Irredeemable Currency De-Tooths Savers – Gold And Silver Report

Arbitrary Interest Rates

In the past few weeks, we have argued that interest rates will not rise. We have made our arguments based on observable cases of soft credit demand that falls with rising rates, and analysis of the incentives on creditors and debtors. Ours is a case that rates can’t go up much, for long, because demand for credit won’t chase rates up. In the postwar period up to 1981, borrowers chased rates all the way up the moon. But not since then.

Now, we want to make a theoretical argument that rates in an irredeemable currency are arbitrary (we promise to return to the topic of capital destruction soon).

Consider a real good such as beef. If a disease suddenly strikes down 20% of the cattle, this will reduce the supply of beef. Assuming all else is equal, the price of beef will rise. Perhaps substantially—there is not necessarily a linear relationship between the 20% reduction in supply and the price. The price could go up 2%, 20%, or 200%.

We can be confident that the price will go up. That’s how the market determines which former beef-eaters will become chicken-eaters. The marginal beef eaters.

Conversely, if beef somehow becomes more abundant—say if China began to subsidize cattle ranching by the thousands of square miles (using borrowed dollars, no doubt), then the price of beef would drop. So we can say, without much controversy, that ceteris paribus price moves the opposite to changes in quantity of a good brought to market.

Money is different from a real good such as beef.

As we have said many times, money is not consumed in a transaction (technically, beef is consumed shortly after the transaction). So there is no reason that comes out of quantity theory to explain why the same money cannot be used to endlessly bid up beef prices to infinity.

There is a reason, of course. We say “of course” because it does not happen. One needs to study the individual to discover this reason, as quantity tells you nothing. In our example, the rancher who sold you the beef is the one in possession of the money. He has no reason to bid up the price of cattle—more likely he will buy the feed and other inputs to raise more cows to bring them to market, and push down the price.

We are not, today, discussing the value of money (we will only reiterate here it is not 1/P where P is the price level, and it is not 1/N where N is the number of units or quantity). Our purpose in discussing cattle is to establish some ideas that we will use in our discussion of the interest rate. And what is the interest rate?

Interest is the price to use someone else’s money.

A Free Interest Rate Market

Let’s first look at a free market. A free market is when people can choose what money to hold, what money to set prices in, what money to use as unit of account for their books, and what money to lend and to borrow. It means there is no central bank, no lender of last resort, no bailouts or bail-ins or deposit insurance or other moral hazards. It means no irredeemable currency. It means the absence of force, and the respect for the rights of property and contract. In a free market, people use gold.

A free market means that people are free to pursue their interests, and express their preferences. There are two critical preferences that affect the rate of interest. One is the time preference of the saver. Think about this for yourself. Would you lend us your gold at 0% interest (our recent deal priced at 2.75%)? Of course not! Everyone has a time preference. If interest is below time preference, people will just keep their money.

The other preference affecting interest is the preference of the entrepreneur to make a profit. If he can earn 10% on capital, then how much is he willing to pay to borrow it? Whatever the number, it must permit him to make money for himself. It must be under 10%.

Lending occurs only if interest > time preference. Borrowing occurs only if interest < productivity.