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XX. INTEREST, CREDIT EXPANSION, AND THE TRADE CYCLE


2. The Entrepreneurial Component in the Gross Market Rate of Interest


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. The moneylender is always an entrepreneur. Every grant of credit is a speculative entrepreneurial venture, the success or failure of which is uncertain. The lender is always faced with the possibility that he may lose a part or the whole of the principal lent. His appraisal of this danger determines his conduct in bargaining with the prospective debtor about the terms of the contract.

There can never be perfect safety either in moneylending or in other classes of credit transactions and deferred payments. Debtors, guarantors, and warrantors may become insolvent; collateral and mortgages may become worthless. The creditor is always a virtual partner of the debtor or a virtual owner of the pledged and mortgaged property. He can be affected by changes in the market data concerning them. He has linked his fate with that of the debtor or with the changes occurring in the price of the collateral. 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. The dictum pecunia pecuniam parere non potest (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. Gross interest can be reaped only by creditors who have been successful in their lending. If they earn any net interest at all, it is included in a yield which contains more than merely net interest. Net interest is a magnitude which only analytical thinking can extract from the gross proceeds of the creditor. [p. 540]

The entrepreneurial component included in the creditor's gross proceeds is determined by all those factors which are operative in every entrepreneurial venture. It is, moreover, codetermined by the legal and institutional setting. The contracts which place the debtor and his fortune or the collateral as a buffer between the creditor and the disastrous consequences of malinvestment of the capital lent, are conditioned by laws and institutions. The creditor is less exposed to loss and failure than the debtor only in so far as this legal and institutional framework makes it possible for him to enforce his claims against refractory debtors. There is, however, no need for economics to enter into a detailed scrutiny of the legal aspects involved in bonds and debentures, preferred stock, mortgages, and other kinds of credit transactions.

The entrepreneurial component is present in all species of loans. It is customary to distinguish between consumption or personal loans on the one hand, and productive or business loans on the other. The characteristic mark of the former class is that it enables the borrower to spend expected future proceeds. In acquiring a claim to a share in these future proceeds, the lender becomes virtually an entrepreneur, as in acquiring a claim to a share in the future proceeds of a business. The particular uncertainty of the outcome of his lending consists in the uncertainty about these future proceeds.

It is furthermore customary to distinguish between private and public loans, i.e., loans to governments and subdivisions of governments. The particular uncertainty inherent in such loans concerns the life of secular power. Empires may crumble and governments may be overthrown by revolutionaries who are not prepared to assume responsibility for the debts contracted by their predecessors. That there is, besides, something basically vicious in all kinds of long-term government debts, has been pointed out already.[1]

Over all species of deferred payments hangs, like the sword of Damocles, the danger of government interference. Public opinion has always been biased against creditors. It identifies creditors with the idle rich and debtors with the industrious poor. It abhors the former as ruthless exploiters and pities the latter as innocent victims of oppression. It considers government action designed to curtail the claims of the creditors as measures extremely beneficial to the immense majority at the expense of a small minority of hardboiled usurers. It did not notice at all that nineteenth-century capitalist innovations have wholly changed the composition of the classes of creditors and debtors. In the days of Solon the Athenian, of ancient [p. 541] Rome's agrarian laws, and of the Middle Ages, the creditors were by and large the rich and the debtors the poor. But in this age of bonds and debentures, mortgage banks, saving banks, life insurance policies, and social security benefits, the masses of people with more moderate income are rather themselves creditors. On the other hand, the rich, in their capacity as owners of common stock, of plants, farms, and real estate, are more often debtors than creditors. In asking for the expropriation of creditors, the masses are unwittingly attacking their own particular interests.

With public opinion in this state, the creditor's unfavorable chance of being harmed by anticreditor measures is not balanced by a favorable chance of being privileged by antidebtor measures. This unbalance would bring about a unilateral tendency toward a rise of the entrepreneurial component contained in the gross rate of interest if the political danger were limited to the loan market, and would not in the same way affect today all kinds of private ownership of the means of production. As things are in our day, no kind of investment is safe against the political dangers of anticapitalistic measures. A capitalist cannot reduce the vulnerability of his wealth by preferring direct investment in business to lending his capital to business or to the government.

The political risks involved in moneylending do not affect the height of originary interest; they affect the entrepreneurial component included in the gross market rate. In the extreme case---i.e., in a situation in which the impending nullification of all contracts concerning deferred payments is expected--they would cause the entrepreneurial component to increase beyond all measure.[2]

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[1] Cf. above, pp. 226-228.

[2] The difference between this case (case b) and the case of the expected end of all earthly things dealt with on p. 527 (case a) is this: in case a, originary interest increases beyond all measure because future goods become entirely worthless; in case b, originary interest does not change while the entrepreneurial component increases beyond all measure.

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