Front Page Titles (by Subject) CHAPTER 22: MONEY AND CAPITALIZATION - Economics, vol. 1: Economic Principles
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CHAPTER 22: MONEY AND CAPITALIZATION - Frank A. Fetter, Economics, vol. 1: Economic Principles 
Economics, vol. 1: Economic Principles, (New York: The Century Co., 1915).
Part of: Economics, 2 vols.
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MONEY AND CAPITALIZATION
§ 1. The functions of money. § 2. The standard of deferred payments. § 3. Property. § 4. Wealth and property rights. § 5. Origin of capital; its definition. § 6. Capitalization of direct durative agents. § 7. Capitalization of indirect durative agents. § 8. Time-price without loans. § 9. Present price and the discount on future uses.
§ 1. The functions of money. As trade among a number of traders is greatly facilitated and price is given a more exact expression when a common objective standard, money, comes into use, so a price paid for time-transfers of many kinds can be much better expressed in a common standard by the use of money.
Money is first a means of trade, a medium of exchange. (For preliminary definition, see above, Chapter 7.) It is some object which has value to all men and which, because of its convenience, comes to have the most general marketability of any good. It is thus selected because of certain qualities in which it excels any other good. It is always some object containing in the view of every one, a good deal of value in small bulk, most easily kept without physical decay and that has come, as markets develop, to be one of the goods in most trades.
The general medium of exchange is necessarily the most general price-good. As all other things are constantly exchanged for money, they can each in turn be compared with all the others in terms of money. It becomes the common denominator of prices. The price of any one thing in terms of another can be found from the money-prices of the two. This permits and cultivates habits of exacter conscious calculation of prices both by buyers and sellers than were before possible.
Whenever money is kept for an hour or a day, awaiting the fitting moment to complete the double exchange, it is serving the purpose of a storehouse of saving. Because of the same qualities that make it generally exchangeable (certainty of sale and physical durability) it is one of the best objects to keep for longer periods (to be saved, hoarded) against a day of need. It is a generalized means of abstinence, kept for a general purpose without choice as yet of the particular good for which it will be spent. The use of money as a storehouse of saving was more common formerly than it is now, for in advanced countries better ways than the hoarding of money are found for “laying up for a rainy day.” In some measure, however, even here money serves this use and in large parts of the world as in Egypt, China, India, this use is of very great importance. A thing ceases to be money, logically viewed, the moment its owner keeps it without the purpose that it shall be spent ultimately. The typical miser is a man who has lost his reason as regards the money use, has forgotten that it is a means to an end. Whether serving as a storehouse of saving or as a medium of exchange, in either case money is to be kept only till the moment when the owner believes it will best gratify his desires. Its use thus even as a medium of exchange involves a recognition, and a more or less conscious calculation, of time-value.
§ 2. The standard of deferred payments. But this connection with time-value is yet more important as money comes to be used more and more as a standard of deferred payments, a standard for prices over a period of time. A deferred payment is a payment made in fulfilment of a bargain made for goods delivered at an earlier date. It is the completion of a credit transaction. Credit means, first, trust or confidence reposed by a seller in a buyer, and hence the selling of things “on trust,” in exchange for a promise of pay at a later date. Now as money is the common price denominator, and the price of nearly all things whether they are sold for cash or on credit is expressed in money, it is the unit in which the comparison of goods is made when one chooses goods in different periods of time. It is not an absolute standard of value; a “dollar” is not necessarily of the same value-magnitude to any one person from year to year, much less to all persons together. Money is subject to fluctuations of its own (for example, those due to changes in gold production) having remarkable consequences in industry which must be separately studied. But money is taken as the objective standard in borrowing and lending to which the time-preferences of men are adjusted, as value is adjusted to price. This is to be treated under the subject of interest.
