Value & Capital, CHAPTER XI -- INTEREST

In this first section of Chapter XI, the author, Sir John Hicks, references the discussions of the preceding sections to introduce the concept of a loan transaction, as well as that of interest.  Previously, he had introduced the concept of a "Spot Economy" in which all transactions were made for immediate delivery, as well as that of a "Futures Economy" in which "everything was fixed up in advance" for some considerable amount of lead time.  These concepts were helpful exploring potential sources of disequilibrium in an economy.  In this section he notes that "there is no reason why the two sides of a bargain should be due to be executed at the same date."  Thus we have another kind of transaction -- loan transactions -- where the transaction is divided in time;  one side is executed immediately, and the other at some future date or series of future dates.

Any exchange of this sort is technically a loan, but by far the most common in practice is an exchange of money now for money later.  It is uncommon to exchange goods of one sort now for goods of another sort later, for the same reason that barter is not more common:  the inconvenience of searching for someone who wants exactly the goods you have and can offer you goods that you want in exchange.  Transactions involving goods now for money later, or goods later for money now, occur frequently, but Hicks notes that "they are naturally thought of as reducible to a money loan plus a spot transaction (or a forward transaction)."  To illustrate, he imagines a pure-barter case of exchanging "coffee now for coffee a year hence" and notes that it can be reduced to a spot transaction, a forward transaction, and a money loan.  He then goes into a discussion of how a forward market implicitly determines a rate of interest in terms of whatever commodity is being traded.  Using an example in which the price of coffee for delivery in one year is trading at 3 percent above the spot price, and the interest rate on money is 5 percent, he determines the coffee rate of interest to be 105/103, or approximately 2 percent.  The reasoning is as follows:  a person who wants to "lend coffee for one year" could, in this example, sell the coffee in the spot market, loan the money proceeds at 5 percent, and cover the sale of the coffee by purchasing on the forward market.  To put it another way, a person who has coffee now should be able to obtain an increased amount of coffee in a year (even though the price of coffee is expected to increase) because, in this example, money can grow slightly faster.  Hicks concludes the discussion by noting that the coffee rate of interest will be the same as the money rate of interest only if the forward price of coffee is the same as the spot price (i.e. if the denominator of the fraction above is 100 instead of 103).

After concluding the discussion on commodity rates of interest, Hicks summarizes by saying that these rates of interest are of relatively "little direct importance," just as a rate of exchange between two commodities is of relatively little importance "when neither of the two commodities is the standard of value" (i.e. when neither one is being used as money).  With no further assumptions about the properties of money, then, 

[W]e are entitled to assume that all loans are in money terms; for any loan transaction which takes place otherwise is always capable of being reduced to a money loan combined with a spot transaction and a forward transaction.