3. A rise of real interest rates (i.r.s) destroys part of the real value of existing capital, in increasing measure of its putative longevity. [1] This is an economic loss, a loss that is just as real as physical destruction. The cash flow from durable capital will, after a rise of i.r.s, be divided more in favor of interest, less in favor of Capital Consumption Allowances (CCAs). The appropriate accounting adjustment on the asset side is called "marking to market value." The loss of value occurs whether or not it is formally recognized on the books.
The basic mathematics of finance is available, and is quite precise and consistent.
Conversely, a fall of real i.r.s adds to the real value of existing capital, having the same effect as creating capital.
[Both those effects are muted by countervailing effects on ground rents and land prices. See point #9, below.]
IMPLICATIONS.
A. The response to a shortness of available (soft) capital is economically to destroy part of durable (hard) capital. This raises the possibility of a macro-economic "glitch," (a perverse episode of harmful "positive feedback," often called a "vicious spiral.") This effect, variously described and with varying emphases, has been noted by Ricardo, Jevons, BÃ ¶hm-Bawerk, Wicksell, Spiethoff, Hayek, and others. Ricardo's Chapter 1, "On Value," and Chapter 31, "On Machinery," are good introductions. They are nominally well-known, and at the same time treated as non-existent: a feat of compartment-mindedness we find in too much economic writing. As Lionel Robbins points out, micro theory after 1870 became one of acapitalistic production. [2] Capital theory simply disappears from the picture. [3]
4. The property tax rate on capital items affects their value just as would a rise in the (real) i.r. of the same percentage. A rise in the rate thus destroys existing real capital; a fall in the rate creates real capital.
5. A rise in i.r.s lowers market prices of land by a much larger factor than it lowers prices of existing capital, because the value of land derives from more remote future prospects, overall. Land prices, accordingly, are hypersensitive to i.r.s. [4] [ "I.r.s" is used here to subsume all the conditions of availability of both loans and equity funds.] Thus land loans are a most undesirable basis for demand deposits. This was recognized by the English Bubble Act of the early 18th Century, and then alternately forgotten and rediscovered with each succeeding episode of land boom and bust.
6. Changes in the market price of land, when caused by inverse changes in i.r.s, do not represent changes in social wealth. In this respect they differ from changes in the market price, or Discounted Cash Flow (DCF), of depreciable capital. Many potentially useful analyses of our subject are deeply flawed by failure to hew to this difference. [5]
Land prices are also sensitive to changes in expected growth rates of net income, both real and inflationary. These changes, likewise, do not represent changes in social wealth.
The third major factor determining land prices is the current net income (cash or service flow). This may rise for purely distributive causes, e.g. a fall of the interest charge on financing a new building. ( This is separate from the cap rate applied to the net income of land to find the selling price. Land prices are doubly sensitive to the i.r. for this reason alone.) A fall in wage rates may also raise the residual land rent. These changes, again, do not represent changes in social wealth.
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