Book II, Chapter IV, 1

On Stock Lent at Interest.

Stock lent at interest is always regarded as capital by the lender. He expects it to be returned in due course and, meanwhile, expects the borrower to pay him a certain annual rent for its use. The borrower may use it either as capital or as stock reserved for immediate consumption. If he uses it as capital, he employs it to maintain productive laborers, who reproduce its value with a profit. He can then both return the capital and pay the interest without selling or drawing on any other source of revenue. If he uses it as stock for immediate consumption, he plays the spendthrift, squandering on the maintenance of the idle what was intended to support the industrious. He can then neither return the capital nor pay the interest without selling or drawing on some other source of revenue, such as property or rent from land.

Stock lent at interest is undoubtedly sometimes employed in each way, but far more often in the former than in the latter. Someone who borrows to spend will soon be ruined, and anyone who lends to him will generally regret his folly. Borrowing or lending for this purpose, then, is contrary to both parties' interests whenever gross usury is not involved. And though people undoubtedly sometimes do both, their concern for their own interest assures us that it cannot happen nearly so often as we tend to imagine. Ask any rich man of ordinary prudence whether he has lent most of his stock to people he believes will employ it profitably or to those who will spend it idly, and he will laugh at the question. Thus even among borrowers, who are not the people most renowned for frugality, the frugal and industrious considerably outnumber the extravagant and idle.

The only people commonly lent stock without any expectation that they will use it very profitably are country gentlemen borrowing on mortgages. Even they scarcely ever borrow simply to spend. What they borrow, one might say, they have generally spent already. They have usually consumed so many goods supplied on credit by shopkeepers and tradesmen that they must borrow at interest to pay the debt. The borrowed capital replaces the capital of those shopkeepers and tradesmen which the country gentlemen could not replace out of their estates' rents. Strictly speaking, it is borrowed not to be spent but to replace capital spent earlier.

Nearly all interest-bearing loans are made in money, whether paper or gold and silver. But what the borrower really wants, and the lender readily gives him, is not the money but its purchasing power—the goods it can buy. If he wants a stock for immediate consumption, only those goods can fill it. If he wants capital with which to employ industry, only those goods can provide industrious workers with the tools, materials, and maintenance they need to carry on their work. By lending, the lender in effect assigns the borrower his right to a certain part of the country's annual produce of land and labor, for the borrower to use as he sees fit.

The amount of stock—or, as it is commonly called, money—that can be lent at interest in any country is therefore determined not by the value of the money, whether paper or coin, that serves as the instrument of its various loans, but by the value of that part of the annual produce which, as soon as it emerges from the ground or from productive laborers' hands, is destined to replace capital, and specifically capital its owner does not wish to trouble himself to employ. Because these capitals are usually lent and repaid in money, they make up what is called the moneyed interest. It is distinct from the landed interest and also from the trading and manufacturing interests, in which owners employ their own capital. Even for the moneyed interest, however, money is only, as it were, a deed of assignment conveying between people the capital that its owners do not wish to employ themselves. That capital may be almost any multiple of the amount of money that conveys it, since the same pieces of money serve successively for many loans and many purchases. A, for example, lends W £1000, with which W immediately buys £1000 worth of goods from B. B, having no need of the money himself, lends those very pieces to X, who immediately buys another £1000 worth of goods from C. C likewise, for the same reason, lends them to Y, who buys goods with them from D. In a few days the same pieces of coin or paper can thus serve as the instrument of three separate loans and three separate purchases, each worth the full amount of those pieces. What the three moneyed men, A, B, and C, assigned to the three borrowers, W, X, and Y, was the power to make those purchases. That power is both the value and the use of the loans. The stock lent by the three moneyed men equals the value of the goods purchasable with it, and is three times the value of the money used to make the purchases. All those loans may nevertheless be perfectly secure if the different debtors employ the goods they buy so that, in due course, an equal value of coin or paper returns with a profit. And just as the same pieces of money can serve as instruments of different loans for three times—or, by the same reasoning, thirty times—their value, so they can successively serve as instruments of repayment.

