It's of Interest
Speculative anticipations are not interest.
Chapter 17 of The General Theory, The Essential Properties of Interest and Money, is dull, implausible and full of obscurities, non-sequiturs and other fallacies.
Even Alvin Hansen, Keynes's leading American disciple, has written,
Immediately after the appearance of the General Theory, there was a fascination about Chapter 17, due partly, no doubt, to its obscurity.
Digging in this area, however, soon ceased, after it was found that the Chapter contained no gold mines.
In general, not much would have been lost had it never been written.
Keynes's discussion in section 1, chapter 17, is confused and of no real importance.
I am tempted to let the matter go at this, but some of the fallacies that appear in this
chapter are worth analysis both in the interests of thoroughness and for the light the analysis
may throw on the rest of the general theory.
It is in this chapter that Keynes toys with the strange notion of own rates of interest.
The money rate of interest, we may remind the reader, is nothing more than a percentage
excess of a sum of money contracted for forward delivery, e.g. a year hence, over what we
may call the spot or cash price of the sum thus contracted for forward delivery.
It would seem, therefore, that for every kind of capital asset there must be an analogue
of the rate of interest on money.
For there is a definite quantity of, e.g., wheat, to be delivered a year hence, which
has the same exchange value today as one hundred quarters of wheat for spot delivery.
If the former quantity is 105 quarters, we may say that the wheat rate of interest is
5% per annum, and if it is 95 quarters, that it is minus 5% per annum.
Thus, for every durable commodity, we have a rate of interest in terms of itself, a wheat
rate of interest, a copper rate of interest, a house rate of interest, even a steel plant
Rate of Interest, p. 222-223.
Of all the confusions in the general theory, this is one of the most incredible.
Even such loyal Keynesians as Hansen and Lerner boggle at it.
The own rate of interest, the house rate, the wheat rate and the money rate, Hansen
and insists, is in fact the marginal efficiency of a unit, whether that unit be a house, a
bushel of wheat, or a sum of money. The all-embracing term for the so-called own rate of interest
is the marginal efficiency rate, or the rate of return over cost from investment in an
increment of the capital asset in question. Now, this is only a little less nonsensical,
a little less violent misnomer than Keynes's own term.
What Keynes is talking about is certainly not an interest rate of any kind, nor is it,
as Hansen supposes, a marginal efficiency rate.
It is not merely that it would be confusing and silly to talk of a marginal efficiency
rate of a bushel of wheat.
This marginal efficiency rate would often be a negative sum.
And if the marginal efficiency of a bushel of wheat were negative, the price of a bushel
of wheat would also be negative, or at least zero.
Now, an interest rate is at least a rate.
If it amounts to R for one year, then it is 2R for two years, 3R for three years, ½R
for One Half Year, and so on.
On such an analogy, one might perhaps talk of the net rent of a house as a house rate
of interest.
But what Keynes is talking about is not even a hiring rate, which would at least have some
reasonable analogy with an interest rate.
He is talking merely of speculative anticipations of price changes, which may change from day
Day to Day, Hour to Hour, or Minute to Minute.
Keynes should have had some intimation that he was talking nonsense, one would suppose,
when he was explaining own rates of interest to the reader.
Let us suppose, he writes, that the spot price of wheat is one hundred pounds sterling per
one hundred quarters, that the price of the future contract for wheat for delivery a year
Here hence is one hundred seven pounds sterling per hundred quarters, and that the money rate
of interest is five percent.
What is the wheat rate of interest?
Page 223.
After a slight calculation, he concludes that, in this case, the wheat rate of interest is
minus two percent per annum.
And he adds, in a footnote, This relationship was first pointed out by Mr. Straffa, Economic
Journal, March, 1932, page 223.
Now a negative interest rate is in itself a foolish and self-contradictory conception,
for it is impossible to imagine any sane person lending any amount of wheat or money or anything
in order to make a foreseen loss, and the term interest rate implies that the rate is
foreseen if it implies anything.
The term interest rate again implies that something is being lent by one party to the
transaction and borrowed by the other, and that the principal sum or object is being
returned by the borrower to the lender at the end of the contractual period.
But no lending or borrowing of wheat occurs in the transaction described by Keynes, but
merely a purchase and sale.
