Lesson 5 of 7
The ground that survived
The later school kept one of the three grounds and built interest on it alone. What that gains in consistency it pays for in what can be tested.
By Javier Sanz
Founder of ValueScreener. Built Ninety Nine, a securities services provider, and sold it to a tier-one global bank; ran operations and internationalization at Alpaca, the brokerage API.
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In one minute
- Mises reduces interest to one thing: the ratio between what a person assigns to satisfying a want sooner and to satisfying it later.
- He rejects the technological ground on the grounds that it reverses the causation. Interest explains why shorter methods are chosen despite lower physical yield, not the other way round.
- The gain is a theory with one cause. The cost is that the cause is never observed directly, and what is observed is a market rate that contains several other things.
Bohm-Bawerk gave three reasons a present good trades above a future one. Mises kept one of them and argued the third was a mistake. That narrowing is what most people now mean by the Austrian theory of interest.
From three grounds to one
Bohm-Bawerk, 1889
- Ground one: circumstances differ between periods.
- Ground two: the future is systematically discounted.
- Ground three: present goods can start longer, more productive methods.
- Interest emerges from all three together.
Mises, 1949
- Time preference is a category of action itself.
- A person acting at all prefers satisfaction sooner, other things equal.
- The technological ground is rejected as circular.
- Originary interest is the resulting ratio, and nothing else.
One cause, stated as a feature of action rather than of technology.
What Mises puts in its place
In chapter XIX of Human Action he defines originary interest as the ratio between the value put on satisfying a want in the near future and the value put on satisfying it in a more remote one. It is not a price charged by anybody. It is a discount that exists because people act, and acting means choosing when as well as what.
He argues it would persist in an economy where technology had stopped improving entirely, as long as goods are scarce and people must choose between sooner and later. That is the test he uses to separate his account from a productivity one.
Why he rejects the third ground
His objection is about the direction of causation. If longer methods really yield more, the question is why anyone ever uses a shorter one, and the answer is that waiting is costly. So the premium on present goods explains the choice of shorter methods, rather than the productivity of longer ones explaining the premium.
He adds a reductio: if interest depended on technical improvement, a fully developed technology would leave no interest at all, which he treats as untenable.
What the narrowing costs
Consistency is bought with testability, and it is worth saying so plainly.
Originary interest is not observable. What is observable is a market rate on some instrument, which on this account contains originary interest plus compensation for the borrower's credit, plus an allowance for expected changes in purchasing power, plus whatever the specific contract carries. Separating the first term from the rest is not something anyone has a method for.
A theory whose central quantity is never measured directly is in the position the first course described. It can be reasoned about and it is hard to check, and the dedicated critique course later in this track takes that up.
Check yourself
How does Mises define originary interest?
- The return on capital employed
- The ratio between the value put on satisfying a want sooner and later
- The market rate on a safe bond
Show the answer
Answer: B.
Chapter XIX of Human Action defines it as a ratio of valuations across time, arising from action itself rather than from any technology or any market.What is his objection to the technological ground?
- That longer methods do not in fact yield more
- That it reverses the causation, since interest is what explains the choice of shorter methods
- That it cannot be measured
Show the answer
Answer: B.
He argues the premium on present goods explains why shorter methods are chosen despite lower yield, and adds that a fully developed technology would otherwise leave no interest at all.What does a quoted market rate contain, on this account?
- Only originary interest
- Originary interest plus credit risk, expected purchasing power changes and contract terms
- Only credit risk and inflation expectations
Show the answer
Answer: B.
The central quantity is not observable on its own. That is a real cost of the narrowing, and this lesson states it rather than working around it.Sources
- Mises, Human Action, 1949, chapter XIX, section 2, on originary interest as a ratio of valuations across time, on why it would persist without technological progress, and on his rejection of the technological ground.
- Bohm-Bawerk, The Positive Theory of Capital, 1889, English translation by Smart, Book V, chapters II to IV, for the three grounds this lesson narrows.
What this leaves out
- This is a heterodox tradition. The mainstream account of the same phenomenon differs, and nothing here is a forecast or a view on any security.
- The 7 percent borrowing is an invented illustration of what a quoted rate contains. It describes no company and no instrument.
- Not everyone inside the tradition accepts the narrowing. The dispute between pure time preference accounts and those keeping a productivity element is live, and this lesson reports Mises's side of it rather than settling it.