Chap. V: Of the Regulation of Interest by Statute

From the principles deduced the preceding chapter, we have seen how, without the aid of any law, the interest of money, in a trading nation, becomes determined, from natural causes, and from the irresistible effects of competition.

But as there is no country in the world so entirely given to commerce, as not to contain great numbers of people, who are totally unacquainted with it, some regulation with respect to the rate of interest becomes necessary in order to restrain, on one hand, the frenzy of those, who, listening to nothing but the violence of their passions, are willing to procure money at any rate for the gratification of them, let the political consequences of their dissipation prove ever so hurtful to the state; and on the other, to protect those who, from necessity, may be obliged to submit to the heavy oppression of their usurious creditors.

Laws restraining usury, are directly calculated for the sake of those two classes, not engaged in commerce, and indirectly calculated for commerce itself; which otherwise might receive a wound through their sides.

In entering upon the subject mentioned in the title of this chapter, I think we may agree in this, that hitherto all regulations made concerning interest, have been calculated either for bringing it down, or for preventing its rise. The distress which may come upon a state, by its falling too low, is a phaenomenon which has not yet manifested itself in any modern state, by any symptom I can at present recollect.

Now if it be true, as I think it has been proved, that the operations of demand and competition work irresistible effects in determining the rate of interest in commercial states; the statesman who is about to make a regulation, must keep these principles constantly in his eye.

If we examine the writings of those who have treated of this subject with intelligence (among whom, I think, Sir Josiah Child has a right to stand in the foremost rank), we shall find very little attention bestowed upon that most necessary and ruling principle, competition.

He lays it down as an axiom, that low interest is the soul of trade, in which he is certainly right; but he seems to think, that it is in the power of a legislature, by statute, to bring interest down to that level which is most advantageous to trade; and in this I differ from him. I must do him the justice to say, that he no where directly affirms this proposition; but by suggesting none of the inconveniences which may follow upon an arbitrary reduction of interest by statute, he leaves his reader at liberty to suppose, that the lowering of it is solely in the hands of a statesman.

It is very plain, from the history he has given us of the successive rates of interest in England, from 10 to 6 per cent that without the interposition of statutes, such diminutions would not, in that period, have taken place, from the principle of competition: but I am not so clear that, at this time, when trade is so well understood, and credit so generally established in many nations of Europe, that a like administration would work effects equally advantageous.

It is with great diffidence I presume to differ from Child upon this subject; and I find a sensible satisfaction in perceiving that upon the whole, my principles bring me so very near to his sentiments on this matter.

The strong arguments in favour of Child's opinion, are grounded upon facts. He says, that when interest was brought down by statute, 1625, from 10 to 8 per cent instead of producing any bad effect, it had that of bringing it still lower immediately afterwards; and the same thing happened, anno 1650, when it was reduced a second time by statute, from 8 to 6 per cent, at which rate it stood at the time he wrote. These facts I give credit to, and shall now account for them, from the consequences of sudden revolutions.

When a law is made for the reduction of interest, all debtors immediately profit by it. Upon this, the creditors must either submit, or call in their capitals. If they submit, land immediately rises in its value. If they call in their capitals, they must have an outlet for lending them again, beyond the limits of the jurisdiction of the legislature. Now this outlet was not then to be found; because credit was no where well established, except in Holland, where interest was still lower.

They were, therefore, obliged to submit, and thus interest was violently brought down by statute; and a great advantage resulted from it to the commercial interests of England.

The subsequent fall of interest, in the natural way, is thus easily accounted for.

The consequence of lowering the interest, was, that the price of land rose several years in purchase: the landed men, who had long groaned under the heavy interest of 10 per cent finding their lands rise from 12 years' purchase to 15, upon reducing the interest to 8 per cent sold off part of their lands, and cleared themselves. The natural consequence of this was, to make money regorge in the hands of the monied men; to diminish the number of borrowers; and consequently, to bring the rate of interest still lower.

One sudden revolution produces another. When interest is brought down by statute, the price of land must rise by a jerk; and landed men will suddenly profit of the change in their favour. When it falls gently, by a natural revolution in the state of demand, the effects are more insensible; the sharper sighted only profit of it; others, from expectation of a still greater rise in the price of their lands, neglect to sell in the proper point of time; and may perhaps be disappointed from a new fluctuation in favour of money. This is at present actually the case in Great Britain, since the peace of 1762. I write in 1764.

These facts speak strongly in favour of Child's opinion, namely, that it is expedient to have recourse directly to the statute, whenever there is a prospect of advancing the interests of trade by a reduction of interest.

It is impossible to reply to matters of fact: all, therefore, I have to allege in favour of my own opinion, is, that it is more consistent with the very principles in which both Child and I agree; it implies no sudden revolution, and will, in a short time, operate the same effect.

The method of proceeding, according to my principles, is shortly this:

Since it is agreed on all hands, that low interest is the soul of trade, and the firmest basis of public credit; that it rises in proportion to the demand of borrowers, and sinks in proportion as money is made to regorge in the hands of the monied interest;

The statesman should set out by such steps of administration as will discourage borrowing in those who employ their money in prodigality and dissipation, as far as may be consistent with the interest of the lower classes employed in supplying home consumption, according to the principles laid down in the second book. He should abstain from borrowing himself, and even from creating new outlets for money, except from the most cogent motives. By this he will, in a short time, gently reduce the rate of interest. Then by statute he may bring it down a little, but not so very low as the foregoing operations may have reduced it; contenting himself with having farther restricted the extent of the ordinary fluctuations.

As for example: let us suppose interest limited by law to 5 per cent. and that by good management the state may be enabled to borrow easily at 3 per cent. I believe there would result a notable advantage, in reducing the legal rate to 4 per cent and were it brought down to 3 per cent there might follow a very great inconvenience to landed men, in case a war should suddenly occasion a revolution in favour of money.

The difference then between Child and me, is, that I am more scrupulous than he, in introducing restraint into political oeconomy; and my only reason against applying the statute, as he proposes, is for fear of the immediate bad effects which might follow (in many ways impossible to be foreseen) upon a sudden and violent revolution, in a point so excessively delicate as public credit.

In his days, credit was not so well established, nor was it stretched as at present: it was more accustomed to violent shocks, and could bear a rougher treatment. But in order to come the better to a thorough knowledge of this matter, let us examine what might be the consequence, if Great Britain should, at this time, bring down, by statute, the rate of interest below the level of the stocks, which I take to be the best rule for determining the present value of money; and this is also the best method of examining the expediency of Child's method of reducing interest, under the present state of all our political circumstances.