And if a rate of interest is being paid, it is impossible to figure from whom to whom.
It is even impossible to know, from the illustration Keynes gives, whether the purchaser of the
future contract for wheat has made a profit or a loss.
To know that, one would also have to know the spot price for wheat when the year was
up and compare it with the 107-pound sterling that the purchaser of the future contract
had to pay.
We cannot even say, in the illustration given, that the seller of the one hundred quarters
of wheat is two pounds sterling better off than if he had not sold the wheat but had
I borrowed £100 sterling at 5% to carry it, because this would depend entirely upon the
spot price he would have to pay for the same amount of wheat when the year was up.
Similarly, we cannot even say that the buyer of the future contract for wheat is £2 sterling
worse off than if he had not bought the forward contract but had lent out his £100 sterling
at 5% for a year instead.
To answer either question, we must know what the spot price of wheat is at the time that
the future contract falls due.
If the price of spot wheat is then 114 pounds sterling, the previous seller of the wheat
is 9 pounds sterling worse off than he might have been if he had held his wheat, and the
The buyer of the forward wheat is nine pounds sterling better off than he would have been
if he had not bought the forward contract.
Similarly, if the spot price of wheat at the end of the year is still one hundred pounds
sterling, then the seller of the wheat is five pounds sterling better off than if he
had held his wheat and paid five pounds sterling interest to carry it, and the buyer is five
The whole illustration, in fact, leads one to question how much Keynes knew about actual
transactions in the speculative commodity markets.
I pick up the newspaper as of the day I am writing this and quote some illustrations as
I find them.
As of August 8, 1957, then, the opening price of Chicago Wheat, new contract, for September
delivery was $2.14 a bushel.
For December delivery, $2.19 a bushel.
For the following March, $2.213.25 per bushel, but for the following May, $2.167.8 of a cent,
and for the following July, $2.375.
How could one figure from this the wheat rate of interest?
There is, of course, a premium of five and a half cents for December wheat over September,
and a premium of seven and three-quarters of a cent of March over September and of two
and a quarter cents of March over December.
If one finds such confusion amusing, one could treat these sums as a negative wheat rate
of interest.
Even here, however, one would be hard put to explain it why the negative wheat rate
of interest was so much lower for six months than for three months.
But what is one to do when one gets to the May and July deliveries and finds the situation
completely reversed so that one can buy a bushel of wheat for delivery eleven months
off for ten and a quarter cents less than one pays for delivery next month?
Here are all sorts of positive and negative rates of interest for the same commodity on
the same day.
If we turn to Chicago corn, also on August 8, 1957, we find exactly the reverse situation.
There, the price of bushel for corn for September delivery is $1.307.80.
For December delivery, $1.267.80.
For March delivery, one dollar and thirty-one and one-eighth of a cent.
And for May delivery, one dollar and thirty-three and seven-eighths of a cent.
So the corn rate of interest, unlike the wheat rate of interest, for the first three months
is a positive rate, talking in Keynesian terms, but for six and eight months suddenly becomes
a negative rate.
If we throw out all such nonsense, stop calling apples cherries and triangles squares, and
ask what really happens, we find that the difference between spot prices and future
prices, or between one future price and another, is merely the result of differences in speculative
anticipations.
The speculative community, in other words, is putting a separate guess on the probable
and the Federal Supply and Demand situation regarding each commodity at each of a series of delivery dates in the future.
Unlike the situation with regard to riskless money lending, the profit or loss from these transactions cannot be known in advance,
unless they are hedging operations designed to avoid a speculative risk by taking the risk both ways.
Studies.
This does not mean that the going short-term interest rate on money does not play a part
in speculative prices.
Where the wheat that is being sold for forward delivery must meanwhile be carried by the
seller in storage, the seller will mentally deduct the prospective storage, insurance
and other carrying charges, including the interest he has to pay to borrow the money
to carry it, in figuring what he is really getting for his wheat, and the buyer will
mentally add these carrying charges in figuring what he is really paying.
But both are in fact betting on what they expect the spot price to be for wheat on the
day of delivery.
The buyer thinks he will be getting the wheat cheaper, or at least avoiding the risks of
of Loss by buying it now at the existing futures price than by paying the spot price as he
expects it to be six or nine months hence.
