Interest rates in a deflationary currency

[Impaler]

Again I do not claim to lack values, I do use the term usury as a pejorative and I like the company that I'm keeping on this side of the issue.  Accusing me of something I'm openly claiming and doing is not much of an accusation, your simply trying to divert attention from YOUR 'Austrian' values, they don't call it 'supply side' economics for nothing, Austrian theory puts savings first and gives it prime power to create everything else.  Saying that you have not put a value on that is like saying you believe a god has created the universe but you don't put any moral value on said god, it's just an absurd claim.

Your Austrian explanation for interest is subsumed by Gesell's theory because he looks INTO the money paradigm.  Austrian theory basically starts with hard money as a given then finds the obvious liquidity premium and under hard money you will inevitably get interest as a kind of waste byproduct of the mismatch of the two, with hard money as an axiom interest is an inevitable conclusion.  But Gesell shows that the same liquidity always exists and money can just be made to counter it rather then creating an unnecessary and unearned flow of funds called interest.  Now in all likelihood the rate of demurrage would need be be variable and market based to give a stable economic output, this is something we have thought about and may try as a future innovation if we can figure out how to structure the market (some kind of illiquid bond with no counter party probably).

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[myrkul]

Your views color your perception of the world, Impaler. By looking at interest with a bias, you seek evermore complex "solutions" to a problem that isn't there.

You are like the early astronomers who, because a biased view that Earth was the center of the universe, had to concoct elaborate schemes to explain the motion of the planets, when a simpler, heliocentric model would explain it all, without planets having to do loop-die-loops in the sky.

Interest is not bad, it is not good, no more than the price of grain is good or bad. Interest is simply the price of money.

[notme]

http://en.wikipedia.org/wiki/Usury

Interest in itself is not usury (in most cultures, there are exceptions).  Usury is more generally accepted as earning interest higher than what is normal for the level of risk taken.

[myrkul]

http://en.wikipedia.org/wiki/Usury

Interest in itself is not usury (in most cultures, there are exceptions).  Usury is more generally accepted as earning interest higher than what is normal for the level of risk taken.

And who is best suited to determining the level of risk? The lender? Or a bureaucrat with no knowledge of the borrower at all? Legal definitions of usury are necessarily arbitrary price ceilings. And price ceilings, when they do anything, cause shortages.

[aaaxn]

http://en.wikipedia.org/wiki/Usury

Interest in itself is not usury (in most cultures, there are exceptions).  Usury is more generally accepted as earning interest higher than what is normal for the level of risk taken.

And who is best suited to determining the level of risk? The lender? Or a bureaucrat with no knowledge of the borrower at all? Legal definitions of usury are necessarily arbitrary price ceilings. And price ceilings, when they do anything, cause shortages.

I think the whole point of limiting interest is to cause shortage of lending with interest higher than cap. You seem to agree it works.

[myrkul]

http://en.wikipedia.org/wiki/Usury

Interest in itself is not usury (in most cultures, there are exceptions).  Usury is more generally accepted as earning interest higher than what is normal for the level of risk taken.

And who is best suited to determining the level of risk? The lender? Or a bureaucrat with no knowledge of the borrower at all? Legal definitions of usury are necessarily arbitrary price ceilings. And price ceilings, when they do anything, cause shortages.

I think the whole point of limiting interest is to cause shortage of lending with interest higher than cap. You seem to agree it works.

Of course it works, but the point is, why do it? Why intentionally cause a shortage of money?

[notme]

http://en.wikipedia.org/wiki/Usury

Interest in itself is not usury (in most cultures, there are exceptions).  Usury is more generally accepted as earning interest higher than what is normal for the level of risk taken.

And who is best suited to determining the level of risk? The lender? Or a bureaucrat with no knowledge of the borrower at all? Legal definitions of usury are necessarily arbitrary price ceilings. And price ceilings, when they do anything, cause shortages.

I agree.  Only the market can properly determine risk, and only when it is not interfered with.

[malditonuke]

Well on this thread you're the one banging on the pulpit.

I never said I wasn't, it's myrkul who needs to defend this absurd claim that the rest of 'you' and 'Austrians' broadly are not operating out of a moralistic framework that rationalizes usury by defining the lender as morally virtuous and the borrower as morally flawed.

Economics is value-free.  Borrowers are not "bad" and savers are not "good".  If you want to argue about "usury", do it in the religious section.

