Finance Capital, Hilferding 1910

6

The Rate of Interest

In the capitalist system of production, every sum of money is able to function as capital, that is, to produce a profit, so long as it is made available to productive capitalists.

Take it that the average rate of profit is 20 per cent. In that case, a machine valued at £100, employed as capital under the prevailing average conditions and with an average exertion of intelligence and adequate activity, would yield a profit of £20. In other words, a man having £100 at his disposal holds in his hands a power by which £100 may be turned into £120. . . . He holds in his hands a potential capital of £100. If this man relinquishes these £100 for one year to another man who uses this sum actually as capital, he gives him the power to produce a profit of 20 per cent, a surplus value which costs this other nothing, for which he pays no equivalent. If this man should pay, say £5, at the close of the year to the owner of the £100, out of the produced profit, he would be paying for the use value of £100, the use value of its function as capital. . . . That part of the profit which he pays to the owner is called interest. It is merely another name, a special term for a certain part of the profit which capital in the process of its function has to give up to the owner, instead of keeping it in its own pocket.

It is evident that the possession of £100 gives to their owner the power to absorb the interest, a certain portion of the profit produced by his capital. If he did not give the £100 to the other man, then this other could not produce any profit, and could not act in the capacity of capitalist at all with reference to these £100.[1]

From the standpoint of the owner of money, the money he lends is capital because it returns to him after a time in an increased amount. Capital, however, can acquire an added value only in production, through the exploitation of labour-power, and the appropriation of unpaid labour. Consequently, the money capital of the lenders cannot yield a profit unless it becomes the money capital of producers and is used in production. The profit which results is now divided, one part returning to the loan capitalist as interest, the other remaining with the productive capitalist. Under normal conditions, therefore, profit constitutes the upper limit of interest because the interest is a fraction of profit. This is the only possible relationship between interest and profit. On the other hand, interest is not some definite fixed part of profit. The level of interest depends upon the demand for and supply of loan capital. It is possible to conceive, and to formulate the bases of, capitalist society on the assumption that money owners and productive capitalists are identical, or in other words, that all productive capitalists have at their disposal the necessary money capital. In that case, there would be no such thing as interest. But capitalist production without the production of profit is inconceivable; the two mean the same thing. The production of profit is both the condition and the purpose of capitalist production. Its production of surplus value (embodied in the surplus product) is determined by objective factors. Profit arises directly from the economic relationship, from the capital relationship, from the separation of the means of production from labour, and from the opposition of capital and wage labour. Its size depends upon the new value which the working class produces with the available means of production, and upon the division of this new value between the capitalist class and the working class, which, in turn, is determined by the value of labour power. We are dealing here with factors which are determined in a completely objective manner.

Interest, however, is another matter. It does not arise from an essential feature of capitalism - the separation of the means of production from labour - but from the fortuitous circumstance that it is not only productive capitalists who dispose over money. In consequence, the whole money capital need not enter the cycle of the individual capital at all times, but may lie idle occasionally. What part of the profit the loan capitalists can appropriate depends upon the changing level of producers' demand for money capital.[2]

If interest is determined by supply and demand, we have to ask how supply and demand themselves are determined. On one side there is a sum of money temporarily lying idle but seeking investment; and on the other, the demand of the capitalists for money which can be converted into capital for use in production. Capital credit makes this allocation, and the state of the capital market determines the rate of interest. At any given moment, a definite sum of money, which represents the supply, is available to capitalist society, and on the other side, there is at the same time a demand for money capital arising from the expansion of production and circulation. In other words, the 'loan price of money', or rate of interest, at any given time is determined by the confrontation on the market between supply and demand as two determinate magnitudes. This determination of the rate of interest presents no further problem, and difficulties only arise when we , begin to analyse fluctuations in the rate of interest.