The seller thinks he is getting more, or avoiding risk, by selling at the futures price now than
by waiting to sell and taking a chance on the spot price six or nine months hence.
Buyer and seller, in short, have different estimates.
Each is betting against the judgment of the other.
There is no need for any concept of a Wheat rate of interest in understanding such a transaction.
There is no real analogy with any rate of interest, and nothing but confusion can result
from introducing a spurious analogy.
Impossible Miracles
Because there is no validity at all in the idea of own rates of interest, I shall spare
the reader an analysis of the pretentious algebraic notation, Q minus C plus L, etc.,
that Keynes introduces to explain the differences between the own rates of interest of different
goods.
It is curious, in fact, how Keynes himself pursues this and other of his own ideas to
to the point of reductio ad absurdum while seeming to remain completely blind to the
absurdity.
At one point he even introduces the idea that each national currency must have a different
own rate of interest.
Here, also, the difference between the spot and future contracts for a foreign money in
terms of sterling are not, as a rule, the same for different foreign moneys.
Page 224.
Of course not, and the reason is clearly that, as long as most national currencies remain
on a mere paper basis, there is bound to be a different speculative guess changing daily
concerning the future value of every national currency.
To call these different speculative guesses rates of interest is merely silly.
On the same page, Keynes, in Illustrating Own Rates of Interest Theory, writes,
To illustrate this, let us take the simplest case, where wheat, one of the alternative
standards, is expected to appreciate at a steady rate of A percent per annum in terms
of money.
Page 224.
The illustration is absurd and impossible.
Never in history has wheat been expected to appreciate at a steady rate of A% per annum
in terms of money, and it is impossible to imagine without self-contradiction the conditions
under which such an expectation could exist.
One would be the expectation of an absolutely fixed objective value for a bushel of wheat
each year, month, day and hour, combined with a steady annual, also monthly, weekly and
daily, depreciation in the value of the currency unit.
Such an expectation, if general, would be falsified because speculative transactions
would anticipate it immediately.
Another condition would be one in which the value of the dollar would be expected to remain
absolutely fixed, while the value of a bushel of wheat appreciated at a steady rate annually,
and presumably monthly, weekly and daily.
For such an anticipation to exist, we should have to imagine a condition in which everybody
miraculously expected the demand for wheat to increase with complete regularity, and
without speculative anticipation, while the supply for equally miraculous reasons remained
rigid, or one would have to imagine so finely adjusted a decline in the production of wheat
as to make a steady appreciation in value at the same uniform rate possible.
One would have to imagine a universally shared expectation upon which no speculator, no buyer
Fair or seller acted, but the assumptions are too self-contradictory to pursue further.
Yet it is always instructive in analyzing a fallacy to try to discover what it was that
led its author to embrace it.
As with so many other fallacies of Keynes, we find that even this one was not original
with him.
Irving Fisher in The Theory of Interest, 1930, played with the idea for a few sentences.
No two forms of goods can be expected to maintain an absolutely constant price ratio toward
each other.
There are, therefore, theoretically just as many rates of interest expressed in terms
of goods as there are kinds of goods diverging from one another in value.
Page 42 But this idea is then almost immediately
dropped.
I think this was because Fisher's common sense recognized that the free convertibility
at all times of money into goods, at market prices, and of goods into money brought about
in effect a single uniform interest rate, THE interest rate, expressed in money.
The constant fluctuations over time in the prices of individual goods can hardly, therefore,
be treated as changes in individual interest rates.
They are speculative oscillations.
The common interest rate is diffused through the whole price system.
Ought wages to be rigid?
I shall have to skip over whole nests of minor fallacies and confusions in the later part
of Keynes's chapter 17 in order to concentrate upon a few major ones.
One of the most important is his contention not only that money wages are sticky, but
that they ought to be.
In other words, Keynes contends not only that money wage rates fail to respond to changes
and Supply and Demand, but that it would un-stabilize the economy if they did so.
It is a very good thing that they are unresponsive.
If money wages were to fall easily, this might often tend to create an expectation of a further
fall with unfavorable reactions on the marginal efficiency of capital.
Page 232
Professor Pigot, with others, has been accustomed to assume that there is a presumption in favor
of real wages being more stable than money wages, but this could only be the case if
there were a presumption in favor of stability of employment.
