The premium of insurance

Thus, the ratio of the premium of insurance, which frequently forms the greater portion of interest, depends on the degree of security presented to the lender. This security consists chiefly in 3 circumstances;

1. The safety of the mode of employment

2. The personal ability and character of the borrower

3. The good government of the country he happens to reside in.

The hazards in the middle ages, raised the premium of insurance.

It is the same with all perilous investments of capital, with a difference in degree only. The Athenians of old, made a dis- tinction between marine interest, or interest of capital afloat, and land-interest, or interest on shore;

The former was rated at 30% more or less per voyage, whether to the Euxine, or to any port in the Mediterranean.[] 58

As two such voyages were accomplished with ease in the year, the annual marine interest may be rated at about 60, while other interest was commonly not more than 12 per cent. Supposing that, of the 12 per cent one half was assigned to cover the risk of the lender; we shall find, that the mere annual rent or hire of money at Athens, was 6 per cent only, which I should still think above the mark; yet, supposing it to have been so high, the marine interest allowed 54 per cent for insurance of the lender’s risk.

So enormous a premium must be attributed in part to the bar-

About the vast influence of personal character and ability in the borrower, in determining the amount of the premium of insurance to the lender, there can be no doubt whatever= they are the basis of what is called personal credit; and it is hardly necessary to say, that a person in good credit borrows at a cheaper rate, than another who has none.

Next to approved integrity and probity, what most contributes to the credit of an individual or of a government, is past punctuality in performance of engagements; this is, in fact, the very corner-stone of credit, and one that seldom proves insecure. But why, it may be asked, may not a man who has never yet made default in his payment, fail the very next moment?

There is very little probability that he will, especially if his punctuality be of long standing. For, to have been ever punctual in his payments, he must either have always been possessed of value in hand sufficient to meet demands upon him; that is to say, he must have been a man of property over and above his debts, which is the best possible ground of trust; or else he must have managed matters so well, and have speculated with so much judgment and safety, as always to have had his returns arrive before the calls became due; thus evincing a degree of ability and prudence, which afforded an excellent guarantee for his future punctuality.

The converse of this is the reason, why a merchant, that has once failed or hesitated in the performance of his engagements, thenceforward loses his credit entirely.

enforces the payment of debts, they must always be ineffec- tive, if law be partially or capriciously administered. The moment a debtor is, or hopes to be, out of his creditor’s reach, there is a risk to be run by the creditor, which is of value, and must be indemnified.

After having thus detached from the rate of bare interest all that is paid as premium of insurance to the lender against the risk of total or partial loss of his capital, it remains to con- sider that part, which is purely and simply interest; that is to say, rent paid for the utility and the use of capital.

This portion of the gross sum called interest is larger in proportion as the supply of capital available for loans is less; and as the demand of capital for that specific object is greater. Demand is the greater in proportion to the more numerous and more lucrative employments of capital.

Consequently, a rise in the rate of interest does not infallibly or universally denote, that capital is growing scarcer; for pos- sibly, it may be a sign, that its uses are multiplied.

Adam Smith has remarked this consequence upon the close of the very successful war on the part of England, which terminated with the peace of 1763. 63

The rate of interest then advanced instead of declining; the important acquisitions of England had opened a new field for her commercial enterprise and speculation; capital was not diminished in quantity, but the demand for it was increased; and the rise of interest, which ensued, though in most cases a sign of impoverishment, was, in this, a conse- quence of the acquisition of new sources of wealth.

Finally, the good government of the country, where the debtor resides, reduces the risk of the creditor, and consequently, the premium of insurance he is obliged to demand to cover that risk. Hence it is, that the rate of interest rises, whenever the laws and their administration do not insure the perfor- mance of engagements. It is yet more aggravated, when they excite to the violation of them; as when they authorise non- payment, or do not acknowledge the validity of bona fide contracts.

France, in 1812, experienced the opposite effect of a cause directly the reverse. A long and destructive war, which had annihilated almost all external communication; exorbitant taxation; the ruinous system of licenses; the commercial en- terprises of the government itself; frequent and arbitrary al- terations in the duties on import; confiscation, destruction, vexation; in fine, a system of administration uniformly avari- cious and hostile to private interest, had rendered all enter- prises of industry difficult, hazardous and ruinous in the ex- treme. The aggregate capital of the nation was probably on the decline; but the beneficial employment of it became still more rare as well as dangerous; so much so, that interest never fell so low in France as at that period; and, what is in general the sign of extreme prosperity, was then the effect of extreme distress.

