Front Page Titles (by Subject) CHAPTER 24: SAVING AND BORROWING - Economics, vol. 1: Economic Principles
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CHAPTER 24: SAVING AND BORROWING - 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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SAVING AND BORROWING
§ 1. Abstinence of the conservative kind. § 2. Cumulative abstinence. § 3. Spenders and savers. § 4. No common standard of abstinence. § 5. Saving without and with the use of money. § 6. Classes of borrowers. § 7. Victims of mischance. § 8. The chronic improvident borrower. § 9. Premium concealed in retail prices. § 10. The prodigal borrower. § 11. Students and apprentices. § 12. Becoming-owners as borrowers. § 13. The borrower for profit.
§ 1. Abstinence of the conservative kind. Abstinence is the name of that faculty of mind which enables present desires to be subordinated to future desires. Abstinence (the faculty) expresses itself in particular acts known as abstaining, or as saving. Conservative abstinence is that which keeps men from using up or invading their present stock of goods, and cumulative abstinence is that which impels them to add to that stock. There is no sharp dividing line, no abrupt break, between these two, yet on the whole they differ. Conservative abstinence is a quality of mind analogous to the inertia and momentum of physical matter, and makes men resist stubbornly a reduction of property, of income, and of an accustomed social position, even when there is little or no disposition to increase or advance them. It is this which makes nearly all men think that using up any part of their principal (when they have sold property or have collected loans) is a very different thing from regularly using up their free income. A large part of accumulation results from the operation of conservative abstinence. Through insurance for one’s family, purchase of annuities, laying up “for a rainy day” or for old age, etc., guided by the conservative quality of mind, men seek to maintain (rather than to increase) the standard of themselves or their families.
§ 2. Cumulative abstinence. Adding to wealth at the cost of a present lowering of long-accustomed standards of living is a rare occurrence; but in a large number of cases where there is no deliberate purpose to go beyond conservative abstinence, the uncertainties of life, insensible changes in the habitual standard of possession, desire to leave children a larger patrimony, etc., tend to the heaping up of wealth for heirs. It is much easier to accept a higher than a lower standard of living. Consequently, deliberate cumulative abstinence is most likely to appear at favorable times in the lives of men of rising fortunes, who, while maintaining or even increasing their scale of expenditure, are able to add to their riches. Accumulation comes to be to some men the one game they can enjoy. I recently met an old man who generously was bent on becoming richer so that, as he said, his attractive young wife might get a second husband as good as her first one.
Many successful business men evidently are accumulating not because of a desire to enjoy more material income themselves, excepting in so far as that is necessary to present success or is the evidence that they are succeeding in the present. Business has in it always something of the character of a game, and the game can not be won unless at one place and another the resources of the business are steadily enlarged. The older inexpensive equipment must be replaced by newer and more costly, the stock must be increased and the buildings enlarged, if the business is to maintain its place among competitors and outstrip them. The cumulative abstinence in such cases seems to be but an outgrowth and result, under favoring conditions, of an original conservative motive.
Abstinence of either kind is the guardian of the individual’s future against his present desires. Upon the conservative faculty depend the preservation, repair, replacement, and economic use of our environment; upon the cumulative faculty depend largely its growth and betterment. As the capital values in a community are many times as great as the savings in a single year, and as a large part of the savings result from conservative motives, it is evident that the pressure and resistance of conservative abstinence against present desires must be steadily many times as great as that exerted by cumulative abstinence.
§ 3. Spenders and savers. The uniform preference for present over future would lead a Robinson Crusoe to use up and wear out his wealth, and to apply all his labor to present enjoyment, even on the penalty of future misery. On the other hand, the excessive preference for the future over the present would condemn him to the miser’s fate of misery and starvation in the midst of wealth. Evidently somewhere between these two extremes he must settle upon some rule of life and habit of choice that involves a ratio of exchange of present and future uses. The world is made up of people each with his habit of choice, not absolutely fixed, slowly changing with years, with education and with circumstances, and occasionally broken into by impulse. Members of families and of groups show some likeness in their habits of choice. Each one having separate control over incomes through the institution of private property, is able to maintain his own standards. It is a matter of degree, ranging from those who spend all they can get hold of, to those who save nearly all. Thus at any time the community is made up of those who are spending more than their incomes, those who are spending just up to their incomes (the large class of conservative abstainers), and those who are spending less than their incomes (the cumulative abstainers). This psychological difference between abstainers and prodigals varies from one person to another, depending on natural temperament, on habit bred of family and community customs and training, and on states of health and on moods affecting the appetites, the imagination, the conscience, and the will.
