<h2>CHAPTER 15</h2>
<h3>THE CAPITALIZATION OF ALL FORMS OF RENT</h3>
<h4>§ I. THE PURCHASE OF RENT-CHARGES AS AN EXAMPLE OF CAPITALIZATION</h4>
<div class="sidenote">The nature and sale of rent-charges</div>
<p>1. <i>From the twelfth to the sixteenth centuries the sale and purchase of
rent-charges was the most general form of borrowing and lending wealth.</i>
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 passed 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 entitling 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<span class="pagenum"><SPAN name="Page_119" id="Page_119">[Pg 119]</SPAN></span> 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.</p>
<div class="sidenote">Rent-charges were a convenient investment in medieval cities</div>
<p>2. <i>The sale of rent-charges grew out of an industrial need of the
exchange of safe permanent incomes for larger sums of wealth.</i> 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 nobles, 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 class of lenders or investors
seeking some safe income. Between the two classes 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.</p>
<p><span class="pagenum"><SPAN name="Page_120" id="Page_120">[Pg 120]</SPAN></span></p>
<div class="sidenote">Rent-charges were not forbidden by the church</div>
<p>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.</p>
<div class="sidenote">The market value of rent-charges reflects the exchange ratio
between present and future money incomes</div>
<p>3. <i>Rent-charges had a market-value, varying with time and place, and
expressed as a number of years' purchase of the rent-charge.</i> 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.</p>
<p>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<span class="pagenum"><SPAN name="Page_121" id="Page_121">[Pg 121]</SPAN></span> is sold, but
that the rental <i>in perpetuity</i> 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.</p>
<p>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.</p>
<div class="sidenote">Purchase and sale of rent-charges gives way to more modern
contracts</div>
<p>4. <i>The sale of rent-charges has gradually given place to the modern
form of money loan.</i> 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<span class="pagenum"><SPAN name="Page_122" id="Page_122">[Pg 122]</SPAN></span> simplicity of the
money loan, and of the sale outright, has led to the almost total disuse
of the older form of transaction.</p>
<p>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 classes 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.</p>
<h4>§ II. CAPITALIZATION INVOLVED IN THE EVALUATING OF INDIRECT AGENTS</h4>
<div class="sidenote">The capital value of durable wealth is the sum of its
expected rents</div>
<p>1. <i>The buying of any indirect agent is practically the purchasing of a
"rent-charge."</i> 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 class 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 analysis 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,<span class="pagenum"><SPAN name="Page_123" id="Page_123">[Pg 123]</SPAN></span> 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 <i>some</i> rate, to their present worth. What determines the
rate of discount is a question that will call later for a fuller
explanation.</p>
<div class="sidenote">Capital value is not primary</div>
<p>2. <i>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).</i> 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.</p>
<div class="sidenote">Expected rents are primary, and capital value is the "years'
purchase"</div>
<p>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<span class="pagenum"><SPAN name="Page_124" id="Page_124">[Pg 124]</SPAN></span> 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 assumes the interest rate. The capital
is of that amount because the anticipated 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.</p>
<div class="sidenote">The rate of capitalization of rents is not fixed merely in
commerce</div>
<p>3. <i>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.</i>
The value of land usually is explained simply as the capitalizing of its
rents at "the prevailing rate of interest." The rate is assumed 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 assuming 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 shifted into another industry. It is true that the values of
goods are so<span class="pagenum"><SPAN name="Page_125" id="Page_125">[Pg 125]</SPAN></span> wonderfully interrelated by substitution 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.</p>
<div class="sidenote">The exchange of any present and future rents results in a
rate of time discount</div>
<p>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
assume 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.</p>
<div class="sidenote">Capitalization of a perpetual uniform series of rents;</div>
<p>4. <i>In practical business may be seen innumerable instances of the
capitalization of both permanent and limited series of incomes.</i> 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.</p>
<p><span class="pagenum"><SPAN name="Page_126" id="Page_126">[Pg 126]</SPAN></span></p>
<div class="sidenote">Of a probably increasing series of rents;</div>
<p>But social changes alter rental values, and so far as these changes are
foreseen, these anticipated 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.</p>
<div class="sidenote">And of a declining or fluctuating series of rents</div>
<p>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.</p>
<div class="sidenote">Mode of fixing the rate of time discount in practical
business</div>
<p>Every exchange of a durable agent involves an estimate, rough and
imperfect it may be, of that agent's future. The practical men, however,
who are thus fixing the "capital value" of goods, are usually only dimly
conscious of the logical nature of the process. In fact the process goes
on in a way much less analytical and conscious, much more empirical,
than this analysis would indicate. Most men simply buy as cheap as they
can the agents which at the price they believe will add most to their
income. The future changes are only roughly, not accurately estimated.
