<h2>CHAPTER 17</h2>
<h3>THE THEORY OF TIME-VALUE</h3>
<h4>§ I. DEFINITION AND SCOPE OF TIME-VALUE</h4>
<div class="sidenote">The simplest cases of time-value</div>
<p>1. <i>Time-value is the difference between the values of things at
different times.</i> Things differ in value according to form, place,
quality of goods, and according to the feelings of men, and—not least
important factor—according to time. The simplest and clearest case of
time-value is the difference noticeable in the same thing at different
moments. Is this good worth more now or next week? Shall this apple be
eaten now or next winter? These questions can be answered only after
comparing the marginal utilities which differ according to the varying
conditions of the two periods.</p>
<p>All the other cases of time-value can, by the practical device of
substituting other goods of equivalent value, be reduced to the typical
case of comparison of the same thing at different times. The comparison
may be between very similar things, the one consumed being replaced by a
duplicate. An apple borrowed now may be returned next year in the form
of one of the same size and quality. The essential thing in this
comparison is not physical identity, but equivalence in size, sort, and
quality at the two periods. This is borrowing under the renting
contract.</p>
<div class="sidenote">Time-value in the case of different kinds of gratifications</div>
<p>But two or more quite different things may be expressed in terms of
another thing and so be made comparable. Money becomes the value-unit
through which different things may be reduced to the same terms for
comparison. With this mode of expressing the value-equivalence of
various<span class="pagenum"><SPAN name="Page_142" id="Page_142">[Pg 142]</SPAN></span> goods, the interest contract first becomes possible, money (the
standard of deferred payments) being the thing exchanged (possibly only
in name) at two periods of time. What is really compared are various
gratifications which may be produced by very different material things
or services. In its last analysis comparison of values at different
periods of time must be a comparison of psychic incomes, of two sums of
gratification. The comparison of the value of a bushel of apples with
that of a barrel of potatoes or a suit of clothes at the same moment
appears simple enough. When all are expressed in terms of money, the
comparison of each with its value-equivalent at a later date becomes
easy. The simplicity and obviousness of time-value in the case of money
loans at interest led men at first to recognize that phase of the
problem exclusively, and later the term "interest," not without much
confusion of thought, was given a wider significance. Let us now see how
large a part of the whole problem of time-value is outside of the money
loan.</p>
<div class="sidenote">Time-value is involved in capitalization of land</div>
<p>2. <i>The problem of time-value is quite separable from the concepts of
money and capital, though usually connected with them in practice and
theory.</i> It is true that the problem of time-value was first clearly
recognized in connection with money and a formally expressed capital
sum. Misled by this fact, and taking a very narrow view, writers
seventy-five years ago recognized but dimly the problem of time-value in
connection with the valuation of the incomes derived from land. It is
true, as has been shown above, that the mere putting of an estimate on a
durable good such as land involves the process of capitalization, which
in turn implies a comparison of the values of the rents expected at
different periods. Diminishing returns in the use of agents involves a
loss of time to secure the usufructs emerging. The relation of these
facts was not clearly seen until of late.</p>
<p>The phenomenon of time-value as above defined may be<span class="pagenum"><SPAN name="Page_143" id="Page_143">[Pg 143]</SPAN></span> seen to be broader
even than that of capitalization. The difference in the value of the
successive rents of wealth must have been recognized and in some degree
measured before there was any conscious calculation of capital value.