§ 3. Property. No trade of goods is possible unless the trader has possession of the goods, or can deliver that control over to the other party in the trade. The fact of possession is implied in all discussions of value, price, use, and rent. Possession is a legal fact. It is legal control, not physical hold of goods. In any settled community it must be regulated by law, the law of property. Property is ownership. It is an intangible right; only by a loose figure of speech has it come to be applied to the object owned (e.g., a man has a property in a house and lot—real estate; hence the house and lot are called his property). The law of property is the rule of the community determining control over economic goods. Economic goods are valuable; other persons would like to have them. A property right is either a claim upon some one else or a limitation of some one else’s claim. You say in various ways, this house with land is mine, it is my own, it is owned by me, it is my property, I have a property right in it, it belongs to me, etc. All these phrases express your right to have and use as against other men’s rights. But you may sell to another man a right to a method of use or to a limited period of use, in a written instrument, a lease. He then has a legal right in his leasehold, and your right is limited by his. He may have an “equity” in the house (a claim upon the income from the house which formerly was enforceable in a court of equity). At the same time you may get repairs made by mechanics who until paid have a legal claim for which the house itself is legal security (law of mechanics’ lien). And so there may be a score of overlapping and mutually limiting claims upon the income from one economic agent. There is a legal distinction between your legal claim to the fee simple of a landed estate, and the various legal claims upon you, or equitable interests in the house (when it is the security). But it is property rights that are traded rather than the things themselves, for legally each party in a trade can deliver the possession and use only of that limited part, aspect, or mode of use, of goods, which is his.
§ 4. Wealth and property rights. The valuable objects themselves, such as lands, houses, cattle, implements, and ships, are wealth. If there are no overlapping legal rights, the property right to a piece of wealth has the value of the wealth itself. In simple conditions of industry each piece of wealth had one owner who had the right to all the income of that wealth; or if others had overlapping claims (of landlord, sovereign, etc.), they were of a fixed sort, not objects of sale. Neither the objects of wealth (the lands, etc.) nor outsiders’ claims upon them were ordinarily bought and sold. Therefore their magnitude was usually estimated in terms of their rents, or incomes, and not in terms of their price if sold as a whole. In England, where land rarely changes hands except by inheritance, an income whether from land or other sources is still spoken of as worth so many pounds a year, rather than as worth so much as a whole. As there comes to be a network of property rights extending over the wealth, and mutually delimiting each other, it is evident that the total price of these rights can not exceed the total price of the uses (products) of the wealth. The different pieces of wealth have yields that are impersonal—the field yields its crop, the house its services, the ship its uses, and these impersonal yields are apportioned to different persons as incomes according to their property rights. Two or more men may be partners, one entitled to ½, another to ⅓ and another to ⅙ of the total usance; or before these incomes are apportioned, many other small prior claims may be first deducted. Corporate ownership with small shares of stock gives a much greater division of claims upon income.
More and more it is these claims to income that have come to be the objects of trade among men, rather than the concrete wealth itself. One may be a very rich man to-day and not own outright, in fee simple, any but small personal belongings. He does not own wealth in the old-fashioned way, he has capital, and is a capitalist.
§ 5. Origin of capital; its definition. Capital is from the Latin adjective capitalis (from caput, head) in the phrase capitalis pars, the chief part, principal part; hence principal, of a money-loan. The capital, or principal, of the lender was this amount of money, distinct from the usury (originally meaning the sum paid for the use) or interest, the amount in addition which was due him at the expiration of the loan. Money loans of this kind were rare except among merchants in cities, and the borrower on his part looked upon the capital as the amount he had to “invest” (literally, clothe) in various kinds of goods. Taking these goods to a distant market, or changing them by manufacture into more valuable forms, he expected to regain when he sold them not only his capital but more than enough to pay the interest.
Merchants, manufacturers, bankers, were constantly thus investing capital. They came to estimate in terms of capital not only the sums borrowed and lent but the value of all their own rights in the goods. Even now the capital-mode of expression is less common in the rural economy, tho it is increasingly used by farmers of the enterprising sort, who are borrowing and making improvements, getting better equipment, etc., in many cases in America going so far as to count also the original price of the land, or its present value, as a part of their capital. We may define capital in accordance with this modern view.