Capital lent at interest may thus be seen as the lender's assignment to the borrower of a substantial portion of the annual produce, on condition that the borrower, in return, assigns the lender a small portion each year while the loan lasts, called interest, and at its end a portion as substantial as the one originally assigned to him, called repayment. Though money, coin or paper, usually serves as the deed of assignment for both the smaller and the larger portion, it is entirely distinct from what the assignment conveys.

As the share of a country's annual produce that is destined to replace capital immediately on emerging from the ground or from productive laborers' hands increases, the moneyed interest naturally increases with it. The growth of those particular capitals from which their owners seek revenue without the trouble of employing them themselves naturally accompanies the general growth of capital. In other words, as stock grows, the stock available for lending at interest grows steadily greater.

As the stock available for lending at interest grows, interest—the price paid for its use—necessarily falls. This happens not only through the general causes that normally lower the market price of things as their quantity increases, but also through causes specific to this case. As a country's capital grows, the profits obtainable from employing it necessarily decline. It becomes progressively harder to find a profitable domestic use for any new capital. Competition consequently arises among different capitals, as one owner tries to take over a line of employment occupied by another. Usually his only hope of displacing the other is to offer more favorable terms. He must not only sell his goods somewhat cheaper but sometimes buy them dearer in order to have them to sell. As the funds destined to maintain productive labor grow, demand for that labor grows greater every day. Laborers easily find jobs; owners of capital struggle to find laborers to hire. Their competition raises wages and lowers the profits of stock. And when profits from using capital are thus diminished, as it were, at both ends, the price one can pay to use it—that is, the rate of interest—must necessarily decline as well.

Mr Locke, Mr Lawe, and Mr Montesquieu, like many other writers, appear to have thought that the increase in gold and silver after the discovery of the Spanish West Indies was the true cause of the falling rate of interest across most of Europe. Those metals, they say, had become less valuable themselves; using a given amount of them must therefore have become less valuable too, and the price payable for their use must have fallen. Mr Hume has so thoroughly exposed this seemingly plausible idea that perhaps nothing further need be said about it. Yet the following very short and simple argument may make clearer the fallacy that seems to have misled those gentlemen.

On Stock Lent at Interest

The lender always treats stock lent at interest as capital. He expects to get it back when the loan is due. Meanwhile, the borrower pays him a fixed yearly rent for its use. The borrower can use it either as capital or as stock set aside for immediate consumption. If he uses it as capital, it supports productive laborers, who replace its value and add a profit. He can then repay the capital and interest without selling anything else that brings him revenue or drawing on it. If he uses it for immediate consumption, he behaves like a wasteful spender. He uses what should have supported working people to support idle ones. He cannot then repay the capital or interest without selling or drawing on some other source of revenue, such as property or rent from land.

Lent stock is sometimes used in both ways, but much more often as capital. A man who borrows to spend will soon be ruined. His lender will usually regret lending to him. So, leaving aside grossly excessive interest, borrowing or lending for that purpose is against the interests of both parties. Of course people sometimes do it. But since everyone cares about his own interests, it cannot happen nearly as often as we might imagine. Ask any reasonably careful rich man whether he has lent most of his stock to people he thinks will use it profitably or to people who will spend it idly. He will laugh at the question. Thus, even among borrowers, who are hardly famous for thrift, careful and hardworking people greatly outnumber wasteful and idle ones.

The only people commonly lent stock without being expected to make much profit from it are country gentlemen who borrow against their property. Even they hardly ever borrow simply to spend. You might say they usually spend the money before they borrow it. They have already consumed so many goods supplied on credit by shopkeepers and tradesmen that they must borrow at interest to pay their debts. The borrowed capital replaces the shopkeepers' and tradesmen's capital, which the gentlemen could not repay from the rent on their estates. The borrowing does not really pay for new spending. It replaces capital already spent.

