Time Will Run Back

by Henry Hazlitt

  Peter blew careful smoke rings as he tried to think this out. “Time-preference! That’s a very interesting phrase.”

  “Patelli,” Adams continued, “argues that we prefer a cup of coffee today to a cup of coffee tomorrow; or one tomorrow to one a year from now; or one a year from now to one a century from now. Suppose, for example, you had no other means of sustenance, and you were asked to give up a crust of bread today on the absolute assurance that you would get in return two or even three crusts of bread a week from today, would you make the exchange?”

  “All that doesn’t necessarily mean,” replied Peter, “that I value present goods more than future goods. It may merely mean that I prefer to eat when I am hungry and drink when I am thirsty. Or it may merely mean that I prefer to spread my consumption out evenly over time. If I had seven rolls of bread to last me for a week, I’d eat only one a day.”

  “Patelli,” continued Adams, “argues that we always tend to underestimate our future needs and to overestimate our future supplies.”

  “Perhaps something like that does happen,” conceded Peter. “You know, I’ve just thought of an interesting comparison between the way we look at time and the way we look at distance. When you stand on a railroad track and look along the track and along the line of telegraph poles beside the track, you now that as a matter of fact each railroad tie is the same width as all the others and each telegraph pole the same height as all the others. Nevertheless, to your eye and to a camera, each tie seems narrower and each telegraph pole shorter than the one in front of it, and the last pole that you can see is reduced to a mere point in space. This is what’s known as perspective. Now perhaps Patelli is right. Perhaps we value things, if I may put it that way, in a sort of diminishing time-perspective just as we see them in a diminishing space-perspective. In other words, the further away a thing is, in either time or space, the smaller it looks to us. Now your telegraph poles, as you look at them, diminish to form a definite triangle. And in the same way a perpetual series of equal added outputs of yards of woolen cloth, or a perpetual series of approximately equal crops from a piece of land, tend, as we look forward into the future, to diminish in value to our mind’s eye year by year so that they form, not an infinite value but a sort of measurable triangle of value, like the triangle formed by telegraph poles in perspective. And perhaps that is why we put only a finite value on the machine or only a finite value on the piece of land.”

  “And we arrive at the same sort of result if we look at the matter the other way round,” added Adams. “If people estimated future goods as highly as present goods, then you ought to be obliged to pay ioo goldgrams for the privilege of receiving 5 gold-grams a year for twenty years. But I have been in touch with a friend of mine who has set up an insurance business, and he tells me that as a matter of fact I can buy the right to receive 5 gold-grams a year for twenty years for only 62.30 goldgrams.”

  “Because the current rate of interest is 5 per cent,” said Peter.

  “But that is only another way of stating the same thing,” persisted Adams. “If people valued future goods as much as present goods, you ought to have to pay an infinite sum for the right to receive 5 goldgrams a year perpetually. But as a matter of fact you can buy that right for only 100 goldgrams. Or let’s clinch the matter by leaving out annual interest payments altogether. I asked my insurance friend how much I would have to pay now for the right to receive 100 goldgrams ten years from now. He tells me that I can buy that right for only 61.39 goldgrams. In other words, 100 goldgrams ten years from today is worth only as much as 61.39 goldgrams today. I also found out that 100 gold-grams twenty years from today is worth only 37.69 goldgrams—”

  “Just a minute!” Peter took out a pen and wrote some figures on a pad. “Ah, just as I suspected, Adams. At a prevailing interest rate of 5 per cent, a man for 100 goldgrams can buy a twenty-year bond that not only pays him 5 goldgrams a year but returns his entire 100 goldgrams at the end of the twenty years. So he actually buys 200 future goldgrams for* 100 present goldgrams. Now your insurance friend tells you that the present value of your 5 goldgrams a year for twenty years is 62.30 goldgrams. And he tells you that the present value of your 100 goldgrams at the end of twenty years is 37.69 goldgrams. Now if you add these you get a total present value of 99.99 goldgrams.”

  “And if you throw in the extra figures beyond the decimal points you get a total present value of 100 goldgrams,” agreed Adams. “So everything totals up correctly.... But you interrupted me in the reinforcing point I was about to make. Here are the figures: 100 goldgrams ten years from now have a present value of 61.39 goldgrams; twenty years from now they have a present value of 37.69; thirty years from now a present value of 23.14; forty years from now a present value of 14.20; fifty years from now a present value of 8.72—”

  “Which proves?”

  “Which bears out your illustration, chief, of the telegraph poles, your phrase about time-perspective; which shows that, other things equal, goods have a constantly diminishing value as they are remote in time.”

  Peter lit another cigarette. He smoked it in silence almost down to the end.

  “I can’t seem to make up my mind just now,” he said at last. “I can’t decide whether time-preference causes the interest rate, or whether the interest rate is caused by the anticipated marginal productivity of capital which in turn causes what Patelli calls time-preference.”

  “But the diminishing value of 100 goldgrams over time—?”

