How to Stop Fiat Currencies from Neutering Savers

Arbitrary Interest Rates

Interest rates in an irredeemable currency are arbitrary.

Price moves in the opposite direction to changes in quantity of a good brought to market. [But] money is different from a real good such as beef.

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 in the opposite direction to changes in quantity of a good brought to market.

Money is different from a real good such as beef.

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 endlessly to 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 us nothing. In our example, the rancher who sold 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.

This discussion is not about the value of money (To 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 a 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 also 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 me 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.

This is an iron law, in a free market. However, we don’t have a free market. We have a regime of irredeemable paper currency. We are forced to keep our books using the irredeemable dollar. We must pay tax if we trade our gold at a higher price in dollars than we bought it for. We borrow and lend in dollars. This regime is so pernicious, that even those who prefer gold get angry when the price of the metal goes down in dollar terms—in terms of the not-money dollar which these folks hate.

Let’s look at that a moment. Why does the price of gold matter? Let’s leave aside the fun and profit of speculating for dollar gains. And also the brainwashing, which has convinced everyone that the dollar is the unit of measure. The answer is simple.

Nearly everyone has dollar debt.

We owe dollars. It is therefore a risk to own an asset which can go down in dollar terms. When the market value of your asset drops relative to the fixed value of your debt, you are moving one step closer towards bankruptcy.

We owe dollars. It is therefore a risk to own an asset which can go down in dollar terms. When the market value of your asset drops relative to the fixed value of your debt, you are moving one step closer towards bankruptcy.

It used to be illegal to own gold. President Roosevelt criminalized it as part of his process of breaking the gold standard. Three decades later, President Nixon finished off the gold standard. After that, gold no longer had any role in the monetary system. A long-forgotten relic, it was legalized again in 1975. Gold no longer mattered. Our monetary masters could ignore it, as hoarding gold, like hoarding cans of tuna fish, is cumbersome and involves considerable friction. Not to mention price risk.

In light of our discussion about interest rates, we can say definitively that hoarding gold coin today is not a good alternative to lending for most people, if the interest rate is too low. Before 1933, holding gold coin had no price risk. It was a choice of gold coin or gold-redeemable bond. Today, the gold coin has price risk, and so is a not a comparable alternative to the irredeemable dollar bond. Indeed, those who own gold are doing so in a belief that the dollar is going down (which many mistakenly call gold going up).

Looking beyond price risk, we see that gold is no alternative to lending at too-low interest. The reason is that the dollar is a closed-loop system. Dollars do not come into the system, nor leave the system in ordinary transactions.

Consider a simple example. Joe buys gold from Mary, because he doesn’t like the interest rate. OK, fine, by buying gold Joe avoids lending too low. However, Mary in selling gold is buying dollars. She inherits the interest rate dilemma from Joe, when she gets his dollars. The dollars are trapped. They remain in the credit system. If Joe buys gold (or anything else), it results in nothing more than changing the name on the banking system record of the dollar deposit.

In a free market, by contrast, one does not buy gold. One sells the bond and receives the gold coin, which is the money. This pushes the price of the bond down. The interest rate is a strict mathematical inverse of the bond price, a see-saw. In his time preference, the saver causes the interest rate to tick up.

Depriving Savers of Choice

In the regime of irredeemable paper, by contrast, one does buy gold. Which means one sells the dollar. The price of the bond in dollars is not affected. The transaction affects the price of the dollar, but not the interest rate.

At the heart of it, the regime of irredeemable currency deprives savers of the choice of whether to lend or to opt out. Everyone who owns a dollar owns the credit instrument of the Federal Reserve. A dollar bill says “Federal Reserve Note” on it. It’s the Fed to whom you are granting credit. It is not a positive thing, an entity that you own. It is a negative relationship, where an entity owes you.

The nature of this relationship, that someone owes you, does not change if you deposit the dollars in a bank. You do not have dollars in a bank. The bank owes you dollars. Which it will use to buy bonds, thus the bond issuer owes the bank. Or instead of depositing the dollars in a bank, you could buy the bond directly. Then the bond issuer owes you. In all cases, a dollar is a relationship between creditor and debtor.

This is the full meaning, nature, and consequences of the regime of irredeemable paper currency. The conservative investor (especially if leverage is used) must buy bonds, because of the risk of a price drop in gold. The price of gold could fall more than the interest rate deficiency. In a day.

The dollars are trapped in the system, like cattle in a pen. Even if the owner of a dollar deposit gets out, the dollars remain. And thus the saver is disenfranchised. He may be unhappy with the interest rate, but he cannot affect it.