Differences in value due to time are everywhere. The problem of
time-value often is present where money is not even spoken of or thought
of. Money no more causes this time-difference in value than balances
cause weight.</p>
<div class="sidenote">Time-value is taken account of in the keeping up of repairs</div>
<p>3. <i>The problem of time-value is involved in repairs and depreciation,
and in the use of consumption goods.</i> It is possible, as we have seen,
to increase the sum available for present needs, and to encroach upon
the future by postponing repairs on intermediate goods. The balancing of
the cost of repairs against the future income is a never-ending task in
practical business. One making repairs must purchase the needed
materials and labor at a capitalization determined by their expected
earning-power in other industries. If the repairs in question will not
ensure an annual saving as great as this expected rent, they will not be
made. When an industry is declining, it may, for the sake of putting the
capital into a better business, be good policy to let the machinery fall
into bad repair. The problem of time-value is involved in the
application of one's energy to repairing one's own possessions. It is a
thought of wide bearings that numberless minor decisions in every petty
business involve, if they are correctly made, a measuring of the rate of
capitalization.</p>
<div class="sidenote">And in the choice of enjoyments</div>
<p>As will be more fully shown in discussing the relation of the prevailing
rate of interest to saving, the recognition of time-value is implied in
the use men make of consumption goods, in their postponement of
enjoyment, in their storing of goods for future use. The varying
gratifications yielded by consumption goods, and their values in
different conditions cannot be explained without taking account of
differences in time. Wherever there can be a choice in the time at
which, and consequently in the conditions under<span class="pagenum"><SPAN name="Page_144" id="Page_144">[Pg 144]</SPAN></span> which, a thing can be
used, there is a choice presented between the different values.
Time-value is present even in a period during which no goods continue to
exist, as when a good is consumed at a moment of greater need, to be
replaced at a time when less valuable. If an apple is borrowed on the
promise to return an apple and a peach at the end of a year, the peach
represents the time-difference in value but in the meantime there has
been no apple in existence. It is only in a figurative sense that it may
be said that interest is paid on that "capital." Interest is paid
because of a difference in want-gratifying power, but during the
interval there is no material capital.</p>
<div class="sidenote">Prodigality and vice involve a high discount of future
happiness</div>
<p>4. <i>The problem of time-value is involved in much foolish pleasure, in
prodigality, and in vice.</i> Economics touches frequently on the borders
of ethics. If there were to be formulated an economics of personal
conduct, it surely would give a large place to the comparison between
present and future pleasures. Forethought, or prudence, is the virtue of
recognizing not only future dangers to be avoided, but the greater
future joys to be gained in exchange for present pleasures. The reckless
and the prodigal underestimate the future and barter all to gratify the
moment's impulse. The drinker exchanges the hopes of worthy life for the
exhilaration of the spree. Indulgence in social pleasures, if secured at
the price of lost sleep, weakened health, and debauched character, are
loans from the future made by youthful prodigals at usurious interest.
If no one ever paid more than a moderate rate of interest for the
gratification of his present whims and impulses, most hospitals,
drug-stores, and medical colleges would close, and half, if not all, the
prisons would be empty.</p>
<p>Indeed, time difference in value is a universal phenomenon of life and
conduct. Contract interest is but one phenomenal form of time-value, and
this in turn is but one phase of value. This section may serve to
suggest how much more varied and pervasive the fact of time-value is
than has<span class="pagenum"><SPAN name="Page_145" id="Page_145">[Pg 145]</SPAN></span> usually been recognized in popular or economic discussion of
the subject of interest.</p>
<h4>§ II. THE ADJUSTMENT OF THE RATE OF TIME-DISCOUNT</h4>
<div class="sidenote">The exchange value of present and future goods</div>
<p>1. <i>The fixing of the discount on future goods is, in its essentials,
like the fixing of the market price of consumption goods.</i> This problem
appears to be one of the most difficult in economic theory; but reduced
to its simplest terms, it is an aspect of exchange value, and its
ultimate explanation must be found in a comparison of psychic incomes.
