This attains the thought of the present value of the estate, or capital sum in it, though the capital sum is thought of as a multiple of the income, instead of the income being calculated as a percentage of the capital value. Now at the rate of "ten years' purchase" an investment of money in land affords an annual interest of ten per cent., as each year the rental is one tenth of the original investment; twelve years' purchase yields eight and one third per cent., twenty years' purchase, five per cent., and twenty-five years' purchase, four per cent. Increase in the number of years' purchase corresponds to a decrease in the rate of interest which the original investment of money, the capital sum, is expected to yield. This is equally true whether the investment be in the legal form of a purchase of the fee-simple of land, or in that of the purchase of a rent-charge. We are brought to this conclusion: that the present value of the rents in perpetuity, of any given wealth, is the capital value of the wealth; and that the reciprocal of the number of years' purchase is the rate of interest that an investment is expected to yield.
Purchase and sale of rent-charges gives way to more modern contracts
4. The sale of rent-charges has gradually given place to the modern form of money loan. The conditions of the contract in the sale of rent-charges were gradually changed for greater convenience. When the purchaser (the lender) was given the right to require repayment of the capital sum at the end of a specified time, the transaction was brought still closer to an ordinary loan. In this form, the sale of rent-charges is still found in southern Germany, but the greater simplicity of the money loan, and of the sale outright, has led to the almost total disuse of the older form of transaction.
The purchase of rent-charges was long looked upon as a very different thing from the loan of money, but to modern eyes it is not, and the old distinctions between the moralities of the two kinds of income appear now mainly quibbles, justified in a slight degree by certain social facts of the time. The rise of industry led to different ideas on the lending of money; the prejudice against it weakened in large classes of the population, especially in Protestant countries, and its use rapidly spread. Not until 1830 did a decision of Rome remove all disapproval on the part of the church. Rent-charges are instructive now as showing the mode in which rents began to be capitalized in earlier centuries.
§ II. CAPITALIZATION INVOLVED IN THE EVALUATING OF INDIRECT AGENTS
The capital value of durable wealth is the sum of its expected rents
1. The buying of any indirect agent is practically the purchasing of a "rent-charge." To account rationally for the market value of anything, its importance must be traced back to "gratification." We have examined and accepted the proposition that if a good is not affording enjoyment at the present moment it is kept because it will yield a rent until it is used. If it is never to afford direct enjoyment, if it is never to mature physically into the class of enjoyable goods, the explanation for its value must be found in the fact that it is capable of yielding a series of rents of enjoyable goods. In the last analysis the value of anything must be found in its power of affording psychic income, a series of psychic rents. Now when such a durable income is bought outright, what is the basis on which its value is estimated? What other than the rents it will afford? Exactly as did the purchasers of a medieval rent-charge, the buyer of the durable wealth pays a definite sum in return for the right to enjoy a series of future rents. As was the case with rent-charges, however, the amount paid will be less than the full matured value of the rents. A long series, even a perpetual series, may be exchanged for no more than ten, twenty, or twenty-five annual rents. While therefore the selling value of the good is the sum of the values of the rents, it evidently is that sum discounted. Immediately, when we have reached this point in the reasoning, our proposition must suggest itself as self-evidently true in this form: the value of any good is the sum of the entire series of rents it contains, discounted, at some rate, to their present worth. What determines the rate of discount is a question that will call later for a fuller explanation.
Capital value is not primary
2. There are two modes of approach to the problem of interest: one from the side of income (rents); the other, from the side of the bearer (capital). The rate of interest expresses a relation between two values, the value of the income and the value of the sum loaned, whether it consists of money or of other wealth expressed in terms of money; But which of these values is primary in a study of the causes of value? Which is the base from which the other is derived by multiplying at the rate expressing their ratio? The answer to this question cannot be a matter of indifference to the economic theorist. Universally heretofore the study of interest has been approached from the side of capital. A capital sum was said to be invested and to earn a certain interest, that is, per cent., of that sum. The usage of speaking of the investment of capital as a sum given, and of "interest on capital" predisposes the mind to this view.
Expected rents are primary, and capital value is the "years' purchase"
But the approach from the side of income has been shown to be in some important cases the historical origin of the rate of interest, and we need but reconsider reasoning that has gone before to see that this is the logical order in all cases. Rent, or income, is a link in the chain of value, connecting gratification or psychic income, consumption goods, rent or usufruct value, and finally capital value. To one keeping in mind the logical cause of value, it becomes inconceivable that capital value could precede income, a view possible only when a fragment of the problem is seen. This being true, the mere mention of a capital sum implies the interest problem, and assumes the interest rate. The capital is of that amount because the anticipated incomes, discounted at some rate, equal that sum. The capital sum is a certain number of years' purchase of the series of rents which can be secured by the use of wealth in various industries. The owner of a number of dollars (or of an amount of other wealth expressed in dollars) has open to him various investments. The value of any wealth is due to the possibility of deriving incomes from it. If, however, the expected income fails to be realized, the capital loses its value, or it is revalued on the basis of the new rents. The investment is then said to be a losing one. Thus, at each stage in the valuation of capital, before it is invested and at every moment thereafter when the valuation is readjusted to the rents realized or expected, rents are logically primary, the source from which the capital sum is derived.
The rate of capitalization of rents is not fixed merely in commerce
3. The capitalization of comparatively safe permanent incomes from real estate contains within itself all the factors for the independent determination of the interest rate, and is not to be explained merely by reference to "the prevailing rate of interest" in other investments. The value of land usually is explained simply as the capitalizing of its rents at "the prevailing rate of interest." The rate is assumed to be fixed by conditions in manufacturing and commerce, and if five per cent, can be gotten there the capitalist would never buy land unless investment in it were made equally attractive. The cause of the rate thus is supposed to rest outside the transaction itself, the exchange of land for other capital seeking investment. The economic student is safe in assuming always that explanations of this sort are fallacious. The cause of value in any one exchange or any one industry is not thus to be juggled and shifted into another industry. It is true that the values of goods are so wonderfully interrelated by substitution that as the price of fresh beef will affect that of salt mackerel, so the capitalization rate of machinery affects that of land; but the influence is not from one side only, it is mutual. When anything has value, it must have in itself an independent cause of value.
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