  “Doesn’t necessarily prove anything about causation, Adams. To say that 100 goldgrams fifty years from now is worth only 8.72 goldgrams today is merely another way of saying that 8.72 goldgrams invested at 5 per cent compound interest today would increase to 100 goldgrams at the end of fifty years.... Maybe the two theories can be reconciled, Adams.... Maybe they are supplementary. Maybe the marginal productivity of capital goods is one cause of the payment of interest, and time-preference is another, just as the value of gold, for example, is partly determined by its industrial and ornamental uses and partly determined by its use as a medium of exchange.... We haven’t time now to straighten out the whole business.”

  “Perhaps we don’t even need to, chief.”

  “What we are certain of, Adams, is this. Relatively few people would bother to save capital at all if they could get no interest for it, and still fewer would consent to let saved capital go out of their hands without the compensation of interest. And we do know that borrowers voluntarily pay interest and even bid against each other to raise interest rates. For if interest rates are less than borrowers are actually willing to pay, there develops what is called a shortage of funds. This can only be corrected by an increase in interest rates which will cause some people to be willing to lend more and others to want to borrow less. In short, we don’t necessarily have to know why people are willing to pay interest any more than we need to know why they are willing to pay high prices for whisky or gold or diamonds—”

  “—or bad paintings.”

  “Or bad paintings. People’s desires and tastes and valuations are what they are, and they seek to gratify them. And it isn’t for us, as bureaucrats, to say that their tastes are misdirected, because posterity may conclude that it was we who preferred the bad paintings to the good ones.”

  “In other words,” said Adams, trying to sum up, “market values are the composite result of the valuations of individuals. Just as prices are fixed by the market, so are wages; and just as wages are fixed by the market, so are interest rates. And just as consumers are willing to pay for consumption goods anything up to the amount that the addition of these goods adds to their satisfactions, so producers are willing to pay for labor and capital anything up to the amount that a further increment of labor or capital promises to add to their profits.”

  “I couldn’t have said it better myself,” said Peter, grinning. “But now let’s see some of the implications of all this. It means that if we forbid the payment of interest rates by law
, or set a legal maximum interest rate lower than a free market would set, we are certain to reduce the volume of savings, certain to prevent loans from going into the most productive channels, and certain to reduce seriously the volume of lending. And this is only another way of saying that we will discourage the accumulation of capital, which in turn is only another way of saying that we will put fewer tools, or poorer quality tools, in the hands of each worker, so reducing his productivity and wages and reducing the productivity of all Freeworld below what it would otherwise have been. For it is above all the accumulation of capital, the increase in the quantity and quality of the tools of production, that determines the wealth and income of the whole society.”

  “All right, chief. I’m completely convinced. Let’s have free interest rates. But I still have some questions about other aspects of our new system—”

  “Not today, you don’t,” said Peter good-naturedly. “It’s after six. And tonight’s my night for practicing by myself. I’ve discovered another wonderful bourgeois composer, Adams. Name of Chopin. I can’t begin to describe to you the intricacy, subtlety, delicacy and tenderness of his music. I need him, especially tonight. And I’d appreciate your company. If you want to come up and just sit and listen, you’re invited.”

  Chapter 37

  I’M still not reconciled, chief,” began Adams the next day, “to the unfair and unreasonable profits that some of these enterprisers are making. This creates great discontent—”

  “Among those who haven’t made the profits?”

  “Yes. And it doesn’t seem to me that such exorbitant profits are necessary to make your free market system work. Enterprisers should be content with a reasonable profit, and it seems to me that we ought to have a law fixing a reasonable profit, a fair profit.”

  “What is a reasonable loss, Adams—a fair loss?”

  “A ‘fair’ loss? Such a phrase is meaningless, chief.”

  “Not any more than a ‘reasonable profit,’ a ‘fair profit.’”

  “But surely—”

  “Let’s see what an enterpriser is, Adams, and what function he performs. The enterpriser is the man who decides whether a new business shall be started, or whether an old business shall be contracted or expanded, or whether to turn from making one product to another. The enterprisers are the men who decide what shall be made, and how much of it, and by what method. There could be no more crucial function in any economy.”

  “Isn’t it dangerous for any single group of private individuals to have such enormous power?”

  “In the first place, they don’t have the power. Let me amend my previous statement. The enterprisers are the men who seem to decide what shall be made, and how much of it, and by what method. Under our new system the real decisions are made by the whole body of consumers. The enterprisers merely try to guess what the wants and preferences of the consumers are going to be. The consumers are the real bosses. If the enterpriser guesses correctly what the wants and preferences of consumers are going to be, if he correctly guesses that too much of one thing is being or is going to be made and too little of another, in relation to these wants and preferences, or if he knows how to make the wanted thing cheaper and better than his competitors, he makes a profit. If his guesses are wrong, or if he is less efficient or competent than his competitors, he suffers a loss. In short, the enterpriser is the man who takes the risk.”

  “You mean he is a sort of gambler?”

  “If you want to call him that, Adams. I prefer to call him the risk-bearer.”

  “But the promoter is also a risk-bearer. So is the speculator.”