This much, at least, is clear; that an increase in production and thus in circulation means an increased demand for money capital which, if it were not matched by an increased supply, would induce a rise in the rate of interest. The problem is that the supply of money would also change along with, and precisely because of, the change in demand. The quantity of money which constitutes the supply comprises two elements: the available cash, and credit money. In our analysis of commercial credit, we found it to be a variable quantity which increases when production increases. This involves an increased demand for money capital, but the increased demand is accompanied by an increased supply in the form of credit money generated by the expansion of production. Hence the interest rate will change only if the demand for money capital changes more than the supply; it will rise, for instance, if the demand for money capital increases more rapidly than the supply of credit money. Under what conditions is this likely to occur?

In the first place, any increase in the quantity of credit money requires an increase in the cash reserves which are needed to ensure that credit money can always be converted. Further, an increase in the circulation of credit money is accompanied by an increase in that part of the total cash supply which is needed to settle uncleared balances. An increased circulation, moreover, is accompanied by an increase in the number of transactions in which credit money plays only a minor part : wage payments to workers and payments for increased retail purchases, for instance, are usually made in cash. Thus the sums available for lending tend to be reduced because part of the cash is needed for these other purposes. Finally, it should be noted that the increase in credit money will lag behind the requirements of increasing production and circulation when the marketing of goods ceases or slows down at the end of a period of prosperity. For this means that the bills drawn against commodities will no longer cancel out, and that at the very least their period of circulation will increase. But if the bills that fall due do not cancel each other out they must be settled in cash. The various forms of credit money (bills, and bank notes issued on the basis of such bills) can no longer perform their money functions, the circulation of commodities, on the same scale as formerly. There is an increased demand for cash to redeem commercial paper, and at the same time to make up the reduced supply of credit money in actual use. It is this demand for cash which brings about the rise in the rate of interest.

If the absolute level of the interest rate thus depends upon the state of the capital market, fluctuations in the rate of interest depend primarily upon the state of commercial credit. A closer analysis of these fluctuations belongs more properly to a discussion of the trade cycle, and will be presented in that connection.

I am not in complete agreement with Marx's view that variations in the rate of interest depend upon the supply of capital which is loaned in the form of money, cash and notes. He states:

The variations of the rate of interest (aside from those occurring over long periods or from differences of the rate of interest in different countries; the first-named are conditioned by the variations of the general rate of profit, the last named by differences in the rates of profit and in the development of credit) depend upon the supply of loan capital, all other circumstances, state of confidence etc., being equal; that is, of the capital loaned in the form of money, hard cash and notes; this is distinguished from industrial capital which, in the shape of commodities, is loaned out by means of commercial credit among the agents of reproduction themselves.[3]

This leaves open the question of how large the volume of bank notes can be. For England, whose situation Marx evidently has in mind, the answer is, of course, given by the legal provisions of the Peel Act, according to which the total volume of cash and notes is constituted by the cash in circulation, the gold reserve of the Bank of England, and 14,000,000 in notes, being the volume of unsecured notes in circulation. In fact, these notes assume the function of state paper money to the extent that they represent - or at least represented in Peel's day - the minimum of circulation replaceable by money tokens. Thus the law provided once and for all that the quantity of bank notes should remain at a prescribed figure. But if we put the question in a more general form, variations in the rate of interest depend upon the supply of loanable money. All money, however, can be loaned which is not in circulation. There is in circulation, first the money tokens, covering the minimum requirements of circulation, and second, a certain quantity of gold. The remainder of the gold is in the coffers of the bank or banks, serving partly as a reserve for domestic circulation, and partly as a reserve for international circulation (since gold must perform the function of international money). Only experience can show the minimum quantity of gold required for these two purposes. The remainder can be loaned out, and in the final analysis constitutes the supply whose use determines the rate of interest. But the extent to which it is employed depends upon the state of the commercial credit advanced by producers to one another. As long as this commercial credit can increase fast enough to satisfy the increased demand, the rate of interest will not change. We should not forget, however, that the greater part of the demand is satisfied by a supply which increases together with the demand. The bulk of credit is commercial credit, or as I prefer to call it, 'circulation credit', and both the demand for and the supply (or if you wish, means of satisfaction) of such commercial credit increase together, and pari passu with the expansion of production. The expansion of credit is possible without any effect on the rate of interest, and indeed occurs at the beginning of a period of prosperity without such effects. The interest rate first begins to rise when the gold holdings of the banks are reduced and the reserves approach the minimum requirements, forcing the banks to raise their discount rate. This happens at the peak of the trade cycle because circulation then requires more gold (with the growth of variable capital, of turnover generally, and of the amount needed to settle balances). The demand for loan capital becomes greatest precisely when the stock of gold is at its lowest point owing to the absorption of gold by the requirements of circulation. The depletion of the gold stock available for loans becomes the immediate occasion for an increase in the bank discount rate, which in such periods becomes the regulator of the rate of interest. The purpose of raising the discount rate is precisely to bring about an influx of gold. The various restrictions imposed by misconceived banking legislation only have the effect of bringing about the higher discount rate sooner than purely economic conditions require. The mistake of all such restrictions is that in one way or another (indirectly in Germany, directly in England) they underestimate the minimum required in circulation and thereby limit the supply of loan capital.

