almost all investments are subject to more or less risk, and the sum received under the denomination of interest must include two elements, one the actual hire for the money, and the other as a premium of insurance on the risk, and just as this risk is greater, so must the premium be higher. Interest will be found to be exactly analogous to rent or hire described in Chapter IV., § 32. It was there seen that the rent or hire of any article comprised two elements, one the profits of the capital invested in it, the other to replace the deterioration or wear and tear of the article itself. Now, bad debts and losses in trade may be considered as the deterioration or wear and tear of capital. And the sum paid for the use of money in a particular employment must, in a similar way, comprehend one element for the simple profits, and the other sufficient to cover the usual losses and risks of that mode of investment. If one business is more hazardous than another, it is quite clear that no capitalist will lend his capital to that employment unless he receives in the long run enough, not only to give the profits of capital, but also to cover the losses and replace the wear and tear, or deterioration, of capital. Hence, the rate of interest will always rise in proportion to the risk of the security, and hence there must always be in the same country, and at the same time, a different market rate of interest for every investment of a different degree of security, just as there is always a different rate of hire or rent for articles of different degrees of perishability. But these different rates will always rise and fall together.

37. We may look at the question in another light. Lending out money at interest may be regarded as the purchase of an annuity, to last for a longer or a shorter period, according to the agreement of the parties. Hence, in purchasing such an annuity, the price of it has to be considered just in the same way as the price of anything else. Now, it is quite evident that the value of the annuity must, in a great measure, depend upon its certainty of being paid, or upon its security; and if there be one species of security more certain than another, it is quite clear that the former is a service of greater intensity than the latter, and must be paid for accordingly. Thus, we may say, that a person who offers to take money at interest wants to sell an annuity to the lender of money, and just in proportion as the security he can offer

is good, so will he get a higher price for it; so that the interest of money paid by the borrower will be just in proportion to the risk run. Thus, money may be lent to merchants, to landowners, or to government. Now, merchants are always subject to unforeseen disasters, not only from their own speculations, which may turn out unfortunate, but they are usually so involved with others that they are always liable to suffer from the faults or misfortunes of others; consequently there is always some risk in lending them money. The owner of land is exempt from many of the risks a merchant is exposed to; he is not generally involved with others in his business, but his prosperity is based upon the land itself, and, as long as that is judiciously managed, it gives forth a sure increase, unless under the effects of some temporary dispensation of Providence. Consequently the security for the payment of an annuity based upon the increase of the earth is far greater than one which is liable to the casualties of commerce. A considerably higher price, therefore, will generally be given for an annuity whose security depends upon land than upon commerce, that is, a landowner can usually borrow on cheaper terms than a trader. The Government of this country, again, is considered to be more secure than either land or commerce; consequently, by the same rule, an annuity purchased from the Government should usually cost more than either of the two former ones. And this exactly corresponds with the fact; the interest obtained by investing money in the funds is usually lower than what is obtained either from mortgage on land or on mercantile security.

We may, therefore, consider that the price paid for the use of the money always includes these two elements, one of which is the fair earnings of the money itself, and the other is the insurance to cover the risk of the loan to the lender. Each of these varies at different times, according to the particular person to whom the money is lent, and the total effect will vary accordingly, and it is sometimes not easy to discriminate the effects due to each separate cause.

These, then, are the circumstances which determine the relative market rates of interest on different species of security in any country at the same time. If the rates of interest be observed at any particular time, the difference arises solely from the difference in the estimated safety of the species of security. And it will also be found, that if the rates in the same species of security

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vary, it is because there is more danger than usual in the particular security offered by an individual. Thus, in the species of security offered by Governments, which are usually called funds, the price of an annuity of £3 a year from the English Government is seldom much under £100, while no one would give more than £30 or £35 for a similar one from the dishonest and bankrupt Government of Spain. That is, the English Government can borrow money at little more than three per cent., while the Spanish Government can scarcely do so at nine. The same may be said in a greater or less degree of every one of the European Governments, and the prices of annuities to be paid by them vary exactly in proportion to the supposed honesty or capacity of each to fulfil its agreements. It is universally true, that the value of the different kinds of annuities at the same time, and in the same market, will vary exactly in proportion to the estimated security of each. But this is by no means the case, if the observation be made at different times, because the value of money itself changes from time to time, like that of any other commodity, and accordingly the price paid for its use will vary according to that value, so that the interest received from the most secure species of investment at one time, may exceed that usually paid for the least secure species at another time, and this difference in value will be caused by an alteration in the relation of supply and demand, in accordance with the general principles that govern price. Thus, when commerce, is stagnant, or there is a superabundance of money that cannot find employment, the competition for lending it increases, and the power of the borrower increases over each lender. On the other hand, when commerce is active, there are more persons who wish to borrow, and, of course, the price will rise in proportion to the increase in the demand, and this will cause a rise in the market rate of all securities.