If indeed some attempt were made to stabilize real wages by fixing wages in terms of wage
The effect could only be to cause a violent oscillation of money prices.
For every small fluctuation in the propensity to consume and the inducement to invest would
cause money prices to rush violently between zero and infinity.
That money wages should be more stable than real wages is a condition of the system possessing
Inherent Stability, p. 238-239.
A full analysis of such passages will be postponed until we come to consider Keynes's Book Five
on Money Wages and Prices.
Here it is enough to notice that Keynes is against, one, flexibility and adjustment of
of Money Wages, and 2. Against Stability of Real Wages, because it would cause money prices
to rush violently between zero and infinity. Evidently, the man is going to be hard to
satisfy. Also, because these positions are mutually contradictory, it is going to be
hard to know which is Keynes's real position when it comes to analyzing his doctrine. I
I may anticipate our conclusions to the extent, however, of pointing out that the belief that
a subsequent adjustment of real wage rates to a prior change in money prices would cause
money prices to rush violently between zero and infinity is such furious nonsense that
no analysis could render it more ridiculous than it is on its face.
We Owe Our Lives to Saving
It is already clear that Keynes is determined, with no matter what argument or assertion,
to exculpate excessively high wage rates from all blame for unemployment, and to pin
that blame onto the demand of lenders for the payment of interest on their loans.
Thus, there is no real difference of doctrine, but merely one of obscurity, complexity, and
and intellectual pretentiousness between the contentions of the general theory and the
baldest and most demagogic propaganda of union leaders.
One difference is, indeed, that Keynes is more openly cynical in his proposals and more
openly contemptuous of everyone who does not accept his doctrine.
He is also more openly contemptuous of the public generally.
develops, that is to say, because people want the moon.
Men cannot be employed when the object of desire, i.e. money, is something which cannot
be produced, and the demand for which cannot be readily choked off.
There is no remedy but to persuade the public that green cheese is practically the same
thing, and to have a green cheese factory, i.e. a central bank, under public control.
Page 235 The theory embodied in this paragraph is that
the public is irrational, that it can be easily gulled, and that the object of government
is to be the chief party to the swindle.
The results of turning central banks into grain-cheese factories to deceive the public
will be examined in a later chapter.
Here I wish to analyze a typical paragraph in which Keynes seeks to put the blame for
almost everything that has gone wrong in history on his great Bait Noir, liquidity preference.
That the world after several millennia of steady individual saving is so poor as it
is in accumulated capital assets is to be explained, in my opinion, neither by the improvident
I differ in this from the older view, as expressed by Marshall with an unusual dogmatic force,
in his Principles of Economics, page 581.
Everyone is aware that the accumulation of wealth is held in check, and the rate of interest
Once more, Keynes has managed to pack an astonishing number of misstatements and fallacies into
a small space.
No doubt the world is still far poorer in accumulated capital assets than it desires
How poor it is compared with what it might have been under ideal conditions is, of course,
a matter of pure speculation.
But Keynes's statement that the world is poor in accumulated capital assets, even as
compared with the past, is subject to statistical test.
There is not space here to go into this matter in great detail.
The reader is referred to the appropriate historical and statistical material.
But aside from the notorious fact that the condition of the masses is enormously better
than it was two centuries ago, just before the Industrial Revolution, i.e. the birth
of modern capitalism, there is the still more notorious fact that the population of the
world since then has increased three-fold or four-fold.
It was capital accumulation that made this possible.
This means that at least two out of every three of us owe our very existence to the
savings and investment of our forebears, in spite of high liquidity premiums, and to the
capitalist system.
What assurance has any of us that he is the one person in every three or four that would
would have come into the world anyway without this capital accumulation.
Could Keynes or anyone else afford to be patronizing about it?
The gain in capital accumulation is not to be measured, of course, merely by number of
factories or amount of machinery.
The gain in world population implies the erection of an enormous amount of housing and it has
has involved, in fact, the continuous qualitative improvement in housing, tools, machinery,
and every sort of capital asset.
It is the qualitative improvement in capital assets which is certainly no less important
than the quantitative increase that Keynes constantly ignores.