§ 4. No common standard of abstinence. It must not be thought that any two men’s savings in terms of dollars express the comparative degrees of abstinence, sacrifice, suffering, deprivation, etc., of the two men. A poor man denies himself many simple comforts for years to pay $1000 for a little home; a rich man may be able to buy $100,000 of bonds with a fraction of the profits of a rising business or of a growing income from investments while increasing his living expenses in all directions. It is absurd to suggest that the latter has abstained a hundred times as much as the former in a subjective sense.
It might seem that it would be easier for a well-fed, well-clothed, well-housed man to exercise abstinence than for a hungry, ill-clad man with no roof over his head. But neither saving nor prodigality is regularly related to any particular state of fortune or is found exclusively among either rich or poor. A poor peasant living on the most meager fare may possess in high degree the quality of abstinence which is entirely lacking in the rich spendthrift. A man well on in life with a simple standard of living can easily save a large share of an increasing income.
Abstinence is a resultant of the opposing forces of desire in the one man’s will. Both of the poor man’s desires dependent on a dollar may be very strong (we have no psychic standard unit) but the desire for present enjoyment be the stronger; whereas both the rich man’s desires that are dependent on a thousand dollars may be very weak, yet the desire for the present good be the weaker. Natural differences in temperament combine with education, habit, and the imitation of prevailing standards to make desires mild or intense. Saving may result when a vivid imagination aids in making the future desire stronger than present strong impulse; or it may result when very simple tastes fixed by habit are combined with equally habitual and unreasoning frugality. The magnitude of 10 minus 8 is greater than that of 100 minus 99. Two men’s powers of abstinence can not be numerically compared, but the objective results appearing in the amounts saved can be compared.
§ 5. Saving without and with the use of money. Abstinence of the conservative sort shows its results in keeping in repair and providing for the replacement of fertile soil, ditches, fences, houses, tools, and equipment of every kind in the owner’s possession. Much of this does not need to take the money form, but much of it does, as in payment of wages and purchase of materials to keep up repairs, and in the laying aside of a depreciation fund, or the provision of insurance to replace the agents when destroyed. It calls for positive effort on the part of the owner to resist treating gross usance and receipts of his fields, tools and other equipment as a disposable income, in order to enjoy a more bountiful present at the expense of the future. In many ways one may “borrow from the future” without borrowing from any person (unless it be one’s self).
Abstinence of the cumulative sort likewise can and does in large measure take the form of saving in kind rather than in money. One has but to dispose of his labor and wealth so as to use in each period less than the full net income of the period and to put the surplus into durable forms yielding future incomes. The pressure of present desire is so great, and so many unexpected present needs crowd upon men, that few find it possible or think it possible to save much in this way, and fewer still find it easy.
When incomes are received in money, saving usually takes that form. Every clear dollar of money income (after providing for the maintenance of the principal) is disposable either as present enjoyment or as savings to constitute a new capital. This may be done by buying labor and materials to build new agents, “adding barn to barn,” or it may be by buying other durative direct agents, as a house to live in where one has been paying rent, or it may be by buying durative indirect agents, as a horse and plow which one has had to hire for use in his own fields. Or the money may be used to purchase a factory, or to hire laborers and to buy materials to create a new industry.
A large part of money savings, however, takes the contractual form. The saver may take out an insurance policy. He may deposit in a savings bank (or commercial bank with a savings department) and get from 2 to 4 per cent interest, the bank in turn buying bonds of corporations, or making loans on mortgage security at a higher rate of interest. He may loan to a business man or to a house builder, taking notes and mortgages, or he may buy bonds and mortgages from a corporation. In all these cases the money loaned is transferred to another, and if wisely invested, will produce new incomes. Money saved can be made to yield an income only by being spent—that is, invested in some way.1
§ 6. Classes of borrowers. A distinction is usually made according to the purpose of the borrower, between two main classes of loans: consumptive and productive loans. Consumptive is the adjective usually applied to a loan made for the direct use of one’s self (or of one’s dependents). It is borrowing by a spender, and virtually undoes, negatives, the act of the abstainer. This was almost the only kind of borrowing before the development of modern money markets. Among the many varieties of circumstances in real life several types of consumptive borrowers are distinguishable: (1) the victim of chance, (2) the chronic improvident, (3) the prodigal, (4) students or apprentices, and (5) abstaining users, or becoming-owners.