There must be noted the conditions of demand and supply, the interplay
and final equilibrium of the two forces. The declining and marginal
utility to the two parties to exchange must be carefully analyzed. One
who can do these things is prepared to find the answer to the problem of
time-value. Whenever a group of buyers and sellers meet, a ratio of
exchange commonly will be arrived at. The ratio of exchange between
buyers and sellers of present and future rents likewise is fixed at the
estimates of a "marginal pair," at which point the amount offered and
taken comes to equilibrium, for at that point no motive exists for any
one to change sides.</p>
<div class="sidenote">The peculiar nature of the exchange in the case of
time-value</div>
<div class="sidenote">Several reasons why this is not easily recognized</div>
<p>2. <i>Time-value as the premium rate on present goods is unlike the
ordinary market price, of goods only in the special nature of the
utilities exchanged.</i> The one peculiar need in the theory of this
subject is a clear understanding on this point. The goods exchanged, or
compared, are direct and indirect goods, or present and future goods,
or, more generally speaking, two goods or groups of goods unequally
distant in time from present enjoyment. What are sold in a case such as
capitalization, involving an estimate of time-value, are present goods
or gratifications; what are bought are future gratifications, or
indirect agents which stand for, typify, or make possible, future
gratifications. Practically every man in a market acts on the knowledge
of what the<span class="pagenum"><SPAN name="Page_146" id="Page_146">[Pg 146]</SPAN></span> exchange of direct and indirect goods means; yet abstractly
stated, the thought seems at first difficult. In valuing any durable
good, the theory of time-value is implied. Every time a machine, a
house, a book, a field, is bought, the distinction between direct and
indirect goods is acted upon, for a choice has been made between present
enjoyment and future provision. Anything that endures is an indirect
good and implies in its valuation a premium rate on present goods.</p>
<p>The real nature of the exchange in time-valuation is made unclear by the
uncertainty of life, leading men to work on to provide against
possibility of mishaps; for the most part the world's treasures never
afford to their temporary owners the gratification that they typify, or
could give. The nature of this exchange is made unclear also by habit,
under the influence of which the exchange in so many cases is not
carefully thought out, is not the result of a close comparison of the
utilities of goods in present and future moments. The real nature of
this exchange is made unclear by the indirect, or induced, gratification
derived from wealth. Wealth gives to its owner power, prestige, the
esteem of his fellows, and pride in evidences of success and growing
prosperity. Its very possession creates a new need and imparts to it
another utility, that of insuring against the misery of a declining
fortune one who has enjoyed wealth and power. Men make the greatest
efforts up to the last moment of life to retain wealth that they will
enjoy only in this subtle and indirect way. Thus every motive that leads
men to postpone present enjoyment makes them bidders for indirect agents
and for future goods, and helps to determine the market rate of premium
on the present, and of discount on the future.</p>
<div class="sidenote">The scarcity of present gratifications</div>
<p>3. <i>There being a limited number of indirect agents, their limited
powers in a given period limit the supply of present goods.</i> The
principle is familiar that value is always connected with relative
scarcity. Now the desire for the present goods is indefinitely large. If
the right kind and<span class="pagenum"><SPAN name="Page_147" id="Page_147">[Pg 147]</SPAN></span> quality could be had at will, an enormously greater
amount of present goods would be used. But the present goods are
dependent on indirect agents. The psychic income of a civilized
community is dependent on a favorable and extremely refined environment:
houses, libraries, theaters, the agencies of travel, as well as the
sources supplying the more material needs. These indirect agents, even
in the richest community, are limited in variety, in quality, and in
number.</p>
<div class="sidenote">The total of future uses in vastly greater</div>
<p>But if indirect agents could produce an indefinitely large product at
any given moment, the supply of present goods could be indefinitely
increased. The supply of utilities, therefore, is limited by
