The Principles of Economics Part 12

[Sidenote: Distinction between money and capital]

3. _Capital must not be identified with money although it is expressed in terms of money._ While money and capital are not identical, neither are they opposite or mutually contradictory. Money is but one species of the genus capital. It is a particularly durable form when industry as a whole is considered, a particularly fleeting form in the individual's possession, and a particularly important, though not necessarily the most important, form in its social significance. The things composing capital are concrete things, scarce forms of wealth, some of which are yielding gratification at the present moment, or are destined to do so at some future moment; others of which are not themselves giving direct gratification, but are indirect agents for the gratifying of wants. To this latter group belongs money.

The caution contained in this proposition may appear to some to be superfluous, but it is most needed. The mind is so p.r.o.ne to identify things that are expressed currently by the same words. The ease with which money and capital are thus confused has led to various popular fallacies on practical economic questions.

[Sidenote: Contractual interest and rent involve a difference of business procedure]

4. _Renting wealth and borrowing capital have the same economic purpose, but the capital contract presents certain peculiar features._ In the interest contract for the loan of capital the interest always is and must be expressed in money; the capital sum must be expressed as value; and the interest rate expresses the relation between these two values.

In each of these features the interest contract is in contrast with the renting contract. While the rent itself may or may not be expressed in terms of money, the value of the rented wealth is not so expressed, and there is no rent-rate expressing the relation between the two values.

[Sidenote: The wealth concept and the capital concept contrasted]

As here presented, the essence of the capital concept is in the mode or form of expression of wealth, not in the physical nature, the origin of its value, or any peculiarity in the kind of wealth; the content of the concept is limited only by man's thought of wealth, every good becoming capital when it is capitalized, that is, when the totality of its uses is expressed as a present sum of values. The difference between the wealth concept and the capital concept is therefore subjective, not objective; it is a difference in the mode of man's thought regarding wealth. The rent contract and the interest contract are modes of borrowing and lending which reflect this difference of conception. In their effort to express more exactly to themselves and to others the relative felt importance of their environment, men take in turn different points of view, and use different modes of expression. The most developed and exact of these devices for the social expression of valuations, which became possible only with a money economy and widened markets, is the capital concept, whose nature has been a.n.a.lyzed here.

[Sidenote: The capital concept now prevalent]

Summarizing the thought of this chapter, it may be said that the capital concept has gradually developed with industry, and is now the most widely prevailing mode of expressing the quant.i.ty of wealth. It is used in the discussion of all the most important problems of modern industry.

The questions of income from wealth, of trusts and corporations, nearly all that is most notable in the development of modern industry, require the use of the capital concept. Yet (returning to the thought with which this chapter started) in many of the outlying districts other modes of looking upon wealth are employed. References to modern industry must be understood usually as applying to the most developed capitalistic conditions.

CHAPTER 15

THE CAPITALIZATION OF ALL FORMS OF RENT

-- I. THE PURCHASE OF RENT-CHARGES AS AN EXAMPLE OF CAPITALIZATION

[Sidenote: The nature and sale of rent-charges]

1. _From the twelfth to the sixteenth centuries the sale and purchase of rent-charges was the most general form of borrowing and lending wealth._ A rent-charge in the Middle Ages was a definite income that was to be paid out of the rents of an estate, business house, manor, etc. The property was said to be "charged" with the payment of that income, and some estates were pa.s.sed on for generations from father to son charged with a certain rent. It was thus possible for the owner of money to buy a rent-charge, either one that had been created a generation before, or a new one created by some landowner for the especial purpose of borrowing money to go on a crusade or of improving his estate or of investing in other business. The transaction took this form: the purchaser of the rent-charge paid a sum of money, called the capital sum, and obtained in return a rent-paper ent.i.tling him to receive permanently a given income. The house or land was security for the debt.

The seller gave up the right to the rent as it came in year by year, and received in return a capital sum in hand. Generally he had the right to repay the sum whenever he wished and thus extinguish the rent-charge.