When this general change takes place in the market rate of interest, it by no means implies that the securities are more dangerous at one period than another, but only that money itself has risen in value, and the different species of securities will preserve the same relative differences as before.

A fall in the rate of interest is so far from proving the safety of the security that it will frequently be found to be worst, when interest has been much depressed below the usual rate. Because

when that happens all sorts of wild schemes and speculations are set afloat, partly on account of the undue facility of obtaining capital, and partly because when interest is so much depressed there are so many persons who live upon the interest of their money who become so distressed by the diminution of their incomes, they are tempted to embark in all sorts of hazardous schemes which promise a better profit. All the great commercial crises of late years have been preceded by a continued and unusual depression in the rate of interest. On the other hand, when it rises much higher than usual it puts a stop to a great deal of legitimate business in a manner that is very injurious to the country. It is clearly, then, most for the public advantage that the interest of money should neither be so low as to tempt persons to embark in dangerous speculations, nor so high as to impede real and useful industry.

38. The expression, Value of Money, being applied to the purchase of two distinct species of articles in commerce, namely, the ratio which a given quantity of money bears to a given quantity of commodities, and also to the price of debts, which is measured by the discount, has given rise to some considerations of a somewhat subtle nature, which we must endeavour to unravel. We have shewn that the rate of interest, or discount, depends upon the quantity of debts offered for sale, compared to the quantity of capital to buy them with, just in the same way as the exchangeable relations of money and commodities are found to be influenced. It might appear therefore at first, that a great increase in the quantity of the precious metals which leads to a diminution of the value of money with respect to one of these articles of commerce, should also necessarily lead to a diminution of the value of money with respect to the other. That is to say, for instance, if the value of money were so diminished with respect to commodities, that it required double the quantity of bullion to purchase any given commodities, that the rate of interest or discount ought to fall to one half. And conversely, that if there was such an increase of capital that the value of money diminished so much in purchasing debts, that the rate of interest, or discount, fell to one half, that therefore the quantity of bullion necessary to purchase commodities should be doubled. It would: appear that such an idea that the value of money should diminish

to one half with respect to commodities and remain the same with respect to discount, was paradoxical, and self-contradictory.

Accordingly Adam Smith says1 that several eminent writers have maintained that the increase of the quantity of gold and silver in consequence of the discovery of the South American mines was the real cause of the lowering of the rate of interest through the greater part of Europe. Those metals, they say, having become of less value (i. e., of less purchasing power with respect to commodities) themselves, the use of any particular portion of them became of less value too, and consequently the price which should be paid for it. Adam Smith says "The following very short and plain argument, however, may serve to explain more distinctly the fallacy which seems to have misled those gentlemen. Before the discovery of the Spanish West Indies, ten per cent. seems to have been the common rate of interest through the greater part of Europe. It has since that time in different countries sunk to six, five, four, and three per cent. Let us suppose that in every particular country, the value of silver has sunk precisely in the same proportion, and that in those countries, for example, where interest has been reduced from ten to five per cent. the same quantity of silver can now purchase just half the quantity of goods which it could have purchased before. This supposition will not, I believe, be found any where agreeable to the truth, but it is the most favorable to the opinion which we are going to examine, and even upon this supposition it is utterly impossible that the lowering of the value of silver could have the smallest tendency to lower the rate of interest. If a hundred pounds are in those countries now of no more value than fifty pounds were then, ten pounds must now be of no more value than five pounds were then. Whatever were the causes which lowered the value of the capital, the same must necessarily have lowered that of the interest, and exactly in the same proportion. The proportion between the value of the capital and that of the interest must have remained the same though the rate had never been altered. By altering the rate, on the contrary, the proportion between those two values is necessarily altered. If a hundred pounds are worth now no more than fifty were then, five pounds can be worth no more than two pounds ten shillings were then. By reducing the rate of interest, therefore, from ten to five per cent. we give for the use of a capital which is

Wealth of Nations, B. II., ch. 4.