Fisher's Theory of Interest #3

Fisher makes income central to his theory of capital. The value of capital must be computed from the value of its estimated future net income, not vice-versa. (He isn't clear about which kind of income he means here, but I assume it is money income.)  Income is derived from capital, but it is from capital goods, not the value of capital. The value of capital is derived from the discounted value of income.

The scheme is:  Capital goods ---> Flow of income ---> Income value ---> Capital value.

"It is true that that the wheat crop depends on the land which yields it. But the value of the crop does not depend on the value of the land. On the contrary, the value of the land depends on the expected value of the crops" (The Theory of Interest, p. 15).

Suppose an orchard yields 1000 barrels of apples a year and this annual crop is expected to be worth $5,000 per year. The physical productivity of the orchard does not by itself imply the value of the orchard. It is valued at $100,000 when the annual crop is valued at $5,000 net per year, and the rate of interest is 5 percent. The $100,000 is the discounted value of the expected annual income (The Theory of Interest, p. 54-5).

Fisher regarded that $5,000 as a perpetuity. He could have arrived at the same $100,000 by assuming the orchard could be sold for $100,000 after any number of years. However, that would look like circular reasoning by assuming a future sale value of the orchard itself. Which of the following is a more reasonable assumption? $5,000 per year with no variation forever? $5,000 per year for several years and selling the orchard for $100,000 at the end (which makes the cash flow akin to a bond)? I am inclined toward the latter.

It is clear from this that Fisher's use of "interest" is much broader than explicit interest on a loan or the implied interest rate of a bond. It includes observable market interest rates, but also subjective rates used to discount future values. Observable market interest rates result from market transactions; discount rates used in subjective valuations are not. This dual usage of the term interest is not confined to Fisher. Böhm-Bawerk and other Austrian economists do likewise. Moreover, the more heterogeneous the capital, the more opaque must be subjective discount rates (except possibly to the person doing the discounting).