Logically viewed, the purchaser bought an equitable part of the income, therefore an equitable part of that rent-bearing wealth. In effect it was just like a loan except that the purchaser of the rent-charge could not demand the repayment of his money. He could, however, sell the rent-charge when he wished to get his capital out. Gradually it became usual to sell and transfer rent-papers just as is done to-day with mortgages and bonds. Rent-papers thus came in the fifteenth century to be negotiable paper in somewhat general use. There was a rise and fall of the value of the rent-paper with changes in the demand for investment in rent-charges or with changes in the security.

[Sidenote: Rent-charges were a convenient investment in medieval cities]

2. _The sale of rent-charges grew out of an industrial need of the exchange of safe permanent incomes for larger sums of wealth._ The custom of the purchase of rent-charges grew up in the cities. The increasing wealth of cities, the growth of commerce and enterprise, caused rent-charges to be sold by the owners of houses and real estate in the cities, and the custom spread to the country. It is an instance of the way income became more fluid in the cities during the Middle Ages. This kind of loan contrasted strikingly in the Middle Ages with those loans made commonly by reckless kings, prodigal n.o.bles, and distressed peasants to secure consumption goods. Merchants needed large amounts of wealth for their growing enterprises, and they felt that if they could get a capital sum down they could make it earn more than the rent-charge. A perpetual income of one hundred units was therefore exchanged for a sum at the moment of twenty or twenty-five times that amount. As the wealth of the cities increased, there were some men who wished to retire from active business, and there were widows and children with property which they could not manage directly. Such persons either could not afford to take the risks of active business, or could not judge of them, and they formed a cla.s.s of lenders or investors seeking some safe income. Between the two cla.s.ses of active merchants and capitalist lenders, each of whom saw his own advantage and followed it, the practice of buying and selling rent-charges thus grew up.

[Sidenote: Rent-charges were not forbidden by the church]

The practice was allowed by the church, though interest and the lending of money were forbidden. The loan was substantially a loan of capital and the rent-charge was substantially interest, but in the eyes of the church moralists there was a marked difference, in that the obligation to the purchaser of the rent-charge was secured by a permanent and substantial form of wealth, and the contract usually was favorable to the borrowers. In its origin the practice was not merely an evasion of the law against usury, but a convenient form of contract. It doubtless came, however, to be used as a means of evading the law of the church against usury, and thus became an entering wedge for the general use of money loans.

[Sidenote: The market value of rent-charges reflects the exchange ratio between present and future money incomes]

3. _Rent-charges had a market-value, varying with time and place, and expressed as a number of years' purchase of the rent-charge._ The sellers of rent-charges were influenced by many motives: a lord wished to build a castle, or go on a crusade; a farmer wished to improve his estate; a merchant wished to embark on larger ventures. Opportunities thus opened in the cities for men of wealth to get a fixed income for a payment of ready money. In the cities, the buyers seeking a fixed income would bid down, or bid up, the value of the rent-charges, which thus came to have a quotable market value. In time, greater and greater amounts were paid by the investors in return for the guarantee of a given income. In rural districts the value of the charges was low, that is, the capital sum was but ten or twelve times the value of the annual rent-charge; while in the cities it rose to twenty and even twenty-five times the annual rent-charge.

A memento of this practice, probably, is the manner in which the price paid for land is spoken of still in England and the continental countries in a phrase quite unfamiliar to American ears, as a certain number of "years' purchase." If an estate is sold for twenty times the annual net rental it is said to be sold at twenty "years' purchase."

This does not mean that the rental for twenty years only is sold, but that the rental _in perpetuity_ is sold for twenty times the annual rent; that is, the land is sold outright for twenty years' rent paid at once. The estate is looked upon primarily as yielding a fixed income; the value of the permanent possession of the estate is thought of as a certain number of times the value of the income secured. "Years'

purchase" means, therefore, the length of time required for the income to amount to the purchasing price.

This attains the thought of the present value of the estate, or capital sum in it, though the capital sum is thought of as a multiple of the income, instead of the income being calculated as a percentage of the capital value. Now at the rate of "ten years' purchase" an investment of money in land affords an annual interest of ten per cent., as each year the rental is one tenth of the original investment; twelve years'

purchase yields eight and one third per cent., twenty years' purchase, five per cent., and twenty-five years' purchase, four per cent. Increase in the number of years' purchase corresponds to a decrease in the rate of interest which the original investment of money, the capital sum, is expected to yield. This is equally true whether the investment be in the legal form of a purchase of the fee-simple of land, or in that of the purchase of a rent-charge. We are brought to this conclusion: that the present value of the rents in perpetuity, of any given wealth, is the capital value of the wealth; and that the reciprocal of the number of years' purchase is the rate of interest that an investment is expected to yield.