Perhaps the greatest single form of capital investment in the world, in fact, is represented
by the improvement in land to make it more get-attable, usable, tillable, fertile, attractive,
productive in every way.
This has involved an immense amount of leveling, road-making, road improvement, canal digging,
forest clearing, draining, irrigation systems, river improvement and flood control systems,
plowing, fertilizing, and in cities, of street-laying, street-widening, sewage systems, the laying
of pipes and wires and sidewalks, and so ad infinitum.
Once this work has been done, the casual or careless observer is apt to take most of it
for granted, as if it had always been that way, or all been provided by nature.
The careless economist is apt to call it simply land, and to forget that, in all civilized
countries, it is land to which an enormous amount of capital improvement has been applied.
It might be added also that the growth of capital accumulation is accelerative.
This acceleration has been most pronounced since the beginning of the Industrial Revolution,
That is to say, since the repeal of the mercantilistic restrictions, the trade barriers, and above
all of the usury laws, those laws against high interest rates that Keynes thinks so
wise.
The next thing to notice, in the passage I have quoted from page 242, is that, after
greatly underestimating the existing amount of world capital accumulation, Keynes speaks
Critics of the high liquidity premiums formerly attaching to the ownership of land.
Now no doubt in the pre-capitalistic period, land ownership represented usually the chief
form of wealth ownership.
But how Keynes figures that land ever bore a liquidity premium is a mystery.
Land is proverbially, and has nearly always been, probably the most illiquid possession
and that a man can hold.
It was usually much more illiquid in the past than it is today, when its liquidity is for
practical purposes greatly increased by numerous real estate agents, by newspaper advertising
and by an organized mortgage market.
It has become less illiquid with the development of capitalism, for in the pre-capitalistic
Finally, we must notice, in the passage quoted, that Keynes not only rejects the time preference
It may be pointed out, however, that he differs in this also from his own previous acknowledgement
in the General Theory itself, of the way in which the psychological time preferences of
an individual, page 166, affect his decisions as between present and future consumption
and from his own frequent use, e.g., page 135, of the term rate of discount in connection
both with the interest rate and the marginal efficiency of capital.
The rate of discount is a meaningless concept, except in relation to time preference.
It is, in fact, merely another name for the rate of interest.
Keynes vs. Wicksell
Section 6 of Chapter 17 contains a short discussion of Newt Wicksell's concept of a natural rate
of interest.
Hans discusses it only to dismiss it.
Here again his dismissal is not based on anything that can properly be called an analysis, but
simply on his personal opinion.
I am now no longer of the opinion that the concept of a natural rate of interest, which
previously seemed to me a most promising idea, has anything very useful or significant to
contribute to our analysis.
It is merely the rate of interest which will preserve the status quo and, in general, we
have no predominant interest in the status quo as such.
Page 243
It is hard to call this anything else than a deliberate misrepresentation.
The implication of Keynes's statement is that what the natural rate of interest would preserve
is the existing distribution of wealth or income, or the existing level of production
or employment.
But the only thing that the natural rate of interest would preserve, on Wicksell's definition,
is the established pre-existing average of prices.
What Wicksell meant by the natural rate of interest, in other words, was the rate of
interest that would be neither inflationary nor deflationary.
We saw that if the rate of interest were pushed above this level, it would unduly discourage
borrowing, cause a contraction in the volume of money and credit, and hence a fall in prices,
activity and employment.
But if the rate of interest fell, or were held down below the natural level, it would
lead to overstimulation of borrowing, and hence to an inflationary expansion in the volume
of money and credit.
Though it was defective in some respects, as pointed out by Ludwig von Mises and others
who improved upon it, Wixsell's discussion of the interest rate and of its relations to
changes in the volume of money and credit marked a great forward step in economic analysis.
While Wixsell correctly saw, unlike Keynes, that the rate of interest is primarily determined
And by real factors, he took full account of the disturbances caused, and he even to
some extent exaggerated the disturbances caused, by changes in the volume of money and credit.
Thus, Wicksell took full account of the one germ of truth in Keynes's otherwise naive
and false theory of interest.
The truth that changes in the volume of money and credit have something to do with changes
Changes in the Interest Rate, but Wicksell saw clearly that in the absence of changes
in the quantity of money and credit, the interest rate would be determined by real factors,
and that changes in the quantity of money act only as disturbing factors which only
transitionally and temporarily affect the interest rate.
