920 That there is, besides, something basically vicious in all kinds of long-term government 72 00:08:00.920 --> 00:08:04.960 debts has been pointed out already. 73 00:08:04.960 --> 00:08:11.120 For all species of deferred payments hangs, like a sword of Damocles, the danger of government 74 00:08:11.120 --> 00:08:18.700 interference. Public opinion has always been biased against creditors. It identifies creditors 75 00:08:18.700 --> 00:08:26.300 with the idle rich and debtors with the industrious poor. It abhors the former as ruthless exploiters 76 00:08:26.300 --> 00:08:32.140 and pities the latter as innocent victims of oppression. It considers government action 77 00:08:32.140 --> 00:08:38.180 is designed to curtail the claims of the creditors as measures extremely beneficial to the immense 78 00:08:38.180 --> 00:08:44.200 majority at the expense of a small minority of hard-boiled userers. 79 00:08:44.200 --> 00:08:50.480 It did not notice at all that 19th century capitalist innovations have wholly changed 80 00:08:50.480 --> 00:08:55.020 the composition of the classes of creditors and debtors. 81 00:08:55.020 --> 00:09:01.420 In the days of Solon the Athenian, of ancient Rome's agrarian laws, and of the Middle Ages, 82 00:09:01.420 --> 00:09:06.420 The creditors were, by and large, the rich and the debtors the poor. 83 00:09:06.420 --> 00:09:12.660 But in this age of bonds and debentures, mortgage banks, savings banks, life insurance policies 84 00:09:12.660 --> 00:09:18.420 and social security benefits, the masses of people with more moderate income are rather 85 00:09:18.420 --> 00:09:21.260 themselves creditors. 86 00:09:21.260 --> 00:09:27.620 On the other hand, the rich, in their capacity as owners of common stock of plants, farms 87 00:09:27.620 --> 00:09:32.660 Creditors and real estate are more often debtors than creditors. 88 00:09:32.660 --> 00:09:38.020 In asking for the expropriation of creditors, the masses are unwittingly attacking their 89 00:09:38.020 --> 00:09:41.340 own particular interests. 90 00:09:41.340 --> 00:09:47.820 With public opinion in this state, the creditor's unfavorable chance of being harmed by anti-creditor 91 00:09:47.820 --> 00:09:55.500 measures is not balanced by a favorable chance of being privileged by anti-debtor measures. 92 00:09:55.500 --> 00:10:01.040 This unbalance would bring about a unilateral tendency toward a rise of the entrepreneurial 93 00:10:01.040 --> 00:10:07.020 component contained in the gross rate of interest if the political danger were limited to the 94 00:10:07.020 --> 00:10:13.120 loan market, and would not in the same way affect today all kinds of private ownership 95 00:10:13.120 --> 00:10:15.740 of the means of production. 96 00:10:15.740 --> 00:10:21.480 As things are in our day, no kind of investment is safe against the political dangers of a 97 00:10:21.480 --> 00:10:25.280 general expropriation of all private property. 98 00:10:25.280 --> 00:10:31.400 A capitalist cannot reduce the vulnerability of his wealth by preferring direct investment 99 00:10:31.400 --> 00:10:36.760 in business to lending his capital to business or to the government. 100 00:10:36.760 --> 00:10:42.820 The political risks involved in money lending do not affect the height of a regionary interest. 101 00:10:42.820 --> 00:10:48.840 They affect the entrepreneurial component included in the gross market rate. 102 00:10:48.840 --> 00:10:54.400 In the limiting case, that is, in a situation in which the impending nullification of all 103 00:10:54.400 --> 00:10:59.400 All contracts concerning deferred payments is generally expected. 104 00:10:59.400 --> 00:11:05.400 They would cause the entrepreneurial component to increase beyond all measure. 105 00:11:05.400 --> 00:11:07.520 3. 106 00:11:07.520 --> 00:11:13.400 The price premium as a component of the gross market rate of interest. 107 00:11:13.400 --> 00:11:19.480 Money is neutral if the cash-induced changes in the monetary unit's purchasing power affect 108 00:11:19.480 --> 00:11:26.800 at the same time and to the same extent the prices of all commodities and services. 109 00:11:26.800 --> 00:11:32.080 With neutral money, a neutral rate of interest would be conceivable, provided there were 110 00:11:32.080 --> 00:11:34.480 no deferred payments. 111 00:11:34.480 --> 00:11:39.720 If there were deferred payments, and if we disregard the entrepreneurial position of 112 00:11:39.720 --> 00:11:45.400 the creditor and the ensuing entrepreneurial component in the gross rate of interest, we 113 00:11:45.400 --> 00:11:51.700 We must furthermore assume that the eventuality of future changes in purchasing power is taken 114 00:11:51.700 --> 00:11:56.340 into account in stipulating the terms of the contract. 