The dollars are trapped in the system, like cattle in a pen. Even if the owner of a dollar deposit gets out, the dollars remain. And thus the saver is disenfranchised. He may be unhappy with the interest rate, but he cannot affect it. If the price of beef goes up too much, he can affect it by not buying beef. Under the gold standard, if the price of the bond goes up too much or the interest rate falls too much, he can affect it by not buying the bond.

In irredeemable currency, the saver has been de-toothed.

If you want proof, look at the negative interest rates that occur in Switzerland and other countries. No other theory can satisfactorily explain how this could happen and why. The study of aggregates by comparing interest to consumer price index is unsatisfactory. My proof is simple. Above, I asked a question, “would you lend me your gold at 0% interest?” No one answered by saying “well, sure, if consumer prices are falling.” Unless a saver is paid sufficient compensation for the time (not to mention risk), he will keep his gold.

However, in irredeemable currency, he has no choice but to lend his dollars, francs, euros, pounds, etc. In software jargon, this is not a bug but a feature.

The bottom line is that concerns about U.S. government risk, fretting about the enormity of the debt, fears about inflation, etc., do not motivate the saver to withdraw his savings, do not drive the saver to sell the bond and take his money home. He cannot withdraw his savings—the currency is irredeemable, which means not withdrawable. He cannot take his money home—there is no money in the monetary system. He could buy gold, if the price risk suits him, but this is nothing more than swapping places with the former owner of the gold.

The interest rate is totally unhinged. It can go up, obviously it did from 1947 to 1981. But not by the mechanism of a free market as is assumed to be the case today. It can go down. Obviously it went down, 1981 through present (not counting the current correction).

However, whatever may be driving the current little upward trend, it is not savers becoming tired of too-low rates. Whether the trend changes after 37 years or not, that change will not be driven by quantity of dollars, consumer prices, the magnitude of the debt problem, etc. The driver since 1981 has been interest rates exceeding marginal productivity

The dollar is failing. Millions of people can see at least some of the major signs, such as the collapse of interest rates, the record-high number of people not counted in the workforce, and debt rising from already-unrepayable levels at an accelerating rate.

Why I Wish to Gold-Cure the Dollar Cancer

I am going to share a little bit about myself and my personal motivation. I want to help fix this problem. The alternative, if it’s not fixed, will be a repeat not of 2008 or the inflation of the 1970’s or 1929. It will be a repeat of 476AD—the collapse of Rome and the known world.

If it weren’t for this, I would have started another software company. I had a successful exit, a world-class team that was ready to jump into the next gig with me, great advisors, and access to capital. And this was the career for which I had trained, and at which I was pretty good.

Instead, I studied monetary economics and started Monetary Metals.

We are on a mission. It is not simply to sell people on gold. When Rome collapsed, people who had gold may have had a better chance to escape than those who didn’t. But where would they go, and how would they survive in a world gone mad? Some problems, gold does not solve.

It is not simply to preach that we need the gold standard. If Mises did not persuade people, then we don’t expect to be successful at the same task.

We think often about that (in)famous quote from archenemy John Maynard Keynes about debauching the currency to overthrow the capitalist order. And the key sentence is:

“The process engages all the hidden forces of economic law on the side of destruction, and does it in a manner which not one man in a million is able to diagnose.”

He was right. He understood how to destroy the system better than everyone else. He was a genius—evil perhaps, but a genius. Except he overestimated the number of people who could diagnose the monetary disease.

The key is to engage the hidden forces of economics, though not for destruction but for salvation. The key is to make it profitable to invest in the gold standard.

So the key is to engage the hidden forces of economics, though not for destruction but for salvation. The key is to make it profitable to invest in the gold standard.

In this talk at the Harvard Club in New York, I discuss more openly than I ever have before what Monetary Metals is doing, and why we are doing it. What is our vision, and how does it work?

We are in Keynes’ “long run.” We have achieved his goal of euthanizing the rentier (killing the saver) with near-zero interest rates. If his plan is not reversed, we are dead.

Monetary Metals is trying to reverse it.

See also:

Interest Rate Stability: The Primary Virtue of the Gold Standard

Does the Fed Print Money? Or Just Create Credit?

Will the Greatest Scam of All Time Ever Come to Light?

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About the Author: Keith Weiner

Keith Weiner is president of the Gold Standard Institute USA in Phoenix, AZ, and CEO of precious metals fund manager Monetary Metals. He created DiamondWare, a technology company that he sold to Nortel Networks in 2008. He speaks and writes about free markets, money, credit, and gold.