It follows, then, that the rate of interest would show a downward tendency only if it could be assumed that the relation of the existing gold stock to the demand for loan capital is always becoming more favourable, that is to say, that the gold stock increases more rapidly than the demand for loan capital. But if we consider only developed capitalist systems, such a tendency for interest rates to decline steadily cannot be established.[4] Nor can it be postulated theoretically, because simultaneously with the increase in the gold reserve and in the minimum of circulation there is an increase in the amount of gold entering circulation in a period of prosperity.

A fall in the rate of profit would involve a decline in the rate of interest only if interest were a fixed part of profit ; but this is not the case. At most, a decline in the rate of profit means that there has been a reduction in the theoretical maximum level of interest, namely the total profit. But this is of no significance, because interest does not generally reach this ceiling in the long term.[5]

But there is another important factor which should not be overlooked. In a developed capitalist system, the rate of interest is fairly stable, while the rate of profit declines, and in consequence the share of interest in the total profit increases to some extent at the expense of entrepreneurial profit. In other words, the share of rentiers grows at the expense of productive capitalists, a phenomenon which does indeed contradict the dogma of the falling interest rate, but nevertheless accords with the facts. It is also a cause of the growing influence and importance of interest-bearing capital, that is to say, of the banks, and one of the main levers for effecting the transformation of capital into finance capital.

Footnotes

[1]Capital, vol. III, pp. 398-9. [MECW, 37, p337]

[2]In order to explain prices by the relationship between supply and demand the latter must be assumed to be fixed and given quantities. That is why the marginal utility theory always endeavours to make the assumption that supply is constant, and to take a given stockpile for granted. Schumpeter, in Das Wesen und der Hauptinhalt der theoretischen Nationalökonomie, is perfectly consistent, therefore, in his attempt to uphold the marginal utility theory by reducing political economy to a static system; whereas it should be dynamic, providing a theory which formulates the laws of motion of capitalist society. The contrast with Marxism is very aptly and precisely expressed here, as is the complete sterility of the marginal theory, 'the final futility of final utility' as Hyndman jokingly described it. The problem is that an economic explanation of the scale of supply would involve explaining the scale of production by formulating the laws which govern production. Demand itself is determined by production and distribution, by the laws which govern the distribution of the social product. Similarly, in any attempt to explain the rate of interest, the difficulty lies in showing what factors determine the extent of the supply.

