Guest Post: In A Gold Standard, How Are Interest Rates Set?

Tyler Durden's picture




 

Submitted by Keith Weiner, President of the Gold Standard Institute, USA

In A Gold Standard, How Are Interest Rates Set?

Today, short-term interest rates are set by the diktats of the central bank.  And long-term interest rates are set in a “market” in which the central bank is obliged to keep coming back to buy ever more bonds, and speculators front-run the central banks to buy ahead of them.  The result has been that, for 30 years and counting, the bond price has been rising, which is the same as to say that the rate of interest has been spiraling into the black hole of zero.  When it gets there (and probably sooner) the entire monetary system will collapse.

This is the terminal stage of the disease of irredeemable paper currency.  They have banished money (gold) from the monetary system, and the result is a positive-feedback-loop that destabilizes the rate of interest.  The rate of interest has a propensity to fall, just like the value of the paper currency itself.

This leads to the question of how interest rates are set by a free market under a gold standard.  This is a non-trivial question, and the answer is profoundly important as we debate what sort of role gold ought to play and evaluate the various gold standards being proposed.

If people are free to own gold coins directly, then the mechanics of setting the rate of interest are simple.  Let’s define a term.  The marginal saver is the saver who could go either way, either holding a bond or a gold coin.  If the rate of interest ticks downward, he will sell the bond (or withdraw his money from the bank, thus forcing the bank to sell the bond) and buy the gold coin.  He would rather hold the gold than commit to the time and risk for such a low interest rate.  If the rate of interest ticks upward, he will buy the bond (or deposit his coin in the bank).

The marginal saver sets the floor under the rate of interest.  It cannot fall below his preference or else he will vote with his gold.  His preference has real teeth (unlike today).

Now let’s define one more term.  The marginal entrepreneur is the entrepreneur whose rate of profit is the lowest possible, while still being viable.  If his profit falls for any reason, such as due to a rise in costs, he will shut down his enterprise.  One cost is the cost of capital, i.e. the rate of interest.  No entrepreneur can borrow at a rate higher than his rate of profit, and the marginal entrepreneur is the first to buy the bond and sell his capital stock at an uptick in the rate of interest.  He is the first to sell a bond and buy capital stock at a downtick in the rate.

The marginal entrepreneur sets the ceiling over the rate of interest.  It cannot rise above his ability to pay, or else he will vote with his capital stock.  He also has teeth.

Under a proper gold standard, the rate of interest is kept in a band that is not only narrow, but which is also stable over long periods of time.  This is the principle virtue of the gold standard.  It does not fix the level of prices, which would be neither possible nor desirable.  It keeps the rate of interest consistent, which serves the interests of wage earners, pensioners, and other savers, and of entrepreneurs whose work provides the goods, services, jobs, and interest payments that on which everyone else depends (and which they take for granted).

When evaluating any proposed gold standard, one should ask the question: how will it determine the rate of interest?

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Wed, 06/06/2012 - 16:53 | 2500928 achmachat
achmachat's picture

But wouldn't that put the bernank out of a job?

Wed, 06/06/2012 - 17:02 | 2500968 SilverTree
SilverTree's picture

Ol'Ben won't survive the paradigm shift.

Wed, 06/06/2012 - 17:30 | 2501103 metastar
metastar's picture

One less tick sucking blood from the people.

Wed, 06/06/2012 - 17:33 | 2501117 dlmaniac
dlmaniac's picture

It'd put all these socialists outta business who rely on the monetary scam to finance their agendas.

Wed, 06/06/2012 - 18:09 | 2501228 Pinto Currency
Pinto Currency's picture

 

First, "gold standards" don't work because they are always abused.

A gold money system does work where gold, and only gold, is money. 

Saving money (i.e. gold) without yield occurs where gold is brought to a savings repository and the gold is stored for a fee paid by the saver - it is not lent out and is safer than gold invested for yield.  This money system is gently deflationary so gold will generally buy more in one year than presently giving an incentive to save.

Generating a return in a gold money system occurs when money is deposited with a lending institution in return for a yield that covers the utility of the money as well as providing a risk premium for potential loss.  The marginal interest rate is determined by the amouint of money (gold) available for lending.  If little is available, the interest rate (cost of borrowing) rises until enough savings are drawn to the lending institutions to meet the need.  If excess gold money is available for lending the interest rate drops until the supply is utilized and balances with supply.