115 00:11:56.340 --> 00:12:02.220 The principle is to be multiplied periodically by the index number, and thus to be increased 116 00:12:02.220 --> 00:12:08.700 or decreased in accordance with the changes that have come to pass in purchasing power. 117 00:12:08.700 --> 00:12:12.820 With the adjustment of the principle, the amount from which the rate of interest is 118 00:12:12.820 --> 00:12:20.180 is to be calculated changes too. Thus, this rate is a neutral rate of interest. 119 00:12:20.180 --> 00:12:24.900 With neutral money, neutralization of the rate of interest could also be attained by 120 00:12:24.900 --> 00:12:30.300 another stipulation, provided the parties are in a position to anticipate correctly 121 00:12:30.300 --> 00:12:37.200 the future changes in purchasing power. They could stipulate a gross rate of interest containing 122 00:12:37.200 --> 00:12:53.800 We may call this allowance the positive or negative price premium. In the case of a quickly 123 00:12:53.800 --> 00:12:59.560 progressing deflation, the negative price premium could not only swallow the whole rate 124 00:12:59.560 --> 00:13:06.080 of originary interest, but even reverse the gross rate into a minus quantity, a rate to 125 00:13:06.080 --> 00:13:09.280 to be passed on the debtor's account. 126 00:13:09.280 --> 00:13:15.080 If the price premium is correctly calculated, neither the creditor's nor the debtor's position 127 00:13:15.080 --> 00:13:19.280 is affected by intervening changes in purchasing power. 128 00:13:19.280 --> 00:13:21.920 The rate of interest is neutral. 129 00:13:21.920 --> 00:13:28.200 However, all these assumptions are not only imaginary, they cannot even hypothetically 130 00:13:28.200 --> 00:13:31.320 be thought of without contradictions. 131 00:13:31.320 --> 00:13:36.380 In the changing economy, the rate of interest can never be neutral. 132 00:13:36.380 --> 00:13:41.920 In the changing economy, there is no uniform rate of originary interest. 133 00:13:41.920 --> 00:13:48.060 There only prevails a tendency toward the establishment of such uniformity. 134 00:13:48.060 --> 00:13:53.800 Before the final state of originary interest is attained, new changes in the data emerge 135 00:13:53.800 --> 00:13:59.720 which divert anew the movement of interest rates toward a new final state. 136 00:13:59.720 --> 00:14:07.220 Where everything is unceasingly in flux, no neutral rate of interest can be established. 137 00:14:07.220 --> 00:14:14.120 In the world of reality, all prices are fluctuating and acting men are forced to take full account 138 00:14:14.120 --> 00:14:16.860 of these changes. 139 00:14:16.860 --> 00:14:22.120 Entrepreneurs embark upon business ventures and capitalists change their investments only 140 00:14:22.120 --> 00:14:27.560 because they anticipate such changes and want to profit from them. 141 00:14:27.560 --> 00:14:33.120 The market economy is essentially characterized as a social system in which there prevails 142 00:14:33.120 --> 00:14:36.760 an incessant urge toward improvement. 143 00:14:36.760 --> 00:14:43.200 The most provident and enterprising individuals are driven to earn profit by readjusting again 144 00:14:43.200 --> 00:14:49.800 and again the arrangement of production activities so as to fill in the best possible way the 145 00:14:49.800 --> 00:14:55.480 needs of the consumers, both those needs of which the consumers themselves are already 146 00:14:55.480 --> 00:15:02.920 be aware, and those latent needs of the satisfaction of which they have not yet thought themselves. 147 00:15:02.920 --> 00:15:08.520 These speculative ventures of the promoters revolutionize afresh each day the structure 148 00:15:08.520 --> 00:15:15.120 of prices, and thereby also the height of the gross market rate of interest. 149 00:15:15.120 --> 00:15:21.280 He who expects a rise in certain prices enters the loan market as a borrower, and is ready 150 00:15:21.280 --> 00:15:26.680 to allow a higher gross rate of interest than he would allow if he were to expect a less 151 00:15:26.680 --> 00:15:31.560 momentous rise in prices, or no rise at all. 152 00:15:31.560 --> 00:15:38.060 On the other hand, the lender, if he himself expects a rise in prices, grants loans only 153 00:15:38.060 --> 00:15:43.200 if the gross rate is higher than it would be under a state of the market in which less 154 00:15:43.200 --> 00:15:48.960 momentous or no upward changes in prices are anticipated. 155 00:15:48.960 --> 00:15:55.520 The borrower is not deterred by a higher rate if his project seems to offer such good chances 156 00:15:55.520 --> 00:15:58.720 that it can afford higher costs. 