The shrewd bargainer is the one who foresees more clearly than his
fellows the complex changes to come. Other men blindly follow. The
ability and the inability to foresee such changes make men rich and
poor. In all this bidding for capital<span class="pagenum"><SPAN name="Page_127" id="Page_127">[Pg 127]</SPAN></span> the logical basis of the value is
the series of rents. When the agent is bought outright, the very
concluding of the bargain fixes a relation between the expected value of
the income and the value of the capital invested. In other words, the
exchange of durable agents virtually wraps up in them a net income,
which it is expected will unfold year by year when rents mature and are
secured. At the moment of the investment, the expected rents are
expressed as a percentage of the capital sum.</p>
<h4>§ III. THE INCREASING ROLE OF CAPITALIZATION IN MODERN INDUSTRY</h4>
<div class="sidenote">As exchange increases capitalization of goods becomes more
usual</div>
<p>1. <i>Where a system of exchange is highly developed, things are looked
upon as capital yielding an objective income rather than as wealth
yielding immediate means of enjoyment.</i> In the old organization of
industry most men got most of their living from the things they raised
or made. At the present time goods are gotten in the most indirect ways;
men seek wealth because it will yield them an objective or money income,
knowing that if they can get the income, they can get other things by
exchange. In business to-day, wherever there is a rental, it is
capitalized, has a market value, is bought and sold. Men compete in the
purchase of income-yielding agents. There is a continual contest in
judgment among investors to secure the largest rent for the smallest
outlay. On the other hand, the owners of any rental strive to secure the
largest capitalization for it that they can. In this market for capital
it is money rents that are exchanged as an indirect means of arriving at
gratifications.</p>
<div class="sidenote">Various kinds of corporation securities put expected incomes
in salable form</div>
<p>2. <i>The issue of capital stock is the putting of the incomes of wealth
into marketable form.</i> Stock companies, or corporations, are business
enterprises which issue stock, or certificates of a share in their
wealth and income. Doubtless the convenience of the sale and transfer of
invested capital<span class="pagenum"><SPAN name="Page_128" id="Page_128">[Pg 128]</SPAN></span> by the use of stock, has been one of several reasons
for the large increase of this form of organization during the past
century. Originally the stock of a company taken collectively
represented all the capital invested, and each share entitled the owner
to a given portion of the total income earned. The shares were issued in
regular denominations in terms of money, and this amount expressed on
the face of the stock remained fixed. But as a business proves more or
less profitable, the value of a share of its income rises and falls
regardless of the original amount of stock issued. At once there is a
divergence between the nominal or face value and the market value of the
stock. The nominal value is relatively permanent, the same year after
year; it may increase by further issues, but rarely is it decreased. But
when stock is the only form of claim on the earnings that is issued, the
fluctuations of the market value of the stock record the real value of
the business, that is, the capital value of the rents it is expected to
yield. But in present practice there are several forms (of which stock
is but one) in which an investor may buy a share in the earnings of a
business. Bonds usually do not give their owner a vote in the management
or make him in the technical legal sense a part owner in the business.