§ 7. Victims of mischance. Some kinds of misfortune are comparatively rare, are difficult if not impossible to provide against, and fall with overwhelming weight upon the unprepared victim. Such misfortunes are fires, floods, hurricanes, earthquakes, failure of crops through drought, excessive rain, pests, hail and windstorms; such are bodily accident through burns, cuts, falls, crushing weights and strains, which partially or completely, temporarily or permanently, disable from labor, or cause the death of a breadwinning member of the family. Such also are many industrial accidents as the cutting off of the usual employment through failure of the sources of materials, loss of vessels in transit, brigandage, war, etc. In all such cases the victim’s condition suddenly falls below the accustomed and the normal. Sometimes immediate food, fuel, and clothing are a necessity of bare existence. One standing face to face with starvation can not be worse off a year hence; nearly always there is some ground to hope that if the present misfortune can be relieved, fate will be kinder in future. One who expects to be better provided in the future will choose to pay a premium for a loan. When the present misfortune is far short of starvation, and is but a certain measure of inconvenience, the same kind of a motive exists, tho in a lesser degree. A loan at such a time, it must be remembered, is but the choice of the least of evils. If the person can not borrow he is tempted to increase his too small present income by converting, pledging, or selling, his control over future income. He may do this at great cost (equivalent to a large discount) by treating the present tangible wealth as if it were income, eating up the seed corn, and neglecting repairs on house and field and tools. Or he may exchange his durative wealth to get a larger present control of enjoyable goods. This, at a forced sale or in an unfavorable market, he can do only at low prices, much lower than must be paid to replace them.2
To one faced with such a choice the pawnbroker with his exacting terms must at the moment appear as a benefactor. He has not created the distress; he appears to offer the best way out of it. A defect of this alternative is that the loan is not made in a true market. There exists no true market for making such loans. The necessitous borrower usually is forced to make an isolated trade where he is in no position to higgle, where he must make the utmost concession to a hard bargainer. Such opportunities attract and develop a class of grasping usurers, “the loan sharks,” who hold the victims of chattel mortgages in a veritable serfdom. The hard bargain is made still harder by other arbitrary and dishonest exactions for renewing the loan. Tho the object pledged may be of little value to others, it often has a personal and sentimental value (as an heirloom or a keepsake) so that the borrower will make great efforts to prevent its forfeiture.
§ 8. The chronic improvident borrower. Another type of necessitous, would-be borrower is the chronic improvident. Not only mental incompetents and drunkards, but many honest families live always near the border of want. It needs no general catastrophe, or no very unusual bodily or industrial accident, to reduce them to distress. Such persons and families, it must be remembered, are always outside of the normal loan market. They are not able to borrow enough to bring their rate of time-preference into uniformity with the market rate of interest. The kind and amount of security (pledges of capital) they have to offer is not acceptable, small loans to them involve such elements of risk and trouble, that ordinarily they can not borrow at perhaps double the prevailing market rate. Within their own economies, therefore, all things are adjusted to a high rate of time-discount. When fortune frowns they too go to the usurer, taking with them the best pledge they can offer. An artist, now successful, tells that he and his wife have a peculiar affection for her engagement ring, because it paid their rent so many times—to the pawn shop at the beginning of each month, and back home again whenever any pictures were sold. Some struggling artists and inventors as well as gamblers and horsemen come to know the pawning value of every belonging—rings, stick-pin, watch, etc. In times of prosperity their saving takes the form of gold ornaments and diamonds (which make good pledges) as they dare not trust themselves to keep money until the time of dire distress. A struggling student of my acquaintance in New York walked twelve miles to exchange a Mexican dollar (his last coin) for forty-four cents with which to buy crackers. A very high rate of premium on present goods was involved in that action. The fact is that even the most improvident and ill-provided families have, involved in their domestic economies, a more or less definite rate of time-preference, and only when the pressure of present desire greatly increases, do they bring their scanty pledges to borrow money as the best way to adjust their incomes in accord with their time-choice.3
§ 9. Premium concealed in retail prices. The borrowing of goods without agreement to pay interest usually involves a premium on present goods. The high rate of time-preference among the chronically improvident is the foundation of the credit system in retail stores. In some cases merchants will not sell cheaper for cash than for credit, for fear of offending their main body of credit customers; but there are good reasons why such a difference should be made, and usually it is made if the buyer for cash quietly urges his proposition. In many stores there are two appreciably different prices, one for “slow pay,” the other for “spot cash.” Some stores specialize on the slow pay customers and sell on the instalment plan, assuring everybody, “Your credit is good here.” If a bill paid at the end of the month is 5 per cent more than what may be called the fair cash price, the difference is equal to 60 per cent per annum on the month’s average expenditure. This much is often paid by perfectly honest persons for the privilege of postponing payment. If a man with an income of $50 a month is always behind a month, and as a result pays 5 per cent premium on his purchases over cash prices, he is losing $2.50 a month, $30 a year, or 60 per cent of one month’s salary, the amount which he is always in debt. Such a premium is paid only by the improvident, but that is a large class with recruits as well from colleges as from factories. Shopkeepers are forced to make this difference to earn the equivalent of interest on the capital thus invested, and to recover the costs of bookkeeping and collections, and the risk and loss of unpaid bills. The high rate paid by the purchaser becomes only a low net rate, on the average, to the shopkeeper. The economical thing for the customer to do would be to retrench expenses rigorously until he “gets $50 ahead” and is able to pay cash. He would be able to use this so as to increase his real income by $30 worth of goods a year; and meantime, and in any case, he could gain $2.08 a month by borrowing $50 at 10 per cent interest (42 cents a month) exorbitant as that rate seems, and paying cash for everything. The obstacle usually is weakness of will power.
