REDUCED INTEREST RATES

Taranaki Daily News, 20 October 1930, Page 9

REDUCED INTEREST RATES

GENERAL MISUNDERSTANDING. PAYMENT FOR USE OF ASSETS. In the latest issue of the summary published by the National Bank of Australasia, the question of interest is discussed as follows; There has been much uninformed talK about reduction of interest rates as a factor in the reduction of production costs. Labour officials have seized, upon the idea, apparently, as a possible alternative to the inevitable reduction of wages. Still, it appears that there is widespread misunderstanding of the position that “interest,” in the everyday use of the term, occupies in the economic structure. It is well known that there are, broadly, three factors which are responsible for all production, viz., land, labour and capital. The wealth produced is distributed between them as wages, rent and interest. Because interest rates on bank overdrafts and certain other forms of borrowing have not been reduced, some people have come to the conclusion that capital generally is not abating its share of the national income, in common with the other factors of production. A little thought will expose the fallacy of this view • . “Interest,” in the economic sense, means the payment to the owner for the use of those assets which constitute “capital.” These take, the form of machinery, tools, buildings and other imple ments of production which so greatly increase the efficiency of labour. Interest, in the economic sense, , therefore, forms a considerable proportion of what is commonly called “rent”- —in so far as “rent” includes a payment for the use of man-made improvements such as buildings, fences and drains. It forms the greater part of tile profits of individuals and firms. Dividends to shareholders in companies are almost entiiely interest on capital. To anyone familiar with business conditions, the fact that rents, profits and dividends, and therefore “interest” in its sense, have already made heavy sacrifices, is self-evident. By far the greater proportion of all interest earned by capital comes under these headings,' as they embrace the return on practically the whole of the country’s privately owned productive assets. The funds available for bank overdrafts are in a different category from capital invested directly in industry. Whereas the latter is permanently sunk in fixed productive assets, and the interest it can earn depends upon the productivity of those assets, bank overdrafts consist largely of “floating”’ capital, the use of which is capable of being “bought” and “sold” like any other commodity. Therefore, it is subject, as regards price (or interest) to the law oi supply and demand, rather than to its actual productivity in use. In volume, bank overdraft funds represent only a small proportion of the whole of the country’s capital, and the interest paid upon them is inconsiderable, relative to all interest earned. Overdraft interest, therefore, is not an important factor in production costs, and a lowering of the rates charged by the banks would p.ovide no appreciable assistance toward reduction of the costs of industry. But the function of bank overdrafts is extremely important. Owing to periodic fluctuations of activity, most industries require more capital at certain timee than at others. If industries required to carry sufficient capital, all the year round, to provide 'for their ‘peak • periods, the interest charge upon nidustry would bs considerably heavier than it is, for funds would be lying idle for Ion" periods in which there would be no profitable use for them. But in actual fact, when one industry requires its maximum of capital, another has sur • plus funds in hand, and by an iugcnic.is but simple system the surplus from one industry is made available to the other through the medium of the banks. law of supply and demand regii, lates interest rates on this “floating capital. When supply falls short of demand, the banks may find it necessary to offer higher rates of interest in order ■to attract the deposit fluids widen they let out on overdraft. Naturally, when this occurs, the borrowers must meet the additional expense. ■ . If the banks were to take notice of tlie agitation for reduction of overdrait interest rates, they would automatically be compelled to reduce the interest they offered to depositors. The action of the banks would not alter the reiutipp of supply and demand. People who wanted to borrow would still be prepared to pay the higher rates, and there would be a distinct tendency among the owners of money to sidestep the banns and lend direct. The banks are a “clearing house” for “floating capital,”., und do the business on such a large scale that even daily fluctuations in their clients’ requirements average themselves out, and the banks are, therefore, able to charge interest on the funds actually I borrowed from day to day. No cheaper method of bringing the supply and demand together could be devised. The economy would be lost if, by tampering with interest rates, the business tended to be done outside the banks, financial agents might gather a harvest of commissions, while borrowers woum De

losing through having to pay interest on loans of fixed amounts, instead of daily balances. A function sometimes overlooked is that of the “risk-taker.” Where capita’ earns unduly high rates of interest, it is usually because of the risk of Joss of capital involved. This is found in such investments as speculative companies and second mortgage loans. Even banks take a certain risk when they arrange overdraft accommodation. They must, therefore, include in their interest rates a charge as an insurance against such losses as are bound to be incurred on their business as a whole.. At a time like the present, when security values are falling, the risk is greater, and this would justify an increase, rather than a decrease, in the rates of overdrafts. Any suggestion that rates on current b >nds and debentures be reduced amounts to breach of faith. In good times money has been invested in such securities at lower rates than it could have earned elsewhere, because the risk was considered negligible, and a continuance of the return was guaranteed even if the return on other forms of capi* I should slump. As a reward for their forbearance, the owners of those finds should now find themselves in the relatively happy position of not sharing in tl- >. losses of interest incurred by capital generally. A special tax on interest would probably have the effect oi inflate." the rates which would require to be offered on note Issues, and live tax w,.uld therefore, in the long run, be paid bv the users, and not by the providers of the money. The tax would, therefore, find its way into production costs.