An interfering government is the only barrier to any revival of a capitalist society. In a free market, market price signals communicate and reveal the subjective valuations of all market participants, including time preference toward present goods over future goods. Market price signals represent scarcity and important information, such as market interest rates, and are relied on to direct factors of production and provide incentives to save. “[There] are powerful objections to any plausible policy […] which largely assumes that markets handle the task of allocating financial assets [and providing financial stability] better than central bankers or regulators can” (Carmichael and Esho in Bell, 2004).[1] In fact, in a mixed economy, it is now found necessary to indirectly alter interest rates to find additional policy stimulus. This, however, distorts market price signals in the market for loanable funds in a similar fashion to the effect price controls have in markets for capital goods and services. Presenting challenges to overcome interest malalignments, which frustrate entrepreneurial calculations. Attempts will be made to analyse the extent of interference, in particular credit expansion. Considering the costs of not accounting for market price distortions, as such misdirected resources and periods of inflation and deflation, to prevent malinvestment and misguided monetary policy decisions.
The theoretical problem of interest focuses absolutely on causes of interest. (Böhm-Bawerk, 1890) While, attention should not be too long fixed on individual theories. Firstly, the productivity theory explains interest as arising from capital that is productive. Therefore, it is not necessary nor sufficient to explain interest as itself from divorcing prices and time value, and assigning value to productivity assumes a zero rate of interest as is offset by depreciation. The pure time preference theory, states interest is ones time preference for present goods over future goods. However, even though it considers time, it too divorces itself from the ‘equivalency valuation’, that is, monetary prices. Both disregard, the uncertainty of the future, functions of money, and the heterogeneity of capital goods. As the money unit ascribes itself to the compensated assurance of discounted future goods and the premium on present goods.
Ludwig von Mises termed the valuation ‘originary interest’ to explain time value being the ratio of value given to the present want satisfaction over value given to future want satisfaction, and ‘gross market interest rate’ to explain equivalent value.[2] Neither a suitable definition, is abstinence to temporally preferring an end sooner rather than later. (French, et. al., 2011). The abstinence theory assumes interest is accumulated from abstaining from present consumption and is the reward for future consumption, however, this theory is absolute from the uncertainty of the future. A final theory to be considered is the liquidity theory, in which money is supplied and demanded for its liquid quality and this determines the interest rate, as rewarding those that part with liquidity for a period of time. Where its employment of equivalency value isolates the function of money as a means to reduce risk amid future uncertainty.
Social and political arguments concern the justness, fairness, and usefulness of whether interest should be attached to capital, abolished, retained, or modified. (Böhm-Bawerk, 1890) However, the radical and numerous schemes to lower or abolish interest by means of a banking reform have been teased, as a zero originary interest rate implies no action always being pushed into ones infinite future period of provision, and a negative originary interest rate implies one could undo action. Though, not rejected or refuted, in fact, it is now found necessary to find additional policy stimulus through cutting the gross market interest rate lower to the point of a zero gross market interest rate. Now, lenders/savers receive no discount of future goods relative to lending/saving present goods.
Alternatively, another option is to move gross market interest rates into negative territories, of which the liquidity theory supports as a means to reduce risk, where lenders/savers pay a premium on future goods. Consequently, charging banks to hold reserves increases risky lending, and depositors withdraw cash to prevent losses. To prevent losing capital one resists lending/saving. Instead of calling in loans to make up for the loss in depositor’s cash, government policies can increase the cost of holding money through taxation or inflation. Charging an exchange ratio between a dollar of bank deposits and a dollar of currency.
The inflation rate is a measure of the increase in asset prices, measuring the percentage change in the average price level from the previous year. Where a positive inflation rate means rising prices, a negative inflation rate means falling prices, and a declining positive inflation rate means rising prices at a slow rate. Central banks effectively try to increase the spending of market participants, on grounds it would push up economic activity and increase inflation.
Resorting to credit expansion through quantitative easing policy, is tempting to inflate away debt and raise seigniorage revenues. (Bassetto & Messer, 2013) A worst case scenario is hyperinflation, see figure one, consistent with the quantity theory of money it shows credit expansion maxes out asset prices, therefore, halting credit expansion, and bond interest elevates as government debt defaults. To prevent miss-calculation investors compute for inflation increases in prices using the real interest rate, “[the] return to saving and the cost of borrowing after adjustment for inflation.” (Mankiw, 2010)
Figure one Money and Prices During Four Hyperinflations
Source: (Mankiw, 2015).
“[Deflationary policy can be adopted, and has been for the past hundred years by governments to destroy paper money, as long as it does not begin to burden the treasury or upset special interests,] to raise, after a prolonged period of inflationary policy, the national monetary unit to its previous metallic parity.” (Mises, 1949) As a unit of capital’s purchasing power consist of all capital goods prices, purchasing power is lower where less money chases goods and higher where more money chases goods. Met with animosity, capital contraction increases interest rates along with capital purchasing power, while deflating prices and crowding out private investment spending. Savers earn more, though increases loan repayment amounts and default numbers. “[The difficult trade-off is it] appears to want to slow credit growth and thereby cool the property sector, but is confronted by a hostile government keen not to upset the mortgage belt.” (Bell, 2004).