The notoriously high retail prices paid by the poor even for cash purchases when made in very small quantities, is a penalty of the same kind for lack of a little capital. They buy a pound of sugar, instead of a dollar’s worth, a bucketful of coal instead of a ton at a time, etc., a practice costly of their own time and of the small shopkeeper’s time who must get higher prices to make a bare living selling in that way. The time-premium outgo from the customer is usually not a corresponding time-premium income to the merchant, but merely pays for services and other store expenses.
Probably we should class as examples of the same type of loans, on a large scale, those made by governments in time of war. If the national territory, or the real or supposed national interests and honor, are threatened, the citizens often value them beyond any possible money-price. To win they are ready to sacrifice their lives, a fortiori they are ready to sacrifice a part of their material fortunes. The immediate need is large supplies to feed soldiers and to arm them with tools to burn, batter, and blow up the enemy. High rates of interest are offered by the government and large obligations are assumed for the future, to tempt its own citizens or those of foreign states to furnish the money to buy these supplies and instruments of destruction.
§ 10. The prodigal borrower. The peculiarity of the prodigal type of consumptive borrower is in the artificial, self-indulgent, subjective character of the desires that impel him to borrow. He has capital, relatively a good deal of it. A prodigal usually is one who has come into his fortune by chance—inheritance, gambling, a lucky stroke of business—and therefore is without discipline in thrift. With a habitual high rate of time-preference, he comes into sudden possession of incomes capitalized at a low rate. He is impatient at the slowness with which the incomes ripen, and he takes measures to hasten them to gratify desires long latent, and now upspringing, often in a favoring atmosphere of flattery, vanity, and false friendship. Sometimes he meets the difficulty by selling some property; or he temporizes and borrows money with a vague hope that some way may be found to retain his property. When interest is 10 per cent, a promise of a hundred dollars a year gives immediate control of a thousand dollars; when 5 per cent, control of two thousand dollars. Lacking business experience he is not likely to find the best form of loan. To secure an immediate loan he lightly agrees to pay an exorbitant rate of interest often made necessary by the prospect of his financial collapse. It is clear that the high rate of interest he pays is but a reflection of a time-valuation that already exists in his mind. The net result of such a course is a transfer of property from the prodigal to others, a wasteful transfer in which often scheming and avaricious men gain unjustly, and often the savings of true abstainers are transformed into riotous living and foolish display.
§ 11. Students and apprentices. We come now to some cases of consumptive loans with a more provident motive, that of increasing the future earning-power of the borrower. A student borrows money to spend for food, clothing, textbooks, tuition, etc., needed while taking a course in college. When he borrows he has little earning-power, but with that faith in himself which makes the young American so interesting, he pictures himself four years later, sheepskin in hand, drawing a munificent salary with which he can easily satisfy the most exacting Shylock. Apprentices, young lawyers waiting for clients, physicians slowly gaining a practice, business men “working up trade,” have enough faith in themselves to borrow meantime what they need to live on. They may be disappointed and suffer loss, but hope supplies their motive in borrowing.4
In this type of consumptive loans we see a very different motive from the former types. The borrower is looking to future needs, not to present indulgence, and the loan is useless for its purpose unless he supplements it with a true abstainer’s spirit, adding his industry, self-denial, and forethought to attain the end of his education. This type of consumptive loan is often economically better than one to spend upon material production.