  “True. The speculator, the promoter, the enterpriser, are various types of risk-bearer. But there is a vital difference, as I see it, between these and the gambler. The gambler deliberately invents his own risks. He doesn’t have to lose money simply because one horse can run faster than another. His risks are artificial. But in economic life the risks already exist; they exist necessarily; somebody has to bear them. The speculator, the promoter and the enterpriser undertake that function.”

  “But why, chief, do the risks exist necessarily?”

  “Because, if we look at the matter from the consumption end, nobody knows precisely what consumers are going to want, or what they are going to want most and what least, or what they are going to be willing to pay. And if we look at the matter from the production end, nobody knows, in farming, what the growing weather is going to be, or the amount of crop damage from storms or pests, or precisely where the storms or pests will strike. And in manufacturing, nobody knows, until it has been tried, whether a new method or a new machine will actually be more economical than an old one. Uncertainty regarding the future inevitably exists in human affairs, particularly in economic affairs. And somebody has to bear it.”

  “Why can’t the government bear it?”

  “That’s exactly the system that broke down, Adams. Bureaucrats tried to get around the consumption half of the problem by not bothering to find out what the consumers really wanted, by not permitting them freedom of choice, but by forcing them to take what the government chose to produce. And when it came to the production half of the problem the bureaucrats didn’t have to be as careful as the private enterpriser in estimating their relative chances of profit and loss, because they weren’t risking their own capital. They could simply throw their losses on the whole community.”

  “But don’t these private enterprisers ever make mistakes?”

  “They do; but there is a crucial difference. First of all, the losses caused by their mistakes fall primarily on the enterprisers themselves. And because they know this in advance, because they have the hope of big profits on the one hand and the fear of big losses on the other, they usually estimate very carefully before they go into a new venture. Therefore their mistakes are incomparably smaller and fewer than those of government bureaucrats. In addition to this, Adams, there is a relentless process of selection and weeding out going on all the time. If the enterpriser’s ventures are good, he can use his profits from them for still bigger ventures; if his ventures are bad, his losses prevent him from undertaking new ones.”

  “And what is the test of whether his ventures are good or bad?”

  “The test is whether he has been better able to foresee and satisfy the needs of consumers than his competitors have been able to foresee and satisfy them.”

  “But don’t wage earners and the owners of capital, chief, also take risks? Don’t they suffer from the mistakes of the incompetent enterprisers?”

  “Yes, and they also gain from the foresight or ingenuity of the good enterprisers. But it is because the enterprisers assume the primary risks that wage earners and those who lend capital at interest are able to minimize their own risks.... Let’s see how this works out. A man decides to launch a new enterprise. He goes to the owners of capital to raise funds, and if he gets the funds, he has to pay the market rate of interest. He rents a factory and has to pay the market rent. He hires workers and has to pay the rate of wages established by the market. Or perhaps he has to pay more than the previous market rate in order to bid capital and labor away from his competitors—”

  “Then it isn’t necessarily the owner of capital who hires and ‘exploits’ workers?”

  “No, Adams. That is just another Marxist error. It is the enterpriser who hires both labor and capital. In so far as the enterpriser puts some of his own capital into the business, he becomes both an enterpriser and a capitalist. But...”

  He paused, trying to think his way through the next point.

  “But what, chief?”

  “Well, all enterprisers, Adams, have to pay the same market prices for the same quantity and quality of money capital, factory and office space, raw materials, labor services, and so on. These prices are formed by the competition of the enterprisers against each other, just as the prices of consumer goods are formed, finally, by the competitive bids of the consumers. And it is the prices of consumption goods that deter
mine how high the enterprisers are willing to bid, and can afford to bid, for labor services, money capital and production goods. Each enterpriser, therefore, when competition forces him to do so, is willing to bid for the factors of production a total price equal to the price that he could get from consumers for what he produces—”

  “With some allowance for the sheer labor and headache of being an enterpriser!”

  “With some allowance for that, of course. But such an allowance would be the imputed value of his managerial labor, which would really be a sort of wage or salary, and not part of what we might call his pure profit.”

  “Go on.”

  “Well, in order that an individual enterpriser may make a profit, Adams, the total income that he can get from the sale of his finished product must be greater than the total income he lays out in paying for the factors of production.”

  “Obviously.”

  “But the competition of enterprisers in keeping up the prices of the factors of production means that in order for an individual enterpriser to make a profit, he must have better foresight than his competitors in meeting the wants of consumers. If he has only average foresight he makes neither a profit nor a loss. And if he has worse than average foresight he makes a loss.”

  “What do you think would happen, chief, if all enterprisers had perfect foresight?”

  “If everybody had perfect foresight no one would make either a profit or a loss. Mutual competition would force up wages, machinery, and raw material prices to the point where the total would just equal the total that everybody got for his finished product.”

  “And what happens under present conditions, chief?”

  “Under present conditions, as I have already pointed out, those enterprisers with the most foresight make the biggest profits. Those enterprisers with less than average foresight pay for their errors with losses.”