[3]Capital, vol. III, pp. 586-7. [MECW, 37, p497]

[4]Such comparative empirical data as are available do not in any way support the dogma of a declining rate of interest. Smith tells us that in his day, the government of Holland paid 2 per cent, and private borrowers with good credit 3 per cent interest. For a time after the war (1763) not only private borrowers of the best credit standing but also some of the largest London trading houses usually paid 5 per cent as compared with the previous rate of from 4 to 41 per cent. Tooke, citing the latter facts, remarks on this point : `In 1764, 4 per cent stock certificates fell below par; navy bills were discounted at 98 per cent; consols which stood at 96 in March, 1763, fell to 80 in October. But in 1765, the 3 per cent stock certificates, of which a new issue followed, stood generally at par, and at times above par; and 3 per cent consols rose to 92.' Thomas Tooke, A History of Prices and of the State of the Circulation, vol. I, pp. 240-41. Schmoller, in Grundriss der allgemeinen Volkswirtschaftslehre, vol. II, p. 207, tells us further that in 1737 the 3 per cent consols stood at 107. The price of state paper, which is also influenced by other factors, is certainly not an absolutely reliable criterion of the level of the interest rate, although it merits some attention.

Nor does an examination of the discount rate of banks of issue reveal any uniform decline in the rate of interest. Table 1 is taken from an interesting article by Dr Alfred Schwoner, `Zinsfuss and Krisen im Lichte der Statistik', in the Berliner Tageblatt of 26 and 27 November 1907. [The symbol C indicates a crisis year, although in 1895 and 1882 (the Bontoux crash) it was a matter of purely speculative crises - R.H.]

Schwoner comments on the table as follows:

`If we try to draw some general conclusions about the movement of the rate of interest from these statistics of the bank discount rate in the nineteenth century, it becomes apparent that no definite tendency, upward or downward, is demonstrable. True, official discount rates below 4 per cent appeared in the course of time, sooner or later according to the economic development of the country. In this respect English was far in advance of other countries. As far back as 1845, the discount rate went down to 2 per cent for the first time. In the case of the Bank of France, the discount rate stood at 3 per cent for the first time in 1852, at 21 per cent in 1867, and at 2 per cent in 1877. The Berlin Bank had a minimum discount rate of 3 per cent as far back as the twenties of last century, but during the period of the Prussian Bank and the German Reichsbank the interest rate fell below 4 per cent for the first time in 1880 [sic]. In the Austro-Hungarian Bank, a 31_. per cent interest rate first appeared in 1903 during the first depression experienced by the Dual Monarchy after the reform of the currency system. Some progress may be discerned in so far as the rate of interest has declined with the technical perfecting of banking organization and the currency system.'

Schwoner also provides the following figures (Table 2).

`The overall average was at its highest by far in the decade 1857-1866, when it amounted to 4.79 per cent, and remained very high in 1867-1876 at 4.09 per cent. In 1877-1886, it fell to 3.63 per cent and reached its lowest point in 1887-1896, at 3.38 per cent. In the last decade, the average was 3.67 per cent, higher, therefore, than in the preceding two decades, but far below the average during the first twenty years of the financial and industrial upswing, 1857-1876.'

The conclusion to be drawn from all this is that the rate of interest is not determined by the rate of profit, but by the stronger or weaker demand for money capital resulting from variations in the rate of development, and the tempo, intensity and duration of periods of prosperity.

A study of excessively high rates of interest will show that their causes are always to be found in the regulation of the monetary system. Thus, for exam• ple, the discount rate in Hamburg rose to 15 per cent in 1799, and even at this rate, only the best bills, in limited amounts, were accepted (Tooke, op. cit., vol. I, p. 241). The cause lies in the absence of a flexible monetary system, as is shown at present by the exceedingly high interest rates and their violent fluctuations in the United States. They have nothing to do with any changes in the rate of profit.

[5]Adam Smith's principle that 'wherever a great deal can be made by it [money] a great deal will commonly be given for the use of it; and wherever little can be made by it, less will commonly be given for it' (Wealth of Nations, bk I, ch. IX), although illuminating, is not demonstrated and not correct.

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