In particular, special parties can argue that expansionary monetary policy can encourage employments in certain industries, though only at the expense of other industries. “No doubt the party benefited will exclaim loudly [and assert] acquired rights [- the] State is bound to protect and encourage [certain] industry; [benefits which spend] more, and thus shower down salaries upon the poor workmen.” (Bastiat, 2007). As, the interest problem that suggests increased present investment and consumption helps society to prosper or provide additional economic stimulus is also a distribution problem. The idea of economic stimulus doctrine should also follow that taxes uninvest toward helping society to prosper, however, as taxes are not the source of revenue for spending then the money must be created and therefore decreases purchasing power. Considering fiscal policy it must be remarked tax is similar to inflation. Endangering not only market price signals but devaluing issued money, as every tax coercively takes a percentage off each dollar. Governors formulating monetary policy are given long terms in a bid to encourage independence from short-term political pressure, as being publicity disclosed and conducted in entering broker markets. (Edison in Reitz, Rülke, & Taylor, 2011).
Factors of production represent means to produce future capital goods, presented in figure two, B capital and capital goods today result from A past producers, and A present production leads to B future capital and capital goods. Preference for future goods, increases savings and lowers interest rates, signalling investors to borrow. Increasing loanable funds directs resources from consumption to investment. Forcing entrepreneurs to lower/higher the unprofitable price or lower costs. Knowing all facts in aggregates, sums, averages, or statistics of an economic problem offer no substitute for every price and relation to each other that guide economic activity. (Hayek, 1985). Additionally, individuals make trade-offs between consuming product A or B represented in the price level, or consuming A and saving/investing in the future, represented in the interest rate.
Figure two A Beginning, B Ending, and Between AB Defines Period of Production
Source: (Rothbard. 2009).
As the government interferes in the money supply, there is difficultly to adjust wages and prices to equilibrium, where the stickiness of these prices are treated as an exogenous constant, the models exclude the laws of the market and sovereignty of consumers. It is contradictory and absurd to impose price maxima or price ceilings/floors to prevent inflation. (Rothbard, 2006) Especially when directing capital through justified credit expansion, to increase spending and consumption from employments satisfying more urgent wants to correct for unsold commodities and services whose prices and wages asked for are currently too high. (Mises, 1949) Benefactors of wage rigidity are labour unions, while “[others] make use of the law to create an artificial rise in the price of bread, meat, iron, or cloth.” (Bastiat, 2007) “[Likewise], the Neo-Scholastics of Salamanca argued that said policies are unadvisable and unjust because they distort the “natural” value of things.” (Graf, 2014) Therefore, money lending and borrowing entails less entrepreneurial risk and malinvestment when profit and loss determines market prices – a ratio between exchanged goods, which represent scarcity and information, such as market interest rates.
In the long run these manipulated values and prices adjust to changes in supply and demand, there is present reluctance to borrow or save currency worth less than its natural value. (Mariana, 2002) In the short run, businesses expand as credit expansion is confused for real loanable funds, there is no market for final goods. Figure three shows the equilibrium interest rate where the quantity of money demanded equals the quantity of money supplied. A positive correlation of savers prefer to exchange supplied present goods against demanded future goods. Conversely, a negative correlation of investors prefer demanded present goods against supplied future goods.
Figure three Neoclassical Conception of the Determination of the Rate of Interest
Source: (Rothbard, 2009).
Monetary equilibrium might be an ideal policy goal, but there exist knowledge and incentive problems that may make it an uncommon practice. The demand curve does not represent present and future effects, and increases in productivity only increase revenue in the short-run. (Rothbard, 2009) Where, there is not time materially available to equal the amount of goods (deficient or excessively supplied and imperfectly employed) to the supply of credit expansion. (Tooke in Marshall, 1920) The supplied capital goods/services has not changed in response, as reliant on the unaltered physical capital, human capital, natural resources, and technological knowledge. As the total quantity of money is unknown and has many meanings. (Hayek, 1985)
Central banks have no direct control over rates, therefore, implement monetary policy through domestic market operations. Where selling government bonds the public purchases with currency and withdrawn bank deposits, indirectly reduces the money supply in circulation and bank reserves/lending. (Mankiw, 2015) Alternatively, buying bonds back increases the money supply. Bond holders in return establish a rate of interest paid each period up until the maturity date.
Assuming new money and its substitutes reach markets via loans. (Mises, 1949) A policy could make matters worse, as money spreads unevenly over time, a lagged response could coincide with a major asset bust. (Bell, 2004) Governments encourage central banks to purchase government bonds, granted little risk it allows selling large debt at low interest rates. “[Quite hypocritical when in] the eyes of cranks and demagogues, interest is a product of the sinister machinations of rugged exploiters.” (Mises, 1949) At risk of over supplying bonds to banks and insurance companies that cannot make repayments, more borrowers can default (fail to pay either interest or principle).