[Sidenote: Purchase and sale of rent-charges gives way to more modern contracts]

4. _The sale of rent-charges has gradually given place to the modern form of money loan._ The conditions of the contract in the sale of rent-charges were gradually changed for greater convenience. When the purchaser (the lender) was given the right to require repayment of the capital sum at the end of a specified time, the transaction was brought still closer to an ordinary loan. In this form, the sale of rent-charges is still found in southern Germany, but the greater simplicity of the money loan, and of the sale outright, has led to the almost total disuse of the older form of transaction.

The purchase of rent-charges was long looked upon as a very different thing from the loan of money, but to modern eyes it is not, and the old distinctions between the moralities of the two kinds of income appear now mainly quibbles, justified in a slight degree by certain social facts of the time. The rise of industry led to different ideas on the lending of money; the prejudice against it weakened in large cla.s.ses of the population, especially in Protestant countries, and its use rapidly spread. Not until 1830 did a decision of Rome remove all disapproval on the part of the church. Rent-charges are instructive now as showing the mode in which rents began to be capitalized in earlier centuries.

-- II. CAPITALIZATION INVOLVED IN THE EVALUATING OF INDIRECT AGENTS

[Sidenote: The capital value of durable wealth is the sum of its expected rents]

1. _The buying of any indirect agent is practically the purchasing of a "rent-charge."_ To account rationally for the market value of anything, its importance must be traced back to "gratification." We have examined and accepted the proposition that if a good is not affording enjoyment at the present moment it is kept because it will yield a rent until it is used. If it is never to afford direct enjoyment, if it is never to mature physically into the cla.s.s of enjoyable goods, the explanation for its value must be found in the fact that it is capable of yielding a series of rents of enjoyable goods. In the last a.n.a.lysis the value of anything must be found in its power of affording psychic income, a series of psychic rents. Now when such a durable income is bought outright, what is the basis on which its value is estimated? What other than the rents it will afford? Exactly as did the purchasers of a medieval rent-charge, the buyer of the durable wealth pays a definite sum in return for the right to enjoy a series of future rents. As was the case with rent-charges, however, the amount paid will be less than the full matured value of the rents. A long series, even a perpetual series, may be exchanged for no more than ten, twenty, or twenty-five annual rents. While therefore the selling value of the good is the sum of the values of the rents, it evidently is that sum discounted.

Immediately, when we have reached this point in the reasoning, our proposition must suggest itself as self-evidently true in this form: the value of any good is the sum of the entire series of rents it contains, discounted, at _some_ rate, to their present worth. What determines the rate of discount is a question that will call later for a fuller explanation.

[Sidenote: Capital value is not primary]

2. _There are two modes of approach to the problem of interest: one from the side of income (rents); the other, from the side of the bearer (capital)._ The rate of interest expresses a relation between two values, the value of the income and the value of the sum loaned, whether it consists of money or of other wealth expressed in terms of money; But which of these values is primary in a study of the causes of value?

Which is the base from which the other is derived by multiplying at the rate expressing their ratio? The answer to this question cannot be a matter of indifference to the economic theorist. Universally heretofore the study of interest has been approached from the side of capital. A capital sum was said to be invested and to earn a certain interest, that is, per cent., of that sum. The usage of speaking of the investment of capital as a sum given, and of "interest on capital" predisposes the mind to this view.