The resort to personal restraint against insolvent debtors has been generally considered as injurious to the borrower; but is, on the contrary, much in his favour. Loans are made more willingly, and on better terms, where the rights of the lender are best secured by law. 60 Besides, the encouragement to ac- cumulate capital is thereby enlarged; whenever individuals mistrust the mode of investing their savings, there is a strong inducement to every one to consume the whole of his income, and this consideration will, perhaps, help to explain a curious moral phenomenon; namely, that irresistible avidity for ex- cessive enjoyment, which is a common symptom in times of political turbulence and confusion. 61

However, while on the subject of the necessity of personal severity towards debtors, I cannot recommend the practice of imprisonment; to confine a debtor is to command him to dis- charge his debts, and at the same time deprive him of the means of so doing. There seems more reason in the Hindu institution, giving the creditor the option of seizing the per- son of his insolvent debtor, and confining him at the creditor’s own home to compulsory labour, for the creditor’s benefit. 62

But, whatever be the means, whereby the public authority These exceptions serve but to confirm the general and eter- nal law, that the more abundant is the disposable capital, in proportion to the multiplicity of its employments, the lower will the interest of borrowed capital fall. With regard to the supply of disposable capital, that must depend on the quan- tum of previous savings. On this head, I must refer to what I 185Jean-Baptise Say, A Treatise on Political Economy have before said upon the subject of the formation of capi- tal. 64 well of interest on capital, as likewise of profit accruing from capita, employed, which we are about to consider presently. If it be desired, that capital in search of employment, and industry in search of capital, should both be satisfied in the fullest manner, entire liberty of dealing must be allowed in all matters touching loans at interest. Disposable capital, be- ing thus left to itself, will seldom remain long unemployed; and there is every reason to believe, that as much industry will be called into activity, as the actual state of society will admit. It has been sometimes supposed, that capital is multiplied by the operation of credit. This error, though frequently recur- ring ir works professing to treat of political economy, can only arise from a total ignorance of the nature and function of capital.

Capital consists of positive value vested in material substance, and not of immaterial products, which are utterly incapable of being accumulated. And a material product evi- dently cannot be in more places than one, or be employed by more persons than one, at the same identical moment. The works, machinery, utensils, provisions, and stock in hand, composing the capital of a manufacturer, may possibly be wholly borrowed; in which case, he will be acting upon a hired capital, and not on one of his own; yet, beyond all ques- tion that capital can be made use of by no one else, so long as it remains within his control and management= the lender has parted with the power of otherwise disposing of it for the time. A hundred others might have equal security and credit to offer; but their applications could not multiply the volume of disposable capital, and could have no other effect than to prevent other capital from remaining idle and out of employ. 65 But it is essential to pay a strict attention to the meaning of the term, supply of disposable capital; for this alone can have any influence upon the rate of interest; it is only so much capital, as the owners have both the power and the will to dispose of, that can be said to be in circulation. A capital already vested and engaged in production or otherwise, is no longer in the market, and therefore no longer forms a part of the total circulating capital; its owner is no longer a competi- tor of other owners in the business of lending, unless the employment be one, from which capital may be easily disen- gaged and transferred to other objects. Thus, capital lent to a trader, and liable to be withdrawn from his hands at a short notice, and, a fortiori, capital employed in the discount of bills of exchange, which is one way of lending among com- mercial men, is capital, readily disposable and transferable to any other channel of employment, which the owner may judge convenient.

It is not to be expected, that I should here enter upon a com- putation of the motives of affection, consanguinity, generos- ity, or gratitude, which may occasionally give rise to the loan of capital, or influence the amount of interest demanded for it. Every reader must take upon himself to appreciate the in- fluence of moral causes upon the laws of political economy, which alone we profess to expound.

Capital employed by the owner on his own account, in a trade that may be soon wound up, in that of a grocer for instance, stands nearly in the same predicament. The articles he deals in find at all times a ready market, and the capital thus em- ployed may be realized, repaid if lent, re-lent and re-employed in other trades, or applied to any other use. It is always either in actual circulation, or at least on the point of being so. Of all values, the one most immediately disposable is that of money.

But capital embarked in the construction of a mill, or other fabric, or even in a movable of small dimensions, is fixed capital, which being no longer available for any other purpose, is withdrawn from the mass of circulating capital, and can no longer yield any other benefit than that of the product wherein it has been vested. Nor should it be lost sight of, that even though the mill or other fabric be sold, its value, as capital, is not by that means restored to circulation; it has merely passed from one proprietor to another. On the other hand, the disposable value, wherewith the buyer has made the purchase, is not thrown out of circulation, having merely passed from his into the seller’s hands. The sale neither in- creases nor diminishes the mass of floating capital ir the mar- ket. Attention to this circumstance is essential to the forming a correct estimate of the causes, that determine the rate, as To limit capitalists to the tending at a certain fixed rate only, is to set an arbitrary value on their commodity, to impose a maximum of price upon it, and to exclude, from the mass of floating or circulating capital, all that portion, whose propri- etors cannot, or will not, accept of the limited rate of interest. Laws of this description are so mischievous, that it is well they are so little regarded as they almost always are, the wants of borrowers combining with those of lenders, for the pur- pose of evading them; which is easily managed, by stipulat- ing for benefits to the lender, not indeed bearing the name of interest, although really the same thing in the end. The only consequence of such enactments is, to raise the rate of inter- est, by adding to the risks, to which the lender is exposed, and against which he must be indemnified. It is somewhat amusing to find that those governments, which have fixed the rate of interest, have almost invariably themselves set the example of breaking their own laws, by borrowing at higher than legal interest in their own case.