§ 12. Becoming-owners as borrowers. The fifth type of consumptive borrower, the becoming-owner, has also a provident motive. He borrows not in order to consume more wealth than he otherwise could, but in order to pay for it by a different method, namely, under the interest contract instead of under the renting contract. To do this he borrows the money to buy the agent in use, and becomes its owner. His right is not absolute but is qualified by the equity of the creditor to whom the property is pledged. (Chapter 22, section 3.) This condition might continue without any effort of the borrower to save and thus reduce the debt; but so generally is this kind of loan prompted by motives of thrift and made in anticipation of and as an aid to saving, that such borrowers deserve to be called abstaining users.
Of this type are purchases on credit or on the instalment plan of sewing machines, typewriters, and many other laborsaving machines, not as added means of direct enjoyment (such as are automobiles, canoes, pianos) but as better means of obtaining direct goods without the sale of products. Of this kind also is the loan to build a house for the borrower, or to buy outright anything of a kind already used by him under the renting contract (as a farm considered as a direct good, a house to live in, a source of food for the family, etc.). If one who has been renting house, farm, machine, etc., ceases to rent and buys under the interest contract, he assumes a new responsibility as the legal owner of the wealth, but often he reaps a benefit by the change. The gross rent paid by a tenant (Chapter 15, section 2) must include not only taxes and repairs, but something to cover risk of bad collections, trouble of management, damage through carelessness of tenants, etc. Rent of a good grade of house built for tenants5 is therefore usually 10 per cent of the selling price, and not infrequently higher, being, it is said, as high as 25 per cent on bad tenements where risk, damage, and trouble are especially great. A man living in a $2400 house and paying $20 a month rent, and able to borrow at 6 per cent could buy the house, pay $12 a month interest, and out of the balance of $8, after paying taxes and repairs, have something left as a sinking fund. By saving a few dollars more each month he can, within a few years, become the absolute owner. His pride and pleasure as an owner often leads him to add further to the value of his investment by making improvements in yard and buildings which he would not make as a tenant.
The great capital in the building and loan associations, over a billion and a quarter dollars in 1914, is slowly becoming the absolute property of the borrowing owners, whose places are taken by others thus acquiring homes. This capital, large as it seems, is but a fraction of the amount constantly being acquired in this way by owners of homes mortgaged to savings banks, to corporations (universities, philanthropic endowments, etc.) and to private lenders, directly or through lending agencies.
§ 13. The borrower for profit. The term “productive loan”6 has generally been applied to the borrowing of capital to be used in carrying on of business either mercantile or manufacturing—that is, in buying goods to sell again. The borrower is a middleman whose motive is to get a “profit” by sale to an ultimate user. This type of loan must be more fully discussed in connection with the problem of enterprise and profit, and only the briefest indication of the relation of the interest-rate to capitalization need here be given. The borrower expects to pay the interest out of the surplus income (over and above the capital investment) which the sale of the products will put into his hands. This success in getting a surplus large enough to leave him a balance sufficient to pay interest depends on his investing the money in agents not capitalized too high; any balance of profit depends on his selecting a kind of agents and so directing their use, that he can make them earn more than the market rate of interest.
[1 ]Some reservoirs of small savings in the United States in 1914 are here indicated.
[2 ]Such cases of dire necessity are in primitive communities usually relieved by a neighbor as a friendly duty, without charge, tho the borrower is under moral obligation not only to repay the loan but to render like friendly accommodation if it should be needed. This view long continued to be accepted as ethical, and charging a premium (interest) on loans was condemned by moral and religious codes. The Jews (and not they alone) retained the prohibition of “usury” among themselves, but permitted “usury” from strangers.
[3 ]To serve this class, public pawnshops have been established by the governments of many European cities, and by private benevolence in some cities of America.
[4 ]Especially when such expenditure for self-improvement is directly in industrial lines, as learning a manual trade, or a profession (as dentistry, medicine, engineering, architecture, etc.) there is a temptation to call this “an investment of capital,” or a capitalizing of man’s earning power. But that is merely a figure of speech, tho it is true that the outlay for utilitarian training is made in order to increase the earning power of the learner. But the future incomes can not be capitalized, because man can not sell himself in sum. He can but earn a wage or salary for successive services.
[5 ]This proviso “built for tenants” is significant, for houses built by well-to-do owners for themselves are often so elaborately finished that they are notoriously poor investments when let to tenants.
[6 ]But some of the so-called consumptive loans above are productive in the sense which we recognize. The money borrowed to build a house, to buy a pump to supply water, or a machine to sew cloth, or even an automobile to produce psychic income for the owner, is productive. A clearer distinction can be made between the non-commercial and the commercial nature of the products, between loans by ultimate users of the goods (the occupant of the house, the user of the water from the pump, etc.), and loans by middlemen who produce to sell to ultimate users.