Banks issuing demand deposits with unbacked reserves trades insolvent without central bank collateral. Acting for temporary inflation as guided by the bank run. Where in the 1900s The American Gold Standard Act objected to satisfy “increased demand” for currency. (Livingston in Rothbard, 2009) As a concern that roubles the operations of a central bank is that credit expansion detracts from the quality in weight and karat of treasury gold. However, the liquidity theory of interest suggests fiat currency takes more value in its liquidity, than a gold standard, as it has no restrictive backing and is irredeemable. (Bassetto & Messer, 2013) Now some central banks no longer use reserve requirements and reserves can vary between different sized banks, as the treasury borrows additional banknotes or credit from the central bank it works as its legal creditor. “If [central banks] blunder in their conduct of affairs, the government forces the consumers, the taxpayers, and the mortgages to foot the bill.” (Mises, 1949)
“Monetary freedom ends where legal-tender laws begin.” (Paul & Lehrman, 2007) As fiat money regimes are more dangerous than a monopoly on any other good or service, as it allows the possibility of pursuing monetary policy. “[Governments] would not effectively suppress at once any development in [the] direction [of competing currencies and] keen on preserving their monopoly […]” (Hayek, 1985). Additionally, insisting tax be paid in the countries fiat currency encourages monopoly powers. Since tax is considered and gold is money, its subjected taxation should be eliminated. (Paul & Lehrman, 2007) Along with the conflict to protection and security placed on money, under tax treatment bonds interest is taxed as an income.
Manipulating interest rates in any degree, one is considered to be committing legal plunder. Though, the law is no less immune to manipulation than are interest rates. The law could not organise interest rates, as such usury laws, without disorganising justice. The resulting transmission of wealth through intended inflation is a violation of property. Legal plunder: represents a portion of wealth passing out of ones hands having acquired it, without consent nor compensation, to another, whether by force or artifice, property is violated and plunder is perpetrated. (Bastiat, 2007)
John Maynard Keynes once said “not one man in a million understands who is to blame for inflation.” (Paul & Lehrman, 2007) Though, the blight of inflation is caused by large quantities of counterfeit money. The government having taken the crooks and counterfeiters out of the equation, by having in place laws which “[hunt] down [like the tax dodger] seriously and efficiently, and [salt any law breaker] away for a very long time; [interfering] with the government’s revenue: specifically, the monopoly power to print money enjoyed by the Federal Reserve.” (Rothbard, 1994) Therefore, no individual other than the central bank is responsible for inflation, as the central bank have the granted exclusive right and ability to create money.
Objecting to government control on anything including this crime, the counter argument concludes one objects to something not being done at all. As if people are incompetent to judge for oneself suitable actions based on one’s alternative costs and benefits. Though, central planners and bankers who plan for all are people too, with limited knowledge and special interests seen somehow more right than everyone else. (Bastiat, 2007)
Assets being almost impossible to assign value to, subjects financial/asset markets to “mood swings”. (Bell, 2004) Credit inflation is a distortion of what actually is available to support current production and consumption levels and cause weary booms, while busts even though are inevitable, should not be prolonged to delay market correction on grounds of devaluing currency and hurting savings. “The boom squanders through malinvestment scarce factors of production and reduces the stock available through overconsumption; its alleged blessings are paid for by impoverishment.” (Mises, 1949) Depressions return factors of production to best satisfy consumer’s urgent needs. (Mises, 1949)
“Many governments, universities, and institutions of economic research lavishly subsidize publications whose main purpose is to praise the blessings of unbridled credit expansion and to slander all opponents as ill-intentioned advocates of the selfish interests of usurers.” (Mises, 1949) Credit expansion is unsustainable in the long-run but profitable for the few in the short-run. For whom, benefits precede costs when policy takes an expansionary turn, but costs precede benefits when policy turns contractionary. Carefully, avoiding describing property sectors as “bubbles” preferring “a slow unwinding of prices” (Bell, 2004).
This paper has examined that interest rates being a market price signal should not be indirectly interfered with at whim, by credit expansion nor artificial inflation taxes. Examining several theories of interest, and an explanation was provided for originary interest and the gross market rate of interest, including how each is distorted and deviates from each other. Considering, the special interests that present themselves amidst the height of interest, and that interventionism is an effort to correct for previous interventionism. Additionally, how governments encroach on not just money, but how money should be used.
Finding that from the several theories and on foundations set by the literature on interest that time preference is sufficient in representing market price signals. In contrast, how the liquidity theory excuses negative interest rates as a way to reduce risk, which then overlooks the squandering in a boom whilst the bust is seen as something to be postponed. Which, in attempt to exclaim the hidden costs to taxation, inflation, or government policies, monetary policy is proven unhelpful in controlling market interest rates, and leads to devastating malinvestment and inflation costs. Arguing that the abolishment of central banks and the promotion of market based competition in money, align interest rates closer to the rate of originary interest. Preventing further perpetration of fraudulent fiat money regimes.
Footnotes
[1] Although central banks and monopolies are relatively new, Glaeser & Scheinkman remind historically that: “Restrictions on the taking of interest are among the oldest and most prevalent forms of economic regulation.” (Journal of Law & Economics, Chicago, 1998, p.1)
[2] See in this context Mises (1949), p. 528-529 and also p. 535-542.
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