157 00:15:58.720 --> 00:16:04.240 The lender would abstain from lending and would himself enter the market as an entrepreneur 158 00:16:04.240 --> 00:16:09.840 and bidder for commodities and services if the gross rate of interest were not to compensate 159 00:16:09.840 --> 00:16:13.440 him for the profits he could reap this way. 160 00:16:13.440 --> 00:16:19.560 The expectation of rising prices thus has the tendency to make the gross rate of interest 161 00:16:19.560 --> 00:16:25.280 rise, while the expectation of dropping prices makes it drop. 162 00:16:25.280 --> 00:16:30.740 If the expected changes in the price structure concern only a limited group of commodities 163 00:16:30.740 --> 00:16:36.640 and services, and are counterbalanced by the expectation of an opposite change in the prices 164 00:16:36.640 --> 00:16:42.620 of other goods, as is the case in the absence of changes in the money relation, the two 165 00:16:42.620 --> 00:16:47.400 Two opposite trends by and large counterpoise each other. 166 00:16:47.400 --> 00:16:53.880 But if the money relation is sensibly altered and a general rise or fall in the prices of 167 00:16:53.880 --> 00:16:59.700 all commodities and services is expected, one tendency carries on. 168 00:16:59.700 --> 00:17:07.100 A positive or negative price premium emerges in all deals concerning deferred payments. 169 00:17:07.100 --> 00:17:12.500 The role of the price premium in the changing economy is different from that we ascribe 170 00:17:12.500 --> 00:17:17.500 in the hypothetical and unrealizable scheme developed above. 171 00:17:17.500 --> 00:17:24.500 It can never entirely remove, even as far as credit operations alone are concerned, 172 00:17:24.500 --> 00:17:27.500 the effects of changes in the money relation. 173 00:17:27.500 --> 00:17:30.500 It can never make interest rates neutral. 174 00:17:30.500 --> 00:17:37.500 It cannot alter the fact that money is essentially equipped with a driving force of its own. 175 00:17:37.500 --> 00:18:07.500 Even if all actors were to know correctly and completely the quantitative data concerning the changes in the supply of money, in the broader sense, in the whole economic system, the dates on which such changes were to occur and what individuals were to be first affected by them, they would not be in a position to know beforehand whether and to what extent the demand for money for cash holding would change, and in what temporal sequence 176 00:18:07.500 --> 00:18:13.460 Sequence, and to what extent the prices of the various commodities would change. 177 00:18:13.460 --> 00:18:19.140 The price premium could counterpoise the effects of changes in the money relation upon the 178 00:18:19.140 --> 00:18:25.900 substantial importance and the economic significance of credit contracts, only if its appearance 179 00:18:25.900 --> 00:18:31.620 were to precede the occurrence of the price changes generated by the alteration in the 180 00:18:31.620 --> 00:18:33.660 money relation. 181 00:18:33.660 --> 00:18:39.180 It would have to be the result of a reasoning by virtue of which the actors try to compute 182 00:18:39.180 --> 00:18:45.820 in advance the date and the extent of such price changes with regard to all commodities 183 00:18:45.820 --> 00:18:52.460 and services which directly or indirectly count for their own state of satisfaction. 184 00:18:52.460 --> 00:18:58.880 However, such computations cannot be established because their performance would require a 185 00:18:58.880 --> 00:19:04.160 A Perfect Knowledge of Future Conditions and Valuations 186 00:19:04.160 --> 00:19:09.720 The emergence of the price premium is not the product of an arithmetical operation which 187 00:19:09.720 --> 00:19:15.760 could provide reliable knowledge and eliminate the uncertainty concerning the future. 188 00:19:15.760 --> 00:19:21.440 It is the outcome of the promoter's understanding of the future and their calculations based 189 00:19:21.440 --> 00:19:23.840 on such an understanding. 190 00:19:23.840 --> 00:19:31.060 It comes into existence step by step as soon as first a few and then successively more 191 00:19:31.060 --> 00:19:37.420 and more actors become aware of the fact that the market is faced with cash-induced changes 192 00:19:37.420 --> 00:19:44.740 in the money relation, and consequently with a trend oriented in a definite direction. 193 00:19:44.740 --> 00:19:50.700 Only when people begin to buy or to sell in order to take advantage of this trend does 194 00:19:50.700 --> 00:19:54.640 as the price premium come into existence. 195 00:19:54.640 --> 00:20:00.340 It is necessary to realize that the price premium is the outgrowth of speculations having 196 00:20:00.340 --> 00:20:05.340 regard for anticipated changes in the money relation. 