"diminishing returns" in the use of agents, making their maximum yield
depend upon the lapse of time. The uses any given material can yield in
a limited period have an absolute limit: an acre of land with the most
perfect cultivation cannot feed the world; but remove the limit of time,
wait an eternity, and the acre would yield an infinite crop. The
economic return of a given agent in a given period is reached much
sooner than the technical return. If agents are forced to yield more
bountifully, it is at the sacrifice of utilities in other agents, and a
point of maximum net yield is found in any given period. Here also the
lapse of time is the condition of the increase of the net utilities
derivable from limited agents.</p>
<div class="sidenote">The choice open to the investor of money</div>
<p>4. <i>The rate of capitalization of income and the rate of contract
interest on money capital tend to unite into a single market rate.</i> A
person wishing to exchange present goods or income for future goods may
buy an income-bearer at its capitalized value, or he may create a new
rent-bearer. Having saved a sum of money, either he may purchase a
factory known to be profitable; or he may hire the services of men and
unite them with materials and machinery to create a new industry or a
new form of income-bearer; or he may loan his money to others to make
either kind of purchase. In any one of the three cases it is evident
that capitalization<span class="pagenum"><SPAN name="Page_148" id="Page_148">[Pg 148]</SPAN></span> (that is, the discounting of future rents in goods)
is the primary and important fact making possible the emergence of a
surplus, or net yield, over and above the value of the capital. The
expected uses contained not only in whole industrial establishments, but
in the particular materials and agents united to form new agents, are
purchased at their capitalized value; that is, the future uses have been
discounted and have entered into the price of the goods as less than
they will be when realized as actual rents. This is the crucial point in
the theory either of contract interest or of time value; for to explain
the rate of interest as due to the process of "producing" capital agents
out of other materials, is to beg the question involved. The surplus
yielded by capital above its cost is but the realization of a net income
made possible by the discounting of future rents.</p>
<div class="sidenote">The choice open to the borrower of wealth</div>
<p>A person wishing to make an exchange of the opposite kind to that
described may sell his wealth for money; he may exchange for present
enjoyable goods his income at its capitalized value; or he may use up
what he has, let it depreciate, fail to make repairs, convert it to
various consumption purposes, and thus invade his earning power. When
the interest rate is five per cent., the sacrifice of any unit of
regular income permits the spending of twenty times that amount for
present enjoyment. The advantages of these various methods tend to
equilibrium. If the owners of developed productive agents hold them at
too high a capitalized value, investors will apply their efforts and
savings to duplicating these forms of wealth. If, in turn, any of the
minor factors, as materials or uses of goods, are overvalued
(overcapitalized) it will appear ultimately in a check in the demand for
them at these prices, and in a reduction in the demand for money loans.
As it is possible for any investor and for any borrower to choose among
these investments and loans, there is practically but one rate, the rate
which expresses the general ratio of exchange between present and future
income. Owners and investors<span class="pagenum"><SPAN name="Page_149" id="Page_149">[Pg 149]</SPAN></span> take the line of least resistance, get the
most they can for their money, and choose whatever form is most
advantageous. The interrelations between the various interest rates are
therefore close and constant. The market rate of interest thus extends
over all forms of wealth and pervades every phase of business. The value
of every durable agent is fixed with reference to a prevailing interest
rate, through the discounting to their present worth of all the incomes
it is believed to contain.</p>
<div class="sidenote">A sacrifice sale involves a high rate of interest</div>
<p>5. <i>Where goods are sold at forced sale or sacrifice, it is equivalent
to a contract loan at a high rate of interest.</i> Market values being
dependent upon market conditions, the offer of goods at a given moment
may not find the usual or normal number of buyers or the usual demand.