There is no "lender of last resort" or "final sucker" to cover gambling risk by financial institutions.

Wed, 06/06/2012 - 17:22 | 2501075 Imminent Collapse
Imminent Collapse's picture

Good to see SnorgTee ad is back.  Vamp me up, baby!

Wed, 06/06/2012 - 19:52 | 2501505 harmonymonkey
harmonymonkey's picture

Yeah, I was jonesing - please everyone, throw in a few extra clicks.   Withdrawal's a bitch, and it's really unnecessary!!

Wed, 06/06/2012 - 17:26 | 2501088 Peter Pan
Peter Pan's picture

People fail to appreciate that holding gold is the equivalent of being your own central bank. Anything else is a lie with a limited time frame.

Wed, 06/06/2012 - 17:37 | 2501137 flacon
flacon's picture

The world "Central" (like the word "Collective") gives me the willies.... but as long as one is Central to themselves and a collective-of-one I have no objection. We call that Individualism. ;) 

Wed, 06/06/2012 - 20:33 | 2501621 disabledvet
disabledvet's picture

More than likely he'd just "follow the gold to New York" and start operating out of those digs. Probably get a nice raise, too.

Thu, 06/07/2012 - 03:52 | 2502553 cranky-old-geezer
cranky-old-geezer's picture

 

 

But wouldn't that put the bernank out of a job?

No, because a gold standard is meaningless.  He could still print currency just like now.

The only possible sort of gold standard any central banker would remotely consider these days would be a non-redeemable gold standard.

If the currency isn't redeemable for gold, then a gold standard is meaningless.

Redeemability is the only thing that counts.  It's the only thing that limits their ability to run the presses.

But then it's not a gold standard.  Gold is money and currency is merely a claim check on gold ...exactly what US currency was before the Fed came along issuing their new FRN "currency", taking US currency out of circulation.

A non-redeemable "gold standard" is just another scam to fool the public into thinking the currency has some intrinsic value.  It does nothing to limit central bankers' ability to run the presses and debase the currency.

But then everything government does these days is a scam to fool the public. 

Wed, 06/06/2012 - 16:54 | 2500934 Motley Fool
Motley Fool's picture

10/10 for being able to copy-paste. >.>

Wed, 06/06/2012 - 17:28 | 2501095 NotApplicable
NotApplicable's picture

I think you're on the wrong website.

Wed, 06/06/2012 - 17:34 | 2501122 Motley Fool
Motley Fool's picture

Because I pointed out that this is blatant plagiarism without acknowledgment?

 

w/e

Wed, 06/06/2012 - 18:12 | 2501239 NotApplicable
NotApplicable's picture

You did no such thing.

Citation, please?

Wed, 06/06/2012 - 18:41 | 2501297 NotApplicable
NotApplicable's picture

LOL, okay, you really got me there. *rolls eyes*

I just never considered one person working on his PhD under another to be a "plagarizing" of their ideas. While the terms and ideas are all Fekete's, it still isn't C&P (I checked).

I give you a +1 for actually knowing of Fekete, as you're likely the only motley fool that does.

Wed, 06/06/2012 - 18:45 | 2501303 Motley Fool
Motley Fool's picture

hehe, I also quickly checked up and came to the same conclusion.

 

You are right, I am likely alone in that regard, also likely in the regard of being the only fool top understand his work, and where he made mistakes - not many.  Haha.

Wed, 06/06/2012 - 19:16 | 2501392 NotApplicable
NotApplicable's picture

Curious, do you consider his mistakes to be the same as those who assail him over at Mises.org?

Someday I'd love to mediate a discussion between them (I found Fekete shortly after Mises and didn't yet realize the gap between their belief systems). IMO, the Mises folks mischaracterize his arguments on real bills, being much akin to the usury arguments in this thread where they are afraid of a nebulous evil that goes against their stated dogma.

Thu, 06/07/2012 - 01:09 | 2502344 Motley Fool
Motley Fool's picture

Nah, I'm not a fan of puerile dogmatic arguments. Fekete does a lot to extend Mises's work, those mischaracterizations notwithstanding.

 

His most blatant mistakes lie in idealism.