[Sidenote: Expected rents are primary, and capital value is the "years'

purchase"]

But the approach from the side of income has been shown to be in some important cases the historical origin of the rate of interest, and we need but reconsider reasoning that has gone before to see that this is the logical order in all cases. Rent, or income, is a link in the chain of value, connecting gratification or psychic income, consumption goods, rent or usufruct value, and finally capital value. To one keeping in mind the logical cause of value, it becomes inconceivable that capital value could precede income, a view possible only when a fragment of the problem is seen. This being true, the mere mention of a capital sum implies the interest problem, and a.s.sumes the interest rate. The capital is of that amount because the antic.i.p.ated incomes, discounted at some rate, equal that sum. The capital sum is a certain number of years'

purchase of the series of rents which can be secured by the use of wealth in various industries. The owner of a number of dollars (or of an amount of other wealth expressed in dollars) has open to him various investments. The value of any wealth is due to the possibility of deriving incomes from it. If, however, the expected income fails to be realized, the capital loses its value, or it is revalued on the basis of the new rents. The investment is then said to be a losing one. Thus, at each stage in the valuation of capital, before it is invested and at every moment thereafter when the valuation is readjusted to the rents realized or expected, rents are logically primary, the source from which the capital sum is derived.

[Sidenote: The rate of capitalization of rents is not fixed merely in commerce]

3. _The capitalization of comparatively safe permanent incomes from real estate contains within itself all the factors for the independent determination of the interest rate, and is not to be explained merely by reference to "the prevailing rate of interest" in other investments._ The value of land usually is explained simply as the capitalizing of its rents at "the prevailing rate of interest." The rate is a.s.sumed to be fixed by conditions in manufacturing and commerce, and if five per cent, can be gotten there the capitalist would never buy land unless investment in it were made equally attractive. The cause of the rate thus is supposed to rest outside the transaction itself, the exchange of land for other capital seeking investment. The economic student is safe in a.s.suming always that explanations of this sort are fallacious. The cause of value in any one exchange or any one industry is not thus to be juggled and s.h.i.+fted into another industry. It is true that the values of goods are so wonderfully interrelated by subst.i.tution that as the price of fresh beef will affect that of salt mackerel, so the capitalization rate of machinery affects that of land; but the influence is not from one side only, it is mutual. When anything has value, it must have in itself an independent cause of value.

[Sidenote: The exchange of any present and future rents results in a rate of time discount]

It can not be otherwise in the particular problem of value called capitalization. The first task of scientific study is to state clearly the nature of the problem. In this case it is seen to be the exchange of a present sum of wealth for a series of future rents. Whenever there are income-bearers and buyers and sellers of them, there are the conditions required for the determination of the market rate at which those future incomes shall be discounted. Manufactures and commerce have no peculiar relation to this process. By a flight of scientific imagination we might a.s.sume that the stock of indirect agents in the world consisted only of natural food producers, and that this stock and its yield were absolutely unchangeable by man's will or efforts. Each man in such case would have to stand with hands tied, and take the fruits as they matured. Even in such a case there would be capitalization and a rate of discount on future rents. The fruit-tree (that is, the whole future series of fruits) would bear a certain relation to one year's yield; the field would bear a certain relation to its crop. Wherever there are buyers and sellers of more or less durable agents of it matters not what kind or origin, there are present the elements and causes for the fixing of a rate of time discount.

[Sidenote: Capitalization of a perpetual uniform series of rents;]

4. _In practical business may be seen innumerable instances of the capitalization of both permanent and limited series of incomes._ The simplest case is the capitalization of an unvarying and supposedly perpetual series of rents. Whatever the rate of time discount prevailing, rents infinitely distant become infinitesimally small when discount is compounded. The present rent is worth most, next year's less, and so on in a decreasing series.

[Sidenote: Of a probably increasing series of rents;]

But social changes alter rental values, and so far as these changes are foreseen, these antic.i.p.ated or expected rents are made the basis for present capitalization. Investors and owners alike may foresee that a piece of land used only for agriculture will, within a few years, be taken up for city lots, or will be needed for a factory or as the site of a railroad station. The capitalized value would not in this case be based upon a series of uniform rents each of the amount yielded annually now, but on the progressive series expected. In some cases the physical output of an agent may decline while the price of the product increases.

Modern foresters foresee that the selling price of the timber will be greater twenty-five years from now than it is to-day, and they therefore estimate the rental value of the forest on the basis of the future price, thus justifying expenditure that would be unwise if present prices were to continue.

[Sidenote: And of a declining or fluctuating series of rents]

Again the expected series of incomes may be declining, as the royalties (not typical rents) secured from mines. If the income is expected steadily to fall, and to disappear at the end of the twenty-fifth year, the value of the mine would be the capitalized sum of a limited and degressive series of incomes.