Capital is an expression of a person’s business power in terms of money, being the estimated price (with reference to market conditions) of the person’s property rights to income. These property rights may be composed in part of claims upon income arising from the labor of others; a promissory note given by a student of good credit, or by an inventor hoping to continue his experiments, is capital in so far as it is saleable, or bankable, tho the income from which it will be paid is to come from personal resources and not from any material agents.
Business- or industrial-capital is more specifically that part of a man’s capital which is invested in his business, from which to draw a monetary income. The value of his house, furniture, and personal belongings is capital, tho ordinarily not thought of as such, but as means of enjoyment. In an emergency they may be converted into money to be used in his business, and being part of the property available to pay his debts, they help to give him greater credit at all times. Nominal capital is the amount of shares of stock issued by a corporation, taken at their par, or nominal, amount. It may have little relation to the true investment. Where there is no regulation of stock issues, a company with no true capital may print shares of millions of dollars of nominal capital. In financial statistics, bonds as well as stocks are often included in the nominal capital (as in the reports on capital in American railroads).
§ 6. Capitalization of direct durative agents.Capitalization is the process of calculating the market-price of saleable incomes (whether sold now or not). It is the estimation of the present worth of marketable incomes. This gives us another way of defining capital: capital is any right to prospective income that can be capitalized. Capital can either be pledged, or sold outright at a price.1
Some expression of the present worth of future uses is involved in the choice made by the individual between any two uses that are not of the same time-period. It is easy to see that this is so in every case where a present stock of goods is kept for use in different periods; it is so in every case of repair of agents for future use; it is so in every case where goods are produced for the future.
Many of these choices involve the choice of an object containing a number of uses of different time-periods, which are summed up—capitalized. Take a direct durative good, such as a fan, a house, a pleasure boat, an article of clothing, etc. That on which the value of the good as a whole is based is a series of uses which can not all be present. The fan represents all the cooling drafts to be got from it not only to-day, but many days to come. Additional uses may be obtained from the house by crowding more people into it, possibly thus slightly increasing the wear, but in no way can next year’s shelter be obtained until next year. Each durative agent yields its uses through a period of time, a period usually not to be shortened except at a cost. The maximum economy of utilization (see Chapter 13) gives a series of uses at different times and of unequal present values. Each succeeding year’s use, until the agent is expected to wear out, is adjusted to the value of this year’s; that is, it is reduced to its present worth, and the sum of the present worths is the present value of the agent. Representing the total value as S (sum) and the annual incomes as a′ for the first year, etc., and the life of the agent as four years, we have:
S = present worth of (a′ + a″ + a″ ′ + a″ ″) and substituting an assumed present worth of a,
S = (10 + 9 + 8 + 7) = 34
§ 7. Capitalization of indirect durative agents. This process of valuing direct uses is extended to those indirect agents whose uses are more or less removed in time. Desires are so expansible that if the right kind and quality of direct goods could be had at will, enormously greater amounts would be used. But the continued income of present goods is dependent on durative agents. The psychic income of a civilized community is conditioned 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 agents, even in the richest community, are limited in variety, in quality, and in number. The present price of these goods is the capitalization of the expected uses they contain.
If a limited supply of agents could and did produce at any moment unlimited products, they would become free goods. The yield of the uses of most things depends, however, upon the lapse of time: an acre of land with the most perfect cultivation can not feed the world; but remove the limit of time, wait an eternity, and the acre would yield an infinite crop. Moreover, the economic return of agents in a given period is reached sooner than is the maximum physical return. If agents are forced to yield more bountifully, it is at the cost of other goods. A point of maximum net yield is found in any given period dependent on the rate of time-preference (see above, Chapter 21, section 10). Here also the lapse of time is the condition of the increase of the values derivable from limited agents.