Wed, 06/06/2012 - 18:42 | 2501299 Motley Fool
Motley Fool's picture

Hmm. A quick bit of research shows him to be a student of Fekete. Still curious that there is no acknowledgment, but this does mean he likely gave permission.

Wed, 06/06/2012 - 16:57 | 2500935 Pladizow
Pladizow's picture

"An invasion of armies can be resisted but not an idea whose time has come." - Victor Hugo
 

"Of all the contrivances for cheating the laboring classes, none has been more effective than that which deludes them with paper money." - Daniel Webster

"Paper money has had the effect in your state that it will ever have, to ruin commerce, oppress the honest, and open the door to every species of fraud and injustice." - George Washington 1787
 

Wed, 06/06/2012 - 17:06 | 2500986 Pbn2Au
Pbn2Au's picture

@Plad +1

'Tis interesting that most all the founding statesmen decried what passes for policy today; while today's 'statesmen' embrace what the founders abhorred.  History indicates we need new statesmen.  Said another way, the 'cranks' of today may have their names on monuments of tomorrow.

Wed, 06/06/2012 - 18:57 | 2501318 Revert_Back_to_...
Revert_Back_to_1792_Act's picture

They weren't cranks!!! ARGH!

It is possible to discern truth.

Consider that the Dollar was on a Silver Standard for 172 years.  With one brief departure in 1853 that raised a huge public outcry (see the old book at bottom of this post for more), the dollar was always redeemable for a set weight of silver and that weight of silver was always worth one dollar.  The Eagle was the unit of measurement and standard for the gold coin- not the dollar.  An Eagle was worth! ten dollars of silver! (and could be reminted at differing weights)

Consdier that we departed from this with the coinage act of 1965 - just two years after Kennedy was assassinated.

Consider what has happened to the USA since that time.  In just 1971 this happened.

http://www.youtube.com/watch?v=iRzr1QU6K1o

Consider if you put away $100.00 of 1964 90 percent silver coin and $100.00 of 1964 paper money.  What would the coin be worth now?  How about the paper money?

The coin would be worth 4218.82 (melt value) in modern paper dollars as of today. @ you could have kept that investment all that time at zero counter party risk except for burglars. 

Now think about that pile of $100 of paper money.  That would just about buy you a single nice dinner or night out on the town. 

Which would you rather have saved?

If government went away, which would you rather have?

In 1900 when we still had gold eagles in circulation, we made and exported 50 percent of the worlds goods and there was NO income tax on labour.

take a look around at the USA NOW!

In fact, a silver or gold coin from any defunct and long gone government still retains its full value today. 

Here is a coin calculator to verify what I said above. 

http://www.coinflation.com/coin_calculators.html

Read these speeches;

http://avalon.law.yale.edu/18th_century/bank-tj.asp

http://avalon.law.yale.edu/19th_century/ajveto01.asp

http://www.afn.org/~govern/mcfadden_speech_1932.html

and this old book

http://archive.org/details/coinsfinancialsc00harvrich

If you can argue with their logic, then go ahead and try.

Bad Coinage laws, Departing from our Constitution, and not understanding the wisdom of our fathers has serious consequences.

Here are a few more quotes about paper money.

http://www.fame.org/NotableQuotes.asp

Study history!

 

Wed, 06/06/2012 - 16:56 | 2500940 ParkAveFlasher
ParkAveFlasher's picture

Correct me if I am wrong but linking a currency to any decentralized, non-plutocratized, non-manipulated thing, whatsoever, means market mechanisms determine all prices and costs including those that drive interest rates.

Wed, 06/06/2012 - 17:10 | 2501016 CPL
CPL's picture

You are completely correct.  Laws of supply and demand exists in everything.  iPads are great example, $20 cost basis but the market can bare $800 for something as disposable as tissue and just as well managed.  The market determines these as infinite for some appearent reason because in true cost the iPad is in the business of following the true rate of inflation otherwise it goes out of business, because it is attacked from it's cost center.

 

Of course the motives of iPads differ from a Physical commodity like Oil which is superior in it's return in terms of EROIE and ROI.  We can live without iPads, but neither we or iPads can live without Oil in this day and age.