Anyone claiming that their ideology is value free is either ignorant or ashamed of the values it actually carries.  Nothing made by man is free of value judgments, especially economics.  You would have to be the most blindly obtuse person ever born to think that Marx-vs-Adam Smith or hard-vs-soft money or the Keynes-vs-Hayek debates are value-free, it is saturated with value judgments.  These are indeed some of the most pivotal value debates that have existed in the last century.

Economics is not an ideology; it is a science.  Like other sciences, to properly study economics you must be able to remove your ideological hats.  I know that it's hard and that many people fail.

[molecular]

Question:How do banks get more coins to pay interest rates if no new money is produced?

Banks don't pay interest rates. They are just (taken we're talking about classic "depository & loans" operations) intermediaries.

Borrowers pay interest rates. They can pay them because they make a good business with the capital and come out on top (investment).

There's also the possibility of default, that's why money doesn't concentrate in a single point in the long run.

[jerye]

Question:How do banks get more coins to pay interest rates if no new money is produced?

Banks don't pay interest rates. They are just (taken we're talking about classic "depository & loans" operations) intermediaries.

Borrowers pay interest rates. They can pay them because they make a good business with the capital and come out on top (investment).

There's also the possibility of default, that's why money doesn't concentrate in a single point in the long run.

There ever exists only 2 types of investments. I being investments and R being next period returns and currency being capped:

1) I<R. More people make this investment and crowding decreases the return until I=R and people stop investing. This is what is happening with asic investments right now.

2) I>R. Keeping the money makes more sense then investing. So these investments are never made.

The problem with a capped currency is almost all investments fall into category 2 and therefore a bitcoin only world would stifle investment.

Read more: https://bitcointalk.org/index.php?topic=213860.0

[painlord2k]

There ever exists only 2 types of investments. I being investments and R being next period returns and currency being capped:

1) I<R. More people make this investment and crowding decreases the return until I=R and people stop investing. This is what is happening with asic investments right now.

2) I>R. Keeping the money makes more sense then investing. So these investments are never made.

The problem with a capped currency is almost all investments fall into category 2 and therefore a bitcoin only world would stifle investment.

Read more: https://bitcointalk.org/index.php?topic=213860.0

You are right about the premises but not the conclusion, because your economic thinking is wrong.

Lowering the level of investment is not wrong if the level of investment is too high.
There is a healthy level of investment (E.G. between 10 and 20% of your net worth) and there is unhealthy levels (E.G. less than 10% and more than 20%).
In the case of not enough investment, the society (or individual) is not able to rebuild the capital consumed in production (E.G. substituting a milling machine with another milling machine when the first become obsolete or break down)
In the case of too much investment, the society (or individual) is investing in something unable to return enough to justify the investment (and associated risks). In short, the investment is at a loss.

With a fixed money supply it is impossible for the government (for anyone) to manipulate the currency so to cause booms and the correlated busts. It can not push people to invest just because it drugged and doped the markets with unlimited cash injections.

As too much money is spent in investment or consumption, the prices spike and people is forced to slow down investment and consumption.

As consumption is lower and only high yields investments are allowed by the markets (compared with inflating fiat), people is able to continuously accumulate real capital (stuff) to use to increase production, make it more efficient, and so on. Capital accumulation is fundamental, because productivity is linked to the capital available:
a man with a shovel is a lot less efficient than a man with a caterpillar, but the latter need a lot more capital.
The work done by the first is one or two orders of magnitude lower than the work done by the latter, but the capital needed is much lower.
The first could be able to earn 5$/hours where the latter could earn 20$ (after the costs are deducted) but one need just 10$ of capital where the latter need 10K $ of capital.
The first could save 1$ at hour of work where the latter could save 12 $.

With a depreciating currency like the US$, with an inflation of 5% (if it was so low) a men would need 500 hours of work (around 6 months of work) just to keep the value of his saving constant at 10.000$ (and be able to move from a hand shovel to a mechanic one).
First year he would be able to save 2800 $, but the price of the MS would be 10.500.
In the second year, he would reach 5600+140 (he also raised his earning of 5% - if he is lucky), but now the caterpillar price is 11.250 $.
In the third year he reach 8827 US$ and the price would go to 11812 $.
In the fourth year he reach 12.068  US$ and the price move up to 12155 $.

If the currency kept his value (so prices are stable) he  would be able to buy a mechanical shovel in 3 years and half, where with a 5% depreciating currency he would be able to buy it in just more than four years.
This guy would delay the ability to go from 5$/h to 20$/h for more than 6 months (months he would just work, eat and sleep to save as much as possible).
Due the additional six months, he would not be able to earn 42.000 additional $.