197 00:20:05.340 --> 00:20:11.620 What induces it, in the case of the expectation that an inflationary trend will keep on going, 198 00:20:11.620 --> 00:20:17.820 is already the first sign of that phenomenon which, later, when it becomes general, is 199 00:20:17.820 --> 00:20:26.820 is called Flight into Real Values and finally produces the crack-up boom and the crash of the monetary system concerned. 200 00:20:26.820 --> 00:20:34.820 As in every case of the understanding of future developments, it is possible that the speculators may err, 201 00:20:34.820 --> 00:20:43.820 that the inflationary or deflationary movement will be stopped or slowed down, and that prices will differ from what they expected. 202 00:20:43.820 --> 00:20:56.820 The increased propensity to buy or to sell, which generates the price premium, affects as a rule short-term loans sooner and to a greater extent than long-term loans. 203 00:20:56.820 --> 00:21:11.820 As far as this is the case, the price premium affects the market for short-term loans first, and only later, by virtue of the concatenation of all parts of the market, also the market for long-term loans. 204 00:21:11.820 --> 00:21:18.780 However, there are instances in which a price premium in long-term loans appears independently 205 00:21:18.780 --> 00:21:23.100 of what is going on with regard to short-term loans. 206 00:21:23.100 --> 00:21:27.940 This was especially the case in international lending in the days in which there was still 207 00:21:27.940 --> 00:21:31.580 a live international capital market. 208 00:21:31.580 --> 00:21:37.100 It happened occasionally that lenders were confident with regard to the short-term development 209 00:21:37.100 --> 00:21:40.220 of a foreign country's national currency. 210 00:21:40.220 --> 00:21:46.320 In short-term loans stipulated in this currency there was no price premium at all, or only 211 00:21:46.320 --> 00:21:48.020 a slight one. 212 00:21:48.020 --> 00:21:54.220 But the appraisal of the long-term aspects of the currency concerned was less favorable, 213 00:21:54.220 --> 00:22:00.420 and in long-term contracts a considerable price premium was taken into account. 214 00:22:00.420 --> 00:22:06.540 The result was that long-term loans stipulated in this currency could be floated only at 215 00:22:06.540 --> 00:22:14.460 at a higher rate than the same debtor's loans stipulated in terms of gold or a foreign currency. 216 00:22:14.460 --> 00:22:21.320 We have shown one reason why the price premium can at best practically deaden but never eliminate 217 00:22:21.320 --> 00:22:27.780 entirely the repercussions of cash-induced changes in the money relation upon the content 218 00:22:27.780 --> 00:22:30.340 of credit transactions. 219 00:22:30.340 --> 00:22:34.440 A second reason will be dealt with in the next section. 220 00:22:34.440 --> 00:22:40.800 The price premium always lags behind the changes in purchasing power because what generates 221 00:22:40.800 --> 00:22:46.480 it is not the change in the supply of money in the broader sense, but the necessarily 222 00:22:46.480 --> 00:22:52.120 later occurring effects of these changes upon the price structure. 223 00:22:52.120 --> 00:22:57.400 Only in the final state of a ceaseless inflation do things become different. 224 00:22:57.400 --> 00:23:03.000 The panic of the currency catastrophe, the crack-up boom, is not only characterized 225 00:23:03.000 --> 00:23:09.720 by a tendency for prices to rise beyond all measure, but also by a rise beyond all measure 226 00:23:09.720 --> 00:23:17.360 of the positive price premium. No gross rate of interest, however great, appears to a prospective 227 00:23:17.360 --> 00:23:22.920 lender high enough to compensate for the losses expected from the progressing drop in the 228 00:23:22.920 --> 00:23:30.520 monetary unit's purchasing power. He abstains from lending and prefers to buy himself real 229 00:23:30.520 --> 00:23:44.640 The gross rates of interest as determined on the loan market are not uniform. 230 00:23:44.640 --> 00:23:51.240 The entrepreneurial component which they always include varies according to the peculiar characteristics 231 00:23:51.240 --> 00:23:53.520 of the specific deal. 232 00:23:53.520 --> 00:23:58.680 It is one of the most serious shortcomings of all historical and statistical studies 233 00:23:58.680 --> 00:24:03.640 devoted to the movement of interest rates that they neglect this factor. 234 00:24:03.640 --> 00:24:09.720 It is useless to arrange data concerning interest rates of the open market or the discount rates 235 00:24:09.720 --> 00:24:13.080 of the central banks in time series. 