Bonds representing money loaned to a company, and entitling their holder
to regular interest payments, are nearest in form to the medieval
rent-charge. Next stands preferred stock, which entitles the owners to
share first in the dividends, if there are any; and finally the common
stock, which gets a share only when the other claims are satisfied. By
the multiplication and further variation of these readily salable claims
on industrial incomes, the needs and desires of investors are met more
fully and with greater precision.</p>
<div class="sidenote">Any continuing income can be capitalized</div>
<p>3. <i>Men seek to convert into marketable capital any increase of income
in their wealth or business.</i> A man who invests a given capital sum in
machines, buildings, and materials buys them, as others do, at prices
that represent their<span class="pagenum"><SPAN name="Page_129" id="Page_129">[Pg 129]</SPAN></span> usual, or market, earning power. If he succeeds
exceptionally in his business, he makes the capital earn more than the
rents on which it was capitalized. The same material wealth becomes
worth more because of the reputation of his products, and therefore the
trade-mark and good-will of the business can be capitalized. In this
sense a good name can be sold, and is at least as much to be desired,
even in a mercenary age, as great riches. Likewise, social changes, new
needs, the growth of population, increase the net income of wealth, or
the rents of a business. The basis of capital value is income, and
whatever be its cause, political or economic, material income can and
will be capitalized and added to the market value of the privilege,
wealth, or industry on which the income is conditioned.</p>
<div class="sidenote">The capitalizing of franchises for public-service
corporations</div>
<p>Notable cases of this sort arise in connection with public franchises.
If a street-railway or a gas-company is given the exclusive right to
operate in a given locality, any income above average interest on the
investment is capitalized either in the higher price of the stock or in
additional stock issued without the addition of any material to the
plant. If the franchise is unlimited, the income may be capitalized as
practically perpetual; if the franchise is limited, and is to expire in
thirty or forty years, only the limited series of privileged incomes can
ordinarily be capitalized. When, however, the managers are able to exert
influence enough to have the franchise extended, and the investors
believe in the skill of the managers and perhaps in their power to bribe
the legislators, the value of the stock continues higher than it could
usually be under a limited franchise. Such circumstances becloud the
question whether the exceptional income arising under the franchise
should go to the public or to the company. Granted, however, that the
company is entitled to the income, the burden of proof is on those who
object to the capitalizing of the income as is done in every other
business.</p>
<div class="sidenote">Some difficulties in the capitalization of corporate incomes</div>
<p>4. <i>The manipulation of dividends and the resulting<span class="pagenum"><SPAN name="Page_130" id="Page_130">[Pg 130]</SPAN></span> changes in
capitalization open up great opportunities for the dishonest increase of
private fortunes.</i> A great change in the market value of stock is made
by a comparatively small change in the income it regularly affords, for
if the prevailing rate of interest on money loans is five per cent.,
each dollar of dividends is capitalized at $20. It might seem that the
dividend would be declared if earned, otherwise not. The matter is not
so simple and impersonal, however. The control of corporations is vested
in the hands of a small group of directors who have both the opportunity
and the temptation to withhold dividends when they are earned, to pay
them with borrowed money if unearned, and in either case to keep the
stockholders and the public in ignorance of the real condition and
earning power of the business. The stocks can, by this manipulation of
dividends, be made a lottery for the legitimate investor, a trap for the
unwary, and a source of unrighteous gain by men recreant to their
trusts.</p>
<p>In this way it may be seen that an earning power not known to bidders in
the market does not enter into capitalization; a fictitious earning
power, however, is capitalized so long as the investors continue to be
deceived. Instances of this kind present problems not only of private
morality, but of the preservation of free industrial institutions. The
solution of these problems would perhaps be hastened if the a economic
nature of capitalization were more clearly understood. Capital value in
modern industry is everywhere the expression of the serial rents of
wealth, discounted at a prevailing rate of time discount.</p>
<hr class="chap" />
<p><span class="pagenum"><SPAN name="Page_131" id="Page_131">[Pg 131]</SPAN></span></p>
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