 

However both are also great examples of a broken financial model disconnected from physical reality.  Both enjoy some weird religious dogma in the users of both items.  The users believe infinite resources exists when the numbers point a illusionary situation that is so far from the truth it borders on delusional neurotic behavior en masse.

 

Wed, 06/06/2012 - 17:29 | 2501098 kito
kito's picture

holy crap!! what a thought!! a decentalized free market actually setting its own interest rates!!! sonofabitch!! actually trusting the marketplace to do its job!!!! 

Wed, 06/06/2012 - 20:37 | 2501634 disabledvet
disabledvet's picture

ah, "trust but verify." i wouldn't trust them either. In New England there was a "slight problem" of the "guy upstream building a dam" which "caused the downstream guy to lose all river power." there was no free market solution to this problem...but there was a Judicial one!

Wed, 06/06/2012 - 16:56 | 2500942 DoChenRollingBearing
DoChenRollingBearing's picture

Yes to gold!

No to a gold standard!

 

fofoa.blogspot.com

Wed, 06/06/2012 - 17:08 | 2500999 NotApplicable
NotApplicable's picture

You know, it really isn't worth it to get all hung up on a single word with an infinite number of definitions. All you're doing is playing into the hands of the Keynesians who used it as a tool to undermine the defacto standard created by using gold as a currency.

To add yet another word, when you criticize the "Gold Standard," you're really criticizing the "Gold-Exchange Standard" (the proper name for the tool).

To state that there should be no standard for a unit of measurement is nonsensical. (As is the idea of "Freegold" needing Euros to exist.)

Wed, 06/06/2012 - 17:14 | 2501039 CPL
CPL's picture

I thought the "Freegold" idea is the ECB were just going to loot the shit out of the Europeans and any vault they can rip from the walls if in reach (Yacht's, Private planes, hidden scooby doo painting safe) under the guise of banking?

 

That's how it historically goes.

Wed, 06/06/2012 - 17:22 | 2501072 NotApplicable
NotApplicable's picture

That looks like the plan to me.

Wed, 06/06/2012 - 17:31 | 2501112 dlmaniac
dlmaniac's picture

FOFOA is a fool thinking a floating standard allowing bankers to issue currencies is a viable solution.

Thu, 06/07/2012 - 02:21 | 2502465 Maos Dog
Maos Dog's picture

The point is that under freegold you can always vote with your feet and easily convert all of your fiat holdings to gold when fiat does get out of control, which will cause the value of fiat to drop and bring the system back into some kind of equilibrium. 

Thu, 06/07/2012 - 14:25 | 2504770 dlmaniac
dlmaniac's picture

We already are able to vote with our feet right now at least here in ZH. Freegold is not addressing the root cause to our problems now. The same banker/politician crooks would still be printing phony paper in FOFOA's system to disrupt the economy, and therefore have every bit of the same motive to rig the price as now. So why do you claim these guys will give you an honest gold price under free gold? 

It won't happen!! They will suppress it from left to right just like today. You guys are making hollow promises.

Wed, 06/06/2012 - 18:15 | 2501145 dlmaniac
dlmaniac's picture

We are in Freegold RIGHT NOW. What people like FOFOA are reluctant to admit is that bankers would still have every bit of the same motifs to suppress the gold price for the privlledge to loot the public under his Freegold system. Expecting bankers to come up with a fair gold system is therefore naive at best.

Wed, 06/06/2012 - 18:37 | 2501288 lasvegaspersona
lasvegaspersona's picture

Maniac
So you read what? It is not FOFOA you are quoting.

Wed, 06/06/2012 - 18:48 | 2501310 NotApplicable
NotApplicable's picture

One word: Euros.

FOFOA lost me the instant that he called me an ignorant westerner for not understanding that "Euros are periodically marked to gold, so it can't hyperinflate, so we're all good."

It's nothing more than dividing the monetary system into good and bad money. Yet, for some reason, they believe they can repeal Gresham's Law.

Personally, I think Another was a Rothschildish Psy-op, pretending to let us in on a big secret, while really just creating the next trap to be sprung.

Wed, 06/06/2012 - 18:58 | 2501341 dlmaniac
dlmaniac's picture

FOFOA once claimed that it's ok for a currency to slowly depreciate as if it's good for economy. That's like saying it's fine for thieves to steal your money as long as they don't make it a spree. He unfortunately makes far less sense than his followers make him look like once you really bother to read what he says.