236 00:24:13.080 --> 00:24:19.260 The various data available for the construction of such time series are incommensurable. 237 00:24:19.260 --> 00:24:24.320 The same central bank's rate of discount meant something different in various periods 238 00:24:24.320 --> 00:24:25.900 of time. 239 00:24:25.900 --> 00:24:31.460 The institutional conditions affecting the activities of various nations' central banks, 240 00:24:31.460 --> 00:24:37.140 their private banks, and their organized loan markets are so different that it is entirely 241 00:24:37.140 --> 00:24:42.820 misleading to compare the nominal interest rates without paying full regard to these 242 00:24:42.820 --> 00:24:44.740 diversities. 243 00:24:44.740 --> 00:24:50.680 We know a priori that, other things being equal, the lenders are intent upon preferring 244 00:24:50.680 --> 00:24:55.680 Preventing high interest rates to low ones, and the debtors upon preferring low rates 245 00:24:55.680 --> 00:24:57.400 to high ones. 246 00:24:57.400 --> 00:25:00.680 But these other things are never equal. 247 00:25:00.680 --> 00:25:06.040 There prevails upon the loan market a tendency toward the equalization of gross interest 248 00:25:06.040 --> 00:25:12.080 rates for loans for which the factors determining the height of the entrepreneurial component 249 00:25:12.080 --> 00:25:15.580 and the price premium are equal. 250 00:25:15.580 --> 00:25:20.520 This knowledge provides a mental tool for the interpretation of the facts concerning 251 00:25:20.520 --> 00:25:23.440 the history of interest rates. 252 00:25:23.440 --> 00:25:28.520 Without the aid of this knowledge, the vast historical and statistical material available 253 00:25:28.520 --> 00:25:32.720 would be merely an accumulation of meaningless figures. 254 00:25:32.720 --> 00:25:39.000 In a ranging time series of the prices of certain primary commodities, empiricism has 255 00:25:39.000 --> 00:25:44.400 at least an apparent justification in the fact that the price data dealt with refer 256 00:25:44.400 --> 00:25:47.360 to the same physical object. 257 00:25:47.360 --> 00:25:53.480 It is a spurious excuse, indeed, as prices are not related to the unchanging physical 258 00:25:53.480 --> 00:26:00.840 properties of things, but to the changing values which acting men attach to them. 259 00:26:00.840 --> 00:26:06.940 But in the study of interest rates, even this lame excuse cannot be advanced. 260 00:26:06.940 --> 00:26:13.200 Gross interest rates, as they appear in reality, have nothing else in common than those characteristics 261 00:26:13.200 --> 00:26:16.460 Economics which Catallactic Theory sees in them. 262 00:26:16.460 --> 00:26:22.600 They are complex phenomena and can never be used for the construction of an empirical 263 00:26:22.600 --> 00:26:26.200 or a posteriori theory of interest. 264 00:26:26.200 --> 00:26:32.740 They can neither verify nor falsify what economics teaches about the problems involved. 265 00:26:32.740 --> 00:26:39.240 They constitute, if carefully analyzed with all the knowledge economics conveys, invaluable 266 00:26:39.240 --> 00:26:42.360 documentation for economic history. 267 00:26:42.360 --> 00:26:46.760 They are of no avail for economic theory. 268 00:26:46.760 --> 00:26:52.240 It is customary to distinguish the market for short-term loans, money market, from the 269 00:26:52.240 --> 00:26:56.120 market for long-term loans, capital market. 270 00:26:56.120 --> 00:27:03.800 A more penetrating analysis must even go further in classifying loans according to their duration. 271 00:27:03.800 --> 00:27:09.280 Besides, there are differences with regard to the legal characteristics which the terms 272 00:27:09.280 --> 00:27:19.600 In short, the loan market is not homogeneous, but the most conspicuous differences arise 273 00:27:19.600 --> 00:27:24.920 from the entrepreneurial component included in the gross rates of interest. 274 00:27:24.920 --> 00:27:32.640 It is this that people refer to when asserting that credit is based on trust or confidence. 275 00:27:32.640 --> 00:27:38.480 The connexity between all sectors of the loan market and the gross rates of interest determined 276 00:27:38.480 --> 00:27:44.720 on them is brought about by the inherent tendency of the net rates of interest included in these 277 00:27:44.720 --> 00:27:50.000 gross rates toward the final state of originary interest. 278 00:27:50.000 --> 00:27:56.040 With regard to this tendency, catalactic theory is free to deal with the market rate of interest 279 00:27:56.040 --> 00:28:02.320 as if it were a uniform phenomenon, and to abstract from the entrepreneurial component, 280 00:28:02.320 --> 00:28:08.120 which is necessarily always included in the gross rates, and from the price premium, which 281 00:28:08.120 --> 00:28:10.980 is occasionally included. 