The Wealth of Nations · Chapter
Of Stock Lent at Interest explained
Smith explains that stock lent at interest is considered a capital by the lender, who expects repayment with interest.
What happens
Smith explains that stock lent at interest is considered a capital by the lender, who expects repayment with interest. The borrower may use it productively (as capital) or consumptively (as revenue), but productive use is far more common. The quantity of loanable stock is determined not by the amount of money but by the portion of annual produce destined for replacement of capital that owners do not wish to employ themselves. As capitals increase, competition reduces profits and interest rates. Smith refutes the notion that the discovery of the Spanish West Indies lowered interest rates by increasing gold and silver, arguing instead that the real cause is the increase of capital and consequent fall in profits.
Themes in this chapter
Wealth and Money
Smith distinguishes between money as a medium of exchange and the real capital it represents, emphasizing that the quantity of loanable stock depends on the annual produce, not the amount of coin or paper.
Self-Interest and the Invisible Hand
Smith argues that self-interest leads lenders to prefer productive borrowers over prodigal ones, and that competition among capitals naturally reduces profits and interest rates.
Characters to notice
- John Locke
Mentioned as one of the writers who mistakenly attributed the lowering of interest rates to the increase of gold and silver from the Spanish West Indies.
- David Hume
Cited as having fully exposed the fallacy that the increase of gold and silver caused the lowering of interest rates.
Key passages
“The stock which is lent at interest is always considered as a capital by the lender. He expects that in due time it is to be restored to him, and that in the meantime the borrower is to pay him a certain annual rent for the use of it.”
When someone lends money at interest, they view it as an investment (capital) and expect both repayment and an annual fee (interest) for its use.
Smith defines the fundamental nature of lending at interest.
“As capitals increase in any country, the profits which can be made by employing them necessarily diminish. It becomes gradually more and more difficult to find within the country a profitable method of employing any new capital.”
As the total amount of capital in a nation grows, it becomes harder to find profitable ways to invest new capital, which reduces the rate of profit.
Smith explains the mechanism by which capital accumulation leads to falling profits and interest rates.
“Mr. Locke, Mr. Law, and Mr. Montesquieu, as well as many other writers, seem to have imagined that the increase of the quantity of gold and silver, in consequence of the discovery of the Spanish West Indies, was the real cause of the lowering of the rate of interest through the greater part of Europe.”
Locke, Law, Montesquieu, and others mistakenly thought that the influx of gold and silver from the Americas caused interest rates to fall across Europe.
Smith identifies and critiques a common contemporary theory about interest rates.