Nearly all interest-bearing loans are made in money, either paper money or gold and silver. But what the borrower really wants, and the lender effectively gives him, is not money itself. It is what money can buy: goods. If the borrower wants stock for immediate consumption, only goods can fill that stock. If he wants capital to employ workers, only goods can supply those workers with the tools, materials, and support they need. Through a loan, the lender effectively transfers to the borrower his claim to part of the country's yearly output of land and labor, to use as the borrower wishes.

So the amount of stock that can be lent at interest in a country—often called the amount of money available to lend—is not determined by the value of the paper or coin used to make its loans. It is determined by the value of a part of its yearly output. This part, as soon as it comes from the land or from productive workers' hands, is intended to replace capital whose owners do not want to employ it themselves. Since these capitals are usually lent and repaid in money, they make up what is called the monied interest. That group is distinct from landowners and also from traders and manufacturers, since the latter use their own capital themselves. Yet even for the monied interest, money is only like a document that transfers ownership: it moves capital from an owner who does not wish to employ it to someone who does. That capital can be many times more valuable than the money used to transfer it. The same money can pass through many loans, just as it can pay for many purchases. For instance, A lends W £1000. W immediately spends it to buy £1000 worth of goods from B. B does not need the money himself, so he lends those very same coins or notes to X. X immediately buys another £1000 worth of goods from C. For the same reason, C lends the money to Y, who buys goods from D. Over a few days the same pieces of coin or paper can thus be used for three separate loans and three separate purchases. Each purchase has a value equal to the full sum of that money. What the three lenders, A, B, and C, gave the three borrowers, W, X, and Y, was the ability to make these purchases. That ability is what makes the loans valuable and useful. The stock the three lenders have lent equals the value of all the goods bought with it, three times the value of the money used to buy them. All these loans may nevertheless be fully secured. The borrowers can use the goods they buy in ways that will eventually return an equal value in coin or paper, with a profit. And just as the same money can make loans worth three times its value—or, for the same reason, thirty times its value—it can also be used in turn to repay them.

A capital lent at interest can thus be seen as a transfer from lender to borrower of a substantial part of the yearly output. In return, while the loan lasts, the borrower transfers a small part to the lender each year, called interest. At the end, he transfers back an equally substantial part, called repayment. Coin or paper money generally serves as the document transferring both the smaller and larger portions. But the money is not itself what is transferred.

As the share of a country's yearly output set aside to replace capital grows, so does the monied interest. This output is set aside as soon as it comes from the land or the hands of productive workers. Growth in capital whose owners want to earn revenue without employing it themselves naturally accompanies the general growth of capital. In other words, as stock grows, more stock gradually becomes available to lend at interest.

As more stock becomes available to lend, the interest charged for using it must fall. This happens partly because prices generally fall when the supply of something rises. But there are also reasons specific to lending. As capital grows in a country, the profits that can be earned by using it must fall. It becomes increasingly hard to find a profitable use within the country for new capital. Owners of different capitals begin to compete. Each wants a share of the business in which another owner's capital is already at work. Usually he can displace that owner only by offering better terms. He has to sell his goods a little cheaper and may sometimes have to pay more to buy the goods he sells. Meanwhile, as the funds available to support productive labor grow, demand for workers keeps rising. Workers easily find jobs, while owners of capital struggle to find workers to hire. Competition among owners raises wages and lowers profits from stock. With profits squeezed in both these ways, the price paid to use capital—that is, the interest rate—must fall too.

Mr Locke, Mr Lawe, Mr Montesquieu, and many other writers seem to have thought that interest rates fell across much of Europe because more gold and silver became available after the discovery of the Spanish West Indies. They say those metals lost value, so the use of a given amount of them was also worth less. Consequently, people would pay less for that use. Mr Hume has so thoroughly shown what is wrong with this seemingly convincing idea that there may be no need to say more about it. Still, the following short and simple argument may make clearer the mistake that seems to have misled these writers.