282 00:28:10.980 --> 00:28:18.420 The prices of all commodities and services are at any instant moving toward a final state. 283 00:28:18.420 --> 00:28:23.960 If this final state were ever to be reached, it would show in the ratio between the prices 284 00:28:23.960 --> 00:28:29.440 of present goods and future goods the final state of originary interest. 285 00:28:29.440 --> 00:28:35.720 However, the changing economy never reaches the imaginary final state. 286 00:28:35.720 --> 00:28:41.640 New data emerge again and again and divert the trend of prices from the previous goal 287 00:28:41.640 --> 00:28:47.140 of their movement toward a different final state, to which a different rate of originary 288 00:28:47.140 --> 00:28:50.000 interest may correspond. 289 00:28:50.000 --> 00:28:55.320 In the rate of originary interest, there is no more permanence than in prices and wage 290 00:28:55.320 --> 00:28:57.000 rates. 291 00:28:57.000 --> 00:29:02.320 Those people whose provident action is intent upon adjusting the employment of the factors 292 00:29:32.320 --> 00:29:37.720 The interest plays in these deliberations of the planning businessman is obvious. 293 00:29:37.720 --> 00:29:43.240 It shows him how far he can go in withholding factors of production from employment for 294 00:29:43.240 --> 00:29:50.080 want satisfaction in nearer periods of the future, and in dedicating them to want satisfaction 295 00:29:50.080 --> 00:29:52.360 in remoter periods. 296 00:29:52.360 --> 00:29:58.700 It shows him what period of production conforms in every concrete case to the difference which 297 00:29:58.700 --> 00:30:05.500 which the public makes in the ratio of valuation between present goods and future goods. 298 00:30:05.500 --> 00:30:10.980 It prevents him from embarking upon projects, the execution of which would not agree with 299 00:30:10.980 --> 00:30:16.900 the limited amount of capital goods provided by the saving of the public. 300 00:30:16.900 --> 00:30:22.660 It is in influencing this primordial function of the rate of interest that the driving force 301 00:30:22.660 --> 00:30:27.780 of money can become operative in a particular way. 302 00:30:27.780 --> 00:30:33.220 Each induced changes in the money relation can, under certain circumstances, affect the 303 00:30:33.220 --> 00:30:38.820 loan market before they affect the prices of commodities and of labor. 304 00:30:38.820 --> 00:30:44.580 The increase or decrease in the supply of money, in the broader sense, can increase 305 00:30:44.580 --> 00:30:50.980 or decrease the supply of money offered on the loan market, and thereby lower or raise 306 00:30:50.980 --> 00:30:56.540 the gross market rate of interest, although no change in the rate of original interest 307 00:30:56.540 --> 00:30:58.740 has taken place. 308 00:30:58.740 --> 00:31:04.580 If this happens, the market rate deviates from the height which the state of originary interest 309 00:31:04.580 --> 00:31:09.540 and the supply of capital goods available for production would require. 310 00:31:09.540 --> 00:31:16.340 Then, the market rate of interest fails to fulfill the function it plays in guiding entrepreneurial 311 00:31:16.340 --> 00:31:17.780 decisions. 312 00:31:17.780 --> 00:31:23.220 It frustrates the entrepreneur's calculation and diverts his actions from those lines in 313 00:31:23.220 --> 00:31:30.660 in which they would in the best possible way satisfy the most urgent needs of the consumers. 314 00:31:30.660 --> 00:31:34.380 Then there is a second important fact to realize. 315 00:31:34.380 --> 00:31:41.060 If other things being equal, the supply of money in the broader sense increases or decreases 316 00:31:41.060 --> 00:31:48.540 and thus brings about a general tendency for prices to rise or to drop, a positive or negative 317 00:31:48.540 --> 00:31:55.920 price premium would have to appear and to raise or lower the gross rate of market interest. 318 00:31:55.920 --> 00:32:01.300 But if such changes in the money relation affect first the loan market, they bring about 319 00:32:01.300 --> 00:32:07.320 just the opposite changes in the configuration of the gross market rates of interest. 320 00:32:07.320 --> 00:32:12.620 While a positive or negative price premium would be required to adjust the market rates 321 00:32:12.620 --> 00:32:19.420 of Interest to the Changes in the Money Relation, gross interest rates are in fact dropping 322 00:32:19.420 --> 00:32:21.540 or rising. 