2.4 Stock Lent at Interest
Stock lent at interest is always considered to be productive capital by the lender, as he expects that in time it will be returned to him, bot in its original amount and wit hthe addition of interest, which constitutes a rent for the use of it.
The borrower's perspective on the same sum may vary according to his use of it. Virtually all loans are made in the form of money, but what the borrower really wants is the goods he intends to purchase with borrowed money. The borrower may employ it to make improvements to his land or equipment, to purchase materials for prosecution, or to pay his productive workers, in which case it is productive capital. He may use it to purchase goods for his own consumption, in which instance it is treated as if it were present use of his future income. He may even set the borrowed sum aside, though unless he has a purpose to which it will be used, there is little sense in doing so.
It is generally expected that loans are more often taken for production than consumption, and creditors are more happy to extend loans, and to charge for them a lower rate of interest, to individuals whom they believe to intend to put it to productive use, as the employment of funds in such manner gives greater confidence that the borrower will have the means to repay.
(EN: this may have changed somewhat since Smith's time, with the expansion of credit to consumers in contemporary society. Many loans are made to purchase homes or automobiles, and consumer credit is commonplace. And so, it's likely safe to assert that consumer credit is more readily available in the current time - though I expect what Smith ahs to say remains entirely accurate:" that it is lent at a higher rate, and in a far smaller amount than commercial credit in aggregate.)
A loan may be issued in money pieces, or it may be issued in the form of a note redeemable for money. In the latter case, it is not unusual for the note to remain in circulation: the original borrower uses the note to purchase materials, and the recipient of the note may use it as currency himself if he has no need of money, as may the next.
Also, while a loan may be extended for a specific amount of time, there are instances in which a loan is extended indefinitely. So long as the borrower pays the interest on the debt periodically, he retails the amount loaned to him until such time as he wishes to repay the principal amount.
(EN: The latter begins to blur the line between money loaned and money invested. In effect, an indefinite loan is a form of ownership in the business, the interest collected representing the creditor's share of the profits of the business in which he invested. The chief difference being that it is paid in a fixed amount rather than dependent on the actual income of the operation.)
Competition affects creditors in much the same way as it affects the supplier of any good. In a situation in which there are more creditors who seek to lend money than borrowers who seek to take loans, creditors must decrease the interest rate, decreasing their own profit, to make loans. If there are more borrowers than creditors, interest rates rise as a buyer must offer more to obtain credit, which is scarce.
There is some consideration of the influence of the money supply on the interest rate of loans, which with Smith disagrees. He uses the example of the discovery of metals in America, and suggests that the net effect of the abundance of precious metal, like the abundance of any good, was simply decreases its value in trade for other goods - whose cost of labor and material would increase just as much as would their revenue when an abundance of metal causes the prices in the market to rise. Because consumption of goods did not increase, the need to produce goods did not increase, and the demand for loans to finance production does not increase.
Smith touches briefly on the notion of usury laws, which restrict the rate of interest that can be charged for loan of money, or prohibit interest altogether. The result of such laws is to decrease credit available to producers - where they are prevented fro collecting sufficient interest to compensate for their risk, the creditor's choice is not to loan at a lower rate, but to refuse to loan at all. As such, production is decreased, and the welfare of the society is decreased.
Various adjustments have been made to attempt to reach a happy medium, the most successful of which is simply raising the usury rate to well above what would naturally be demanded - which is, in effect, not to penalize usury at all. However, even if the usury law specifies a low rate, creditors and debtors have found various ways to circumvent it - not the least of which is to flatly ignore it and continue lending at what rate they please, lending being a private arrangement between individuals, and the borrower having little incentive to turn in his creditor if he wishes to be extended credit by anyone else.
Finally, the decision to loan money to others at all depends on an individual who has capital to loan, and who has no more productive use to which he wishes to put it himself. In this, Smith draws a parallel to the rent of land: a landlord may hire workers to raise crops and sell them himself in the market, or to forego the additional profit he might earn (and defray the risk of not earning it) by renting the land to another to work.