The difference between the two scenarios are staggering: the US paper $ (with 5% inflations) guy lost 6 months and 42.000$ (in constant purchasing power) compared to the gold $ guy.
These 42K$ and six months are available to consume and invest more and earlier.

In the inflating scenario, the people increasing their purchasing power faster are the people able to obtain newly printed $ before all other at low interest, buy stuff and resell it later at higher prices (aka carry trade). They do not benefit society with more good and services, just suck wealth from it.

[Adrian-x]

Interest is not bad, it is not good, no more than the price of grain is good or bad. Interest is simply the price of money.

And how the price of money is valued can only be a function of the market, free of manipulation and distortion.

 In an economy, where you manipulate the money supply to encourage growth you have to invest to maintain your value resulting in perpetual growth ( ie. the economics today - it is unsustainable for scientific reasons, and is immoral as the new money creates poverty as a result of the Cantillon Effect )

In an economy, where you have a fixed money supply growth or lack thereof is a result of corporative trade, if the economy is growing, you have price deflation, investing and borrowing are naturally unfavorable, and saving with 0% interest is beneficial. (Perpetual deflation reflects prosperity)   

When the economy is shrinking you have price inflation (a lack of goods and services), higher prises provides opportunities for entrepreneurs and innovators, investing and borrowing are the way entrepreneurs get capital to grow the economy. Saving with 0% interest while experiencing inflation is unwise as the saved value is eroded, lending is naturally encouraged. (inflation reflects a need to fulfill wants in society)   

In a fixed currency model like the Bit-economics - both saving and lending is reworded according to the needs of the economy - economy being defined as the level of cooperation in trade between individuals and businesses to sustain maximum prosperity.)

So to derive ways to encourage lending and pay interest in a deflating economy is unnecessary and wrong as it sends the incorrect signal to the free market. 

[aaaxn]

Everything's fine except that you are missing that constrained base money does not mean that money supply is constant. Money supply is affected by credit creation and result is that there are  periods monetary inflation and deflation even if base money is constant.

[Adrian-x]

Everything's fine except that you are missing that constrained base money does not mean that money supply is constant. Money supply is affected by credit creation and result is that there are  periods monetary inflation and deflation even if base money is constant.

I was going to add something to address your point, but I thought it was a little deep until I read your reply, what I have come to understand is the money supply should be restricted by the base money supply to degree the free market allows. Free Market Banking money theorists presumed, money creation is a function of the free market, and it shouldn't be. (Although fractional reserve banking in Bitcoin is viable, the valid response should be but why do it! you don't own your Bitcoin's unless you own your Bitcoin's.)  

When banks make money or fractional reserves credit, they are pre-empting or overcompensating for the natural economic correction, this will eventually result in the Boom Bust cycles the Keynesians, set out to eliminate.  Keynesians and Monetarists, ironically try and manage the situation but can only make the cycles bigger and more damaging as they are working of the same incorrect premise.

Hayek, and Mises, on the other hand have taught me that having a fixed money supply free of fractional reserves credit creation will provide maximum prosperity in the economy, and the risk of lending will be driven purely by market forces, and not banking interests.

So the periods of monetary inflation and deflation if base money is constant, should be avoided if the goal is to maximise prosperity in the economy, that is why the Bitcoin experiment is so great, it will allow this idea to be tested despite it flying in the face of "contemporary conventional wisdom".

[asdf]

The problem with a fixed money supply is that if the economy grows too fast, it won't grow very fast. Because interest rates.

[Adrian-x]

The problem with a fixed money supply is that if the economy grows too fast, it won't grow very fast. Because interest rates.

That's not a problem that's amazing, it automatically adjust. Consequently it will cool off and stop growing and the balance of maximum prosperity will be kept in equilibrium.

[aaaxn]

Hayek, and Mises, on the other hand have taught me that having a fixed money supply free of fractional reserves credit creation will provide maximum prosperity in the economy, and the risk of lending will be driven purely by market forces, and not banking interests.

So the periods of monetary inflation and deflation if base money is constant, should be avoided if the goal is to maximise prosperity in the economy, that is why the Bitcoin experiment is so great, it will allow this idea to be tested despite it flying in the face of "contemporary conventional wisdom".

Credit creation is very basic. All you need is to generate some promises to repay (IOU) and if you have enough credibility people can start to accept this IOUs as good as money. There is absolutely no magic in a way bank works. How do you suppose to forbid this? You can however limit to what extend it happens through careful regulation (limit single entity size, limit size of multilateral guarantees, etc), but austrian economists wouldn't be happy with that?
Another approach is to guarantee system solvency at central level (it is quite opposite of limiting regulation) by introducing central banks, but austrian economists are not happy with it too?