323 00:32:21.540 --> 00:32:27.900 This is the second reason why the instrumentality of the price premium cannot entirely eliminate 324 00:32:27.900 --> 00:32:33.160 the repercussions of cash-induced changes in the money relation upon the content of 325 00:32:33.160 --> 00:32:37.040 contracts concerning deferred payments. 326 00:32:37.040 --> 00:32:43.440 Its operation begins too late. It lags behind the changes in purchasing power, as has been 327 00:32:43.440 --> 00:32:49.880 shown above. Now we see that under certain circumstances, the forces that push in the 328 00:32:49.880 --> 00:32:56.960 opposite direction manifest themselves sooner on the market than the price premium. 329 00:32:56.960 --> 00:33:05.180 5. The Effects of Changes in the Money Relation upon Originary Interest 330 00:33:05.180 --> 00:33:11.100 Like every change in the market data, changes in the money relation can possibly influence 331 00:33:11.100 --> 00:33:14.200 the rate of originary interest. 332 00:33:14.200 --> 00:33:19.640 According to the inflationist view of history, inflation by and large tends to increase the 333 00:33:19.640 --> 00:33:22.780 earnings of the entrepreneurs. 334 00:33:22.780 --> 00:33:27.900 Commodity prices rise sooner and to a steeper level than wage rates. 335 00:33:27.900 --> 00:33:33.200 On the one hand, wage earners and salaried people, classes who spend the greater part 336 00:33:33.200 --> 00:33:39.420 of their income for consumption and save little are adversely affected, and must accordingly 337 00:33:39.420 --> 00:33:41.920 restrict their expenditures. 338 00:33:41.920 --> 00:33:47.400 On the other hand, the proprietary strata of the population, whose propensity to save 339 00:33:47.400 --> 00:33:52.160 a considerable part of their income is much greater, are favored. 340 00:33:52.160 --> 00:33:58.120 They do not increase their consumption in proportion, but also increase their savings. 341 00:33:58.120 --> 00:34:04.400 Thus, in the community as a whole, there arises a tendency toward an intensified accumulation 342 00:34:04.400 --> 00:34:06.960 of new capital. 343 00:34:06.960 --> 00:34:11.760 Additional investment is the corollary of the restriction of consumption imposed upon 344 00:34:11.760 --> 00:34:17.080 that part of the population which consumes the much greater part of the annual produce 345 00:34:17.080 --> 00:34:19.760 of the economic system. 346 00:34:19.760 --> 00:34:24.480 This forced saving lowers the rate of originary interest. 347 00:34:24.480 --> 00:34:31.640 that accelerates the pace of economic progress and the improvement in technological methods. 348 00:34:31.640 --> 00:34:37.140 It is important to realize that such forced saving can originate from an inflationary 349 00:34:37.140 --> 00:34:42.420 movement and actually often did so originate in the past. 350 00:34:42.420 --> 00:34:47.200 In dealing with the effects of changes in the money relation upon the height of interest 351 00:34:47.200 --> 00:34:53.360 rates, one must not neglect the fact that such changes can, under certain circumstances, 352 00:34:53.360 --> 00:34:56.840 really alter the rate of originary interest. 353 00:34:56.840 --> 00:35:00.880 But several other facts must be taken into account, too. 354 00:35:00.880 --> 00:35:09.280 First, one must realize that forced saving can result from inflation, but need not, necessarily. 355 00:35:09.280 --> 00:35:14.480 It depends on the particular data of each instance of inflation, whether or not the 356 00:35:14.480 --> 00:35:19.960 rise in wage rates lags behind the rise in commodity prices. 357 00:35:19.960 --> 00:35:26.240 A tendency for real wage rates to drop is not an inescapable consequence of a decline 358 00:35:26.240 --> 00:35:32.720 in the monetary unit's purchasing power. It could happen that nominal wage rates rise 359 00:35:32.720 --> 00:35:39.720 more than or sooner than commodity prices. Furthermore, it is necessary to remember that 360 00:35:39.720 --> 00:35:46.200 the greater propensity of the wealthier classes to save and to accumulate capital is merely 361 00:35:46.200 --> 00:35:50.600 a psychological and not a praxeological fact. 362 00:35:50.600 --> 00:35:55.560 It could happen that these people to whom the inflationary movement conveys additional 363 00:35:55.560 --> 00:36:03.320 proceeds do not save and invest their boon, but employ it for an increase in their consumption. 364 00:36:03.320 --> 00:36:09.240 It is impossible to predict with the apodictic definiteness which characterizes all theorems 365 00:36:09.240 --> 00:36:15.400 of economics in what way those profiting from the inflation will act. 366 00:36:15.400 --> 00:36:20.500 The Theory can tell us what happened in the past, but it cannot assert that it must happen 367 00:36:20.500 --> 00:36:22.340 in the future. 