Wed, 06/06/2012 - 19:07 | 2501361 Motley Fool
Motley Fool's picture

There is a difference between saying something is good, and accepting something as inevitable and making the best of a bad situation.

 

You seem to be confusing wishfull thinking for reality.

Wed, 06/06/2012 - 21:05 | 2501731 dlmaniac
dlmaniac's picture

If you accept that as reality then the reality is FreeGold will only end up being what we have right now AKA another doomed to fail monetary experiment, which contradicts what FOFOA claims to be the cure for the current issues. 

We have seen it through. You guys are still in denial.

Wed, 06/06/2012 - 19:06 | 2501354 Motley Fool
Motley Fool's picture

Haha, you gave up reading due to a bruised ego? lol

"Yet, for some reason, they believe they can repeal Gresham's Law."

No. FreeGold uses Gresham's law, it does not suspend it.

 

Wed, 06/06/2012 - 19:21 | 2501408 NotApplicable
NotApplicable's picture

No, I gave up because there is no point in engaging childish people who resort to such tactics. Especially when they consider their argument to be intellectually superior. The battle of ideas is one thing, egos are another.

Thu, 06/07/2012 - 01:20 | 2502353 Motley Fool
Motley Fool's picture

Hmm. Have you considered that perhaps the argument is intellectually superior? :P

 

One armchair economist to another, I suggest you consider the ideas and stop interacting based on your need to validate your ego.

 

Some thoughts on Gresham's law : http://fofoa.blogspot.com/2009/09/greshams-ghost.html

 

"Gresham's Law states that bad money drives good money out of circulation."

 

Freegold in a (one) nutshell : gold - good  money, fiat - bad money. We spend bad money into the economy and hoard the good money; while both monies are freely exchangable at a floating rate of exchange.

Wed, 06/06/2012 - 23:20 | 2502094 LowProfile
LowProfile's picture

Well, then you thought wrong.

FREEGOLD is gold trading free of any taxation or derivatives.

What the hell, let's do it with silver too.

Wed, 06/06/2012 - 17:00 | 2500957 LawsofPhysics
LawsofPhysics's picture

in short, there is a very real cost for creting capital, especially if you don't create any real value.  If the monetary system and "money" being used do not hold people accountable with real consequences for BAD behavior, the all paper burns, period.

Oh yeah, prosecute the fraud and hold the Fed and all CBs accountable!  We either do that, or they will kill us.  History is very clear about that.

Wed, 06/06/2012 - 17:09 | 2501010 NotApplicable
NotApplicable's picture

Prosecution is one of the main sources of the fraud. In short, we're dead.

Wed, 06/06/2012 - 17:20 | 2501064 CPL
CPL's picture

Well let's hope the dark ages doesn't last as long as last time.  When it all goes down, I'm opening a hand powered print shop. 

 

Zero hedge can be delivered via horse back on strong bond hemp paper thirty years in the future by my children's children...unless something magic pops up in a year in battery technology and miniture nuclear plants, go long gold, silver, horses.

Thu, 06/07/2012 - 10:57 | 2503763 EFNuttin
EFNuttin's picture

If you haven't seen "miniature nuclear plants" you should check out thorium fueled reactors. For a variety of reasons, they have not become commercially viable yet, but they have enormous potential. The first one was running in Oak Ridge, Tennessee around 1962. From what I have read, the decision was made to focus on uranium reactors because they would provide the plutonium needed for making nuclear weapons as a useful byproduct. Thorium and it's byproducts are nowhere near as dangerous as plUtonium. It also doesn't require a lot of shielding and is of no use to bomb makers of any stripe. Thorium fueled plants could be scattered throughout cities with the attendant preservation of higher electrical efficiency that comes from using fewer transformers and fewer miles of electric power lines. If you check YouTube, India is experimenting with thorium-based power.
Any ZH'er out there know why thorium has not caught on?

Wed, 06/06/2012 - 17:02 | 2500966 CvlDobd
CvlDobd's picture

Interesting article.

FWIW. I don't give a shit what te hypothetical rate of some future bond is. I will NEVER deposit my gold with a bank.

EVER!

Do NOT follow this link or you will be banned from the site!