[painlord2k]

Hayek, and Mises, on the other hand have taught me that having a fixed money supply free of fractional reserves credit creation will provide maximum prosperity in the economy, and the risk of lending will be driven purely by market forces, and not banking interests.

So the periods of monetary inflation and deflation if base money is constant, should be avoided if the goal is to maximise prosperity in the economy, that is why the Bitcoin experiment is so great, it will allow this idea to be tested despite it flying in the face of "contemporary conventional wisdom".

Credit creation is very basic. All you need is to generate some promises to repay (IOU) and if you have enough credibility people can start to accept this IOUs as good as money. There is absolutely no magic in a way bank works. How do you suppose to forbid this? You can however limit to what extend it happens through careful regulation (limit single entity size, limit size of multilateral guarantees, etc), but austrian economists wouldn't be happy with that?
Another approach is to guarantee system solvency at central level (it is quite opposite of limiting regulation) by introducing central banks, but austrian economists are not happy with it too?

There is no need to forbid credit creation if the credit is not forced on unwilling people.
If people give credit, they do it at their own risk.

With a fixed supply of money, the government can not create "insurances" like FDIC (because they can not print money), so people would be picky about giving credit to a bank or any other entity.
This would avoid the problem of bankers giving credit to any bum they find just to inflate their ratings and be given bonuses and leaving the mess to someone else a few years later.
People would not bank with a bank with less than 20% of reserve and they would probably prefer bank with much higher reserves.

Banks would specialize in money services (payments, holding, transmitting) or in loaning services (obtain loans/capital from investors, giving loans to dependable people under decent conditions like "50% down to buy the first home and we will finance the other 50% at 5%-10% year).
This would have the advantage money would not be jeopardized without the explicit and informed consent of the owner.

[molecular]

painloard2k, I loved your real-world explanation of austrian school thinking above

There is no need to forbid credit creation if the credit is not forced on unwilling people.
If people give credit, they do it at their own risk.

This hits to the heart of the more general problem we have: people being coerced to do involuntary (or mislead to do unprofitable) transactions.

Regarding other parts of the discussion above: I agree a fixed money supply is a good thing and I think the world would run much more efficiently and general prosperity would be much higher than with the elastic ("managed") supply we currently use that in addition unfairly favors certain groups of people.

The argument that an inflexible money can't support growth of an economy is simply false. Prices can adjust. You could run the world economy on one Bitcoin without a problem. There are some political and psychological problems ("price stickiness") that will have to be overcome, though.

Another argument that is being made against a fixed global money supply is that this would result in the inability of nationstates (or other smaller/bigger economic regions) to adjust the value of their currency in order to "regulate" their local economies import/export ratio. I'm unsure about wether or not I like the idea of local elastic-supply currencies in addition to a global fixed one with exchange markets in between.

The situation in Europe seems to suggest that the common currency will in effect enable a move toward more central policy control and it can be argued that this was the goal of the Euro all along: a centralizing "coup d'etat" from above, essentially a power grab.

Maybe local currencies are a way to decentralize (policy) control?

(sorry, I went off on a tangent there)

[Adrian-x]

Credit creation is very basic. All you need is to generate some promises to repay (IOU) and if you have enough credibility people can start to accept this IOUs as good as money. There is absolutely no magic in a way bank works. How do you suppose to forbid this?

No forbidding necessary we just need to use the same language to ensure we all understand each other. 

Your definition of credit (involving IOU's) is the bases for the system we have today, and it requires unsustainable growth.

Credit also involves the matter of moral principle, and an honest understanding of who can create real credit.
Only the producers in an economy are the ones who create goods and services, and as a result they take the risk by producing (hopefully something other want) and can risk again when lending to others hoping to be repaid with something they want.

Regress to a prehistoric agricultural society, to understand the principle: the producer of the wheat, can create credit by lending the wheat, but if the producer promises to lend the wheat he intends to grow, he has not created credit, but a debt.

As long as credit is created from goods and services that have been produced (or saved), it is honest, and real credit, provided it is given at the discretion of the producer / owner.  But when credit is artificially created, it is a debt, and will ripple through an economy as boom and bust as the system re-balances.

Bitcoin functions on the premise that Bitcoin credit will be created from Bitcoin's already saved, and as a result should only flow at the discretion of the saver.