That interest should be fixed by law is highly proper and necessary; but it should be fixed only in cases, where there is no previous agreement about it; as in the case of a legal recovery of a sum with interest.

And, in such case, I think the interest fixed by law should be estimated at the lowest rate that is usually paid by individuals; because the lowest rate is that paid by the safest investments. Now, it is quite consistent with justice, that the withholder of capital should restore it even with interest; but that is in the supposition, that it has remained all the while in his possession; which it cannot be supposed to have done, without his having invested it in the way the least hazardous, and consequently without his having drawn from it at least the lowest interest it would have afforded. depend upon the quality of the object lent or borrowed Noth- ing is more common in trade, than to lend and borrow other objects than money. When a manufacturer buys the raw ma- terial of his business at a certain credit, he, in fact, borrows the wool, or cotton, as the case may be, making use of the value of those materials in his concern; and their quality has no influence on the interest, with which he credits the seller. 66 The glut or scarcity of the commodity lent only affects its relative price to other commodities, and has no influence whatever on the rate of interest upon its advance or loan. Thus, when silver money lost three-fourths of its former relative value, although four times as much of it was necessary to pass a loan of the same extent of capital, the rate of interest remained unaltered. The quantity of specie or money in the market, might increase tenfold, without multiplying the quan- tity of disposable, or circulating capital. 67

But this rate should not be denominated the legal interest, because the rate of interest ought no more to be restricted, or determined by law, than the rate of exchange, or the price of wine, linen, or any other commodity. And this is the proper place to expose a very prevalent error.

Wherefore, it is a great abuse of words, to talk of the interest of money; and probably this erroneous expression has led to the false inference, that the abundance or scarcity of money regulates the rate of interest. 68 Law, Montesquieu, nay, even the judicious Locke, in a work expressly treating of the means of lowering the interest of money, have all fallen into this mistake; and it is no wonder that others should have been misled by their authority. The theory of interest was wrapped in utter obscurity, until Hume and Smith 69 dispelled the vapour. Nor will it ever be clearly comprehended, except by such as shall have acquired a correct notion of what has, throughout this work, been denominated capital, and shall proceed in the conviction, that the object lent or borrowed, is not a particu- lar commodity or object of merchandise, but a portion of value, — of the aggregate value of the capital available for that ob- ject; and that the percentage paid for the use of this portion of capital, at all times and places, depends on the relative sup- ply and demand of capital to be lent, and is wholly indepen- dent of the specific form or quality of the commodity, wherein the loan is made, whether it be money, or any other article whatever.

Capital, at the moment of lending, commonly assumes the form of money; whence it has been inferred, that abundance of money is the same thing as abundance of capital; and, con- sequently, that abundance of money is what lowers the rate of interest. Hence the erroneous expressions used by men of business, when they tell us, that money is scarce, or that money is plentiful; which, it must be confessed, are equally just and appropriate, as the very incorrect term, interest of money. The fact is, that abundance or scarcity of money, or of its substi- tute, whatever it may be, no more affects the rate of interest, than abundance or scarcity of cinnamon, of wheat, or of silk. The article lent is not any commodity in particular, oi even money, which is itself but a commodity, like all others; but it is a value accumulated and destined to beneficial investment. A man, who is about to lend, converts into money the aggre- gate value he means to devote to that particular purpose; and the borrower no sooner has it at command, than he exchanges it for something else; the money that has effected this opera- tion, forthwith served to effect other similar or dissimilar operations; the payment of a tax perhaps, or the subsidy of an army. The value lent has but for a moment assumed the form of money, in the same manner, as we have traced revenue received and expended, passing through the same temporary form; the identical pieces of money serving perhaps a hun- dred times in the course of a year, to transfer equivalent por- tions of income. So, likewise, the same sum of money, that has served to transfer a value from the hands of one lender into those of a borrower, may, after infinite intervening trans- fers, perform the like office between a second borrower and lender, without stripping the former borrower of any part of the value he has received. In reality, then, it is value which has been borrowed, and not any particular sort of metal or of merchandise. All kinds of merchandise may be lent and bor- rowed, as well as money; nor does the rate of interest at all