That Keynes's purely monetary theory of interest is quite naive and completely fallacious,
We have already seen in chapters 14 and 15, but we may notice again here that, though
Keynes's few references to Wicksell's contribution to the Theory of Interest are all disparaging,
telling us merely that he rejects it, they reveal that he was acquainted with Wicksell's
contribution.
Yet, in his chapter on The Classical Theory of Interest, Wicksell's name appears only
The Reader, unacquainted with the literature of the subject, would get no hint that Wicksell
had fully anticipated the only valid point in Keynes's discussion of the classical theory
of interest, vitilicit, that some account must be taken of the relation of interest
rates to changes in the money supply.
And his disciple, Alvin H. Hansen, calls Keynes to task for this injustice.
With respect to another subsidiary point, Keynes is clearly wrong.
He calls attention to the failure of the classical school to bridge the gap between the theory
of the rate of interest in Book I dealing with the theory of value and that in Book
II dealing with the theory of money.
This is formally correct, at least with respect to many writers, but then he adds the opinion
that also the neoclassical school had made a muddle of its attempt to build a bridge
between the two.
Now this certainly could not be said of Wicksell.
This paragraph, page 183, is far from convincing.
It is hard to escape the conclusion that Keynes, in order to try to prove his own originality
and the wrongness of everybody before him failed to give a clear account of Wicksell's
contribution and sought to solve his conscience by a disparaging reference to it.
Equilibrium of an Ice Cube
While Keynes persistently refuses to acknowledge that the rate of interest has anything to
I had, however, in the treatise of money, overlooked the fact that in any given society
there is, on this definition, a different natural rate of interest for each hypothetical
And similarly, for every rate of interest there is a level of employment for which that rate is the natural rate, in the sense that the system will be in equilibrium with that rate of interest and that level of employment.
I had not then understood that, in certain conditions, the system could be in equilibrium with less than full employment.
Employment, pages 242 to 243.
This entire passage is pure nonsense.
It is absurd, as I have frequently pointed out before, to talk of equilibrium with less
than full employment, because this is simply a contradiction in terms.
The absence of full employment negates the very concept of equilibrium.
Perhaps an analogy will help to make clearer not only why this concept is self-contradictory,
but why Keynesians nonetheless persist in accepting it.
Drop a cube of ice into a bowl of water.
The cube will cause a splash and other disturbances in the water level.
It will plunge toward the bottom of the bowl, then rise to the top, and settle with about
has melted and the water is all at one level.
Frozen wage rates cause frozen unemployment.
When wage rates become fluid again, full employment is restored.
It is perhaps not too difficult to account for Keynes's misuse of the term equilibrium
and for the uncritical acceptance of this misuse by so many writers.
The older economists thought of equilibrium as an actual state of affairs.
They contrasted stability with disturbance, a period of equilibrium with a period of transition.
But any living economy is always in transition, and fortunately so.
An economy that had reached completely stable equilibrium would be an economy that had not
not only stopped growing, but had stopped going.
The only kind of equilibrium worth trying for is the dynamic equilibrium that is approached
through competition and fluid prices and wage rates.
This must not be conceived of as a position that is ever reached, but as ever-changing
positions that are approached or passed through, as the pendulum of a clock constantly approaches
or passes through the vertical equilibrium position but never rests there as long as
the clock is running.
Paraphrasing and reversing Grover Cleveland's famous aphorism, we may say regarding economic
equilibrium that it is a concept that confronts us, not a condition.
Yet this concept is not unrelated to reality.
It is a limiting notion.
There is always a tendency toward equilibrium. An economy can get stuck for a long period
at a point of unemployment, as a clock can get stuck if someone puts chewing gum in the
works. But in neither case should the result be called equilibrium. There is finally no
such functional relationship between the level of interest and the level of employment as
as Keynes assumes.
He offers, in fact, neither statistical nor plausible logical grounds for this assumption.
The really significant relationship which Keynes persistently ignores or denies is that
between the level of wages and the level of employment.
The rate of interest and the level of employment are related in any actual situation, only
Only in the sense that there is some interconnection among all economic phenomena.