§ 8. Time-price without loans. It is clear then that discounts of future uses are necessarily involved in an individual’s valuations of all his own goods which have any durativeness whatever—necessarily whether the person is conscious of it or not. The expression of this discount on the future (or premium on the present) may be and often is inexact and variable, but the fact of the discount (or premium) is always there. If this were not so and present uses in technical processes were not on the whole treated as more important than future uses, labor and resources of all kinds would be distributed impartially over the most distant periods of time. In the extreme case one might starve himself to death in youth while producing goods for his old age.
Now if these discounts are involved in valuations, they must play their part in determining the prices at which trades of objects containing different time-periods are made. Time-value bears the same relation to time-price that value of direct commodities does to their price. (See Chapter 7.) Generically the time-price problem is the same as the problem of commodity-price, and of usance-price (rent); specifically it is different only in as much as the particular value is that due to time. Collectively the valuations are the basis of price, but severally the valuations are socialized and modified by price. That is, the existence of the market gives new conditions of substitution of goods in point of time, and presents new motives and possibilities of using wealth.
Let us see how an arithmetic rate is involved in such trades, when the prices are expressed in money-terms. Trader A has a steer ready to market that will sell now for $100; he trades it to B for five calves that will sell for $102 each in three years, meantime costing to keep, including allowance for labor and trouble, $25 a year each (counted at the end of each year). A gives $100 now, plus $125 a year hence, plus $125 two years hence, plus $125 three years hence, total $475, to get a capital of $510 at the end of three years.2 In this trade there is involved a premium on the investment at the rate of 5 per cent. Do the two parties need to know this when they trade? Not exactly as an arithmetic expression, but approximately as to the outcome.
§ 9. Present price and the discount on future uses. Every exchange of a durable agent involves an estimate, rough and imperfect it may be, of that agent’s future. The practical traders, who in agreeing upon a price are thus involving a rate of capitalization of goods, are usually only dimly conscious of the logical nature of the process. In merely occasional trades the process usually goes on in a very empirical way, by the method of trial and error. The future changes are only roughly, not accurately, estimated. What each tries to do is to get as much as he can and give as little as he must, and, comparing one line of trades with another, shifts back and forth to the line that gives the best results. But the shrewd bargainer is the one who foresees more clearly than his fellows the complex changes to come or shows an intuitive sense of the net result that the common mind lacks. The ability and the inability to foresee such changes make men rich and poor. In all this bidding for capital the logical basis of the present value is the series of expected incomes. 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. This discount on the future incomes (which is involved in the lower present price) evolves, as the agent is kept and yields the expected income, as a rate of premium on the purchase price, that is, as a rate per cent on the amount of invested capital.
There are, of course, different markets for time as for other things at the same moment and near each other. In these the time-rate varies, being high in poor economies and low in good ones. Temporarily, as in time of war, or a panic, the rate may become very high, as shown by the abrupt fall of prices in commercial centers, when prices throughout the country are but slightly affected. The communication between the different markets for investments is imperfect, and the adjustment between them of the rates of discount on future incomes is always more or less incomplete.
In the next chapter we shall see how the various kinds of monetary incomes are capitalized in the business world, how thus continuously a price on investments, or rate of return, prevails, and expresses a ratio of exchange between present and future capital (and incomes) in the market.
[1 ]The value of a slave may be capital. A man, in our times, may not legally sell himself into slavery. Therefore, free men, in any full sense, are not capital, and it is misleading to speak of them as such, or to estimate their capital value as is sometimes done. But to a limited extent, carefully guarded by law, a man may borrow and pledge his future earning power, and thus capitalize it.
[2 ]Of course there are other reasons why the trade may be made, such as the better means that A has for feeding calves, the special use B has for fat steers, etc. Attention is limited here to the time-price problem, in cases where the prices and costs are the same to both parties.