368 00:36:22.340 --> 00:36:27.920 It would be a serious blunder to neglect the fact that inflation also generates forces 369 00:36:27.920 --> 00:36:31.580 which tend toward capital consumption. 370 00:36:31.580 --> 00:36:37.400 One of its consequences is that it falsifies economic calculation and accounting. 371 00:36:37.400 --> 00:36:42.700 It produces the phenomenon of imaginary or apparent profits. 372 00:36:42.700 --> 00:36:48.860 If the annual depreciation quotas are determined in such a way as not to pay full regard to 373 00:36:48.860 --> 00:36:54.260 the fact that the replacement of worn-out equipment will require higher costs than the 374 00:36:54.260 --> 00:37:00.260 amount for which it was purchased in the past, they are obviously insufficient. 375 00:37:00.260 --> 00:37:05.420 If in selling inventories and products the whole difference between the price spent for 376 00:37:05.420 --> 00:37:11.840 their acquisition and the price realized in the sale is entered in the books as a surplus, 377 00:37:11.840 --> 00:37:14.220 Every error is the same. 378 00:37:14.220 --> 00:37:19.740 If the rise in the prices of stocks and real estate is considered as a gain, the illusion 379 00:37:19.740 --> 00:37:22.420 is no less manifest. 380 00:37:22.420 --> 00:37:29.480 What makes people believe that inflation results in general prosperity is precisely such illusory 381 00:37:29.480 --> 00:37:30.480 gains. 382 00:37:30.480 --> 00:37:35.640 They feel lucky and become open-handed in spending and enjoying life. 383 00:37:35.640 --> 00:37:41.680 They embellish their homes, they build new mansions and patronize the entertainment business. 384 00:37:41.680 --> 00:37:47.600 When spending apparent gains the fanciful result of false reckoning, they are consuming 385 00:37:47.600 --> 00:37:49.040 capital. 386 00:37:49.040 --> 00:37:51.880 It does not matter who these spenders are. 387 00:37:51.880 --> 00:37:54.760 They may be businessmen or stock-jobbers. 388 00:37:54.760 --> 00:37:59.980 They may be wage earners whose demand for higher pay is satisfied by the easy-going 389 00:37:59.980 --> 00:38:04.540 employers who think that they are getting richer from day to day. 390 00:38:04.540 --> 00:38:10.040 They may be people supported by taxes, which usually absorb a great part of the apparent 391 00:38:10.040 --> 00:38:11.040 Gains. 392 00:38:11.040 --> 00:38:17.660 Finally, with the progress of inflation, more and more people become aware of the fall in 393 00:38:17.660 --> 00:38:19.600 purchasing power. 394 00:38:19.600 --> 00:38:24.560 For those not personally engaged in business and not familiar with the conditions of the 395 00:38:24.560 --> 00:38:30.600 stock market, the main vehicle of saving is the accumulation of savings deposits, the 396 00:38:30.600 --> 00:38:33.880 purchase of bonds and life insurance. 397 00:38:33.880 --> 00:38:37.240 All such savings are prejudiced by inflation. 398 00:38:37.240 --> 00:38:43.000 Thus, saving is discouraged and extravagance seems to be indicated. 399 00:38:43.000 --> 00:38:48.800 The ultimate reaction of the public, the flight into real values, is a desperate attempt to 400 00:38:48.800 --> 00:38:53.040 salvage some debris from the ruinous breakdown. 401 00:38:53.040 --> 00:38:59.680 It is, viewed from the angle of capital preservation, not a remedy, but merely a poor emergency 402 00:38:59.680 --> 00:39:00.680 measure. 403 00:39:00.680 --> 00:39:06.000 It can, at best, rescue a fraction of the savers' funds. 404 00:39:06.000 --> 00:39:12.080 The main thesis of the champions of inflationism and expansionism is thus rather weak. 405 00:39:12.080 --> 00:39:18.040 It may be admitted that in the past inflation often, but not always, resulted in forced 406 00:39:18.040 --> 00:39:21.600 saving and an increase in capital available. 407 00:39:21.600 --> 00:39:28.160 However, this does not mean that it must produce the same effects in the future too. 408 00:39:28.160 --> 00:39:33.820 On the contrary, one must realize that under modern conditions the forces driving toward 409 00:39:33.820 --> 00:39:39.480 and capital consumption are more likely to prevail under inflationary conditions than 410 00:39:39.480 --> 00:39:42.860 those driving toward capital accumulation. 411 00:39:42.860 --> 00:39:49.040 At any rate, the final effect of such changes upon saving, capital and the originary rate 412 00:39:49.040 --> 00:39:54.320 of interest depends upon the particular data of each instance. 413 00:39:54.320 --> 00:39:59.540 The same is valid with the necessary changes with regard to the analogous consequences 414 00:39:59.540 --> 00:40:03.700 Signs and Effects of a Deflationist or Restrictionist Movement.