Just such conditions are most likely to exist at the times when business
men feel an unusual need of money. Two courses are open to them in this
emergency, either to borrow the money at a very high rate of interest,
holding the goods for better prices, or to sell the goods under the
unfavorable conditions. The end of both courses is the same—to get
ready money; and the methods are not essentially unlike—the exchange of
greater future values for present values. The sacrifice sale thus
reveals the merchant's high estimate of the interest rate. The purchaser
of some kinds of property in times of depression is securing them at a
lower capitalization than they will later have. The rise in value may be
foreseen as well by seller as by buyer, but the low capitalization
reflects the high interest rate temporarily obtaining. A. T. Stewart is
said to have laid the foundation of his fortune when, being out of debt
himself, he bought up the bankrupt stocks of his competitors in a great
financial panic. The high contract interest at such times is but the
reflection of the high premium on present purchasing power. Here then is
another mode in which the prevailing rate of interest on money loans is
kept in close harmony with the rate of time valuation.</p>
<div class="sidenote">Interrelations of the money interest rate and of
time-discount</div>
<p>6. <i>The rate of contract interest on safe long-time loans<span class="pagenum"><SPAN name="Page_150" id="Page_150">[Pg 150]</SPAN></span> registers
pretty nearly the prevailing rate of time-discount in the community.</i>
There are of course different capital markets, and the estimates put
upon next year's income as compared with this year's is very different
in Montana, New York, and London. Because of the friction in the
transfer of investments from one locality to another, these differences
may persist indefinitely; but within each capital market the interest on
any particular loan must, for reasons readily seen, tend to conform
pretty closely to the prevailing rate. Various groups of men living in
the same community have, however, varying estimates of time-value. The
increase of safe long-time bonds issued by strong corporations and by
wealthy nations as, for example, the New York Central Railroad, and the
government of Great Britain, gives a large number of choice investments
where the element of risk is almost entirely absent. Various agencies
have developed for making the loans, that is, for bringing the borrower
and lender together with the minimum of trouble and expense. Other
efficient, but somewhat more costly, agencies for bringing together the
owners of loanable capital and men wishing to use capital are
savings-banks, building and loan associations, insurance companies
issuing endowment policies, and mortgage-investment companies of many
kinds. While on the one side of the bidding are thousands of lenders
offering to exchange ready money for assured incomes, on the other are
thousand of borrowers offering to exchange the promise of assured
incomes for ready money. If either of these classes got far out of touch
with the prevailing rate of capitalization, to which all the valuations
are adjusted, that class would lose greatly.</p>
<div class="sidenote">Relations between the concepts of rent, interest, and
time-value</div>
<p>7. <i>All the net usufructs actually yielded by wealth are rents; economic
time-discount is never a realized income; it is merely a calculation
form, or anticipation of the difference between present and future
gratifications.</i> There has been much discussion as to what should be the
relations in thought between rent and interest. Space permits here<span class="pagenum"><SPAN name="Page_151" id="Page_151">[Pg 151]</SPAN></span> only
an indication of the view on this question involved in the foregoing
treatment. Rent, as the term is here applied, includes all the net
productivity attributable to the ownership and use of capital, whether
the yield be in economic form (in an increment of value) or in
contractual form. Even contract money-interest must be looked upon as a
species of the genus contract rent, the peculiarity in the money loan
being merely that the thing which it is agreed to return is a certain
number of units of the standard money.</p>
<p>The term "interest," first applied in the Middle Ages to a payment for
the use of a money loan, came to be used more broadly by the earlier
economists as the income attributable to those goods which generally
were bought and sold in terms of money. In other words, interest was
supposed (though erroneously) to be uniquely connected with the
particular production instruments to which the term capital was narrowly
and mistakenly confined. Still more to add to the confusion, the term
interest was about this same time identified with the broad problem of
time-value. The terminology has remained ever since in this stage of
arrested development. Our suggestion is to retain the word interest in
its original meaning, still almost universal in business circles, of a
contractual payment on money loans, applying the term time-value (for
lack of a better word) to the subtler economic problem.</p>
<div class="sidenote">Rent and time-value are essentially different phrases of the
value problem</div>
<p>Time-value is here understood to be that all-pervading difference in the
values of uses and gratifications of wealth at different points of time.
A comparison of the value of momently appearing uses of wealth is the
rent problem. Here are, therefore, very different aspects of the value
problem. The rent conception is earlier grasped by men, is nearer in
point of logic; the concept of time-value has only recently been clearly
recognized. If men lived only in the moment, they would be concerned
only with rent; living in the future also, they are constantly
regulating their acts with reference to time-value.</p>
<hr class="chap" />
<p><span class="pagenum"><SPAN name="Page_152" id="Page_152">[Pg 152]</SPAN></span></p>
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