7. The Myth of the Importance of the Producer's Loan Market
We have completed our analysis of the determination of the pure rate of interest as it would be
in the evenly rotating economy, a rate that the market tends to approach in the real world.
We have shown how it is determined by time preferences on the time market and have seen
in the various components of that time market.
This statement will undoubtedly be extremely puzzling to many readers.
Where is the producer's loan market?
This market is always the one that is stressed by writers, often to the exclusion of anything
else.
In fact, rate of interest generally refers to money loans, including loans to consumers
This sort of approach completely overlooks the gross savings of the producers, and even more, the demand for present goods by owners of the original factors.
Instead of being fundamentally suppliers of present goods, capitalists are portrayed as demanders of present goods.
This approach misses the point very badly because it looks at the economy with the superficial eye of an average businessman.
The businessman borrows on a producer's loan market from individual savers,
and he judges how much to borrow on the basis of his expected rate of profit, or rate of return.
The writers assume that he has available a shelf of investment projects,
The Theory of Money and Credit
Superficially, this approach might seem plausible.
It usually happens that a businessman foresees such varying rates of return on different
investments, that he borrows on the market from different individual savers, and that
And he is popularly considered the capitalist or entrepreneur, while the lenders are simply
savers.
And it seems to avoid mysterious complexities and to focus neatly and simply on the rate
of interest for producers' loans, the loans from savers to businessmen, in which they
and most writers on economics are interested.
What is this rate of interest that is generally discussed at great length by economists?
Although popular, this approach is wrong through and through, as will be revealed in the course
of this analysis.
What is the basis for the alleged shelf of available projects, each with different rates
of return?
Why does a particular investment yield any net monetary return at all?
The usual answer is that each dose of new investment has a marginal value productivity,
such as 10%, 9%, 4%, etc., that naturally the most productive investments will be made
first and that therefore, as savings increase, further investments will be less and less
value productive.
The cardinal error here is an old one in economics.
The Attribution of Value Productivity to Monetary Investment
There is no question that investment increases the physical productivity of the productive
process, as well as the productivity per man hour.
Indeed, that is precisely why investment and the consequent lengthening of the periods
of production take place at all.
But what has this to do with value productivity or with the monetary return on investment,
especially in the long run of the ERE?
Suppose for example that a certain quantity of physical factors, and we shall set aside
the question of how this quantity can be measured, produces 10 units of a certain product per
The Theory of Money and Credit
The gross revenue per period is increased from 20 to 50 ounces.
Does this mean that value productivity has increased two and a half times, just as physical productivity increased five-fold?
Certainly not, for as we have seen, producers benefit not from the gross revenue received,
How can there be any permanent benefit when the cumulative factor prices paid by this producer increase from say 18 ounces to 47 ounces?
This is precisely what will happen on the market as competitors vie to invest in these profitable situations.
The price spread, that is, the interest rate, will again be 5%.
In some, the neoclassical doctrine maintains that the interest rate, by which is largely meant the producer's loan market, is co-determined by time preference, which determines the supply of individual savings, and by marginal value productivity of investment, which determines the demand for savings by businessmen.
and by marginal value productivity of investment, which determines the demand for savings by businessmen, which in turn is determined by the rates of return that can be achieved in investments.
But we have seen that these very rates of return are in fact the rate of interest, and that their size is determined by time preferences.
The neoclassicists are partly right in only one respect that the rate of interest in the producer's loan market is dependent on the rates of return on investment.
They hardly realize the extent of this dependence, however.
is clear that these rates of return, which will be equalized into one uniform rate, constitute
the significant rate of interest in the production structure.
Discarding the neoclassical analysis, we may ask, what then is the role of the productive
loan market and of the rate of interest set therein?
This role is one of complete and utter dependence on the rate of interest as determined earlier,
and manifesting itself, as we have seen, in the rate of investment return on the one hand,
and in the consumer's loan market on the other.
These latter two markets are the independent and important subdivisions of the general
Time Market, with the former being the important market for the production system.
In this picture, the producer's loan market has a purely subsidiary and dependent role.
In fact, from the point of view of fundamental analysis, there need not be any producer's
loan market at all.
To examine this conclusion, let us consider a state of business affairs without a producer's
loan market.
What is needed to bring this about?
Individuals save, consuming less than their income.
They then directly invest these savings in the production structure, the incentive for
investment being the rate of interest return, the price spread on the investment.
This rate is determined, along with the rate on the consumer's loan market, by the various
components of the time market that we have portrayed.
There is, in that case, no producer's loan market.
There are no loans from a saving group to another group of investors.
And it is clear that the rate of interest in the production structure still exists.
It is determined by factors that have nothing to do with the usual discussion by economists
of the Producer's Loan Market.