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Author Topic: Interest rates in a deflationary currency  (Read 5554 times)
anaikh
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June 03, 2013, 01:57:36 AM
 #21

The question is If bitcoin is the only currency in the world (as most of you expect), How the Economy will grow if the interest rate is not stable and is very high?

If the economy is growing, one bitcoin has bigger buying power, then why do not the bitcoin owner hoard the money rather than send it to the bank? You can say the bank will pay for the interest. So the lending cost will be the interest + economic growth rate.

How can economy grow? By investing and developing new things/methods to satisfy human needs. No lending, no investing and as a result, no economic growth (even there is economic growth, this kinds of growth will centralize bitcoin to big monopoly enterprises). The ROI(return on investment) must be bigger than the lending cost. Which means the ROIs must exceed the economic growth rate.

Let's assume there is only one project for the whole world with an ROI 10%. Then if the project can be done by its own money, the ROI of the world will be 10% and so the economy growth will be 10%. So where is the interest?

If there are two projects for the whole world with the same size and ROI 15% 5% each. then the economy growth rate will be 10%. People will expect the 5% project can not pay back the interest and will stop investing in it. as a result, the economy growth rate will be 15%/2=7.5%.

If people are expecting economic growth too high, the required ROI will be too high and few projects can achieve that, which will lead to a frozen in the lending market. A frozen market will lead to the withdraw of industry and is harmful to the society.

So here is the conclusion, fixed money amount is not a good choice.

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June 03, 2013, 02:02:49 AM
 #22

Credit is a hard concept in the Bitcoin economy. That being said, lending isn't that terrible. Go back to the basics -

If a bank uses only Bitcoin, then this is how it will make money: through a spread between savers and lenders. That's how traditional banks are supposed to make money too. People deposit their Bitcoins in the bank for safekeeping and they get some rate of interest. If you're borrowing Bitcoin from the bank to start a business, say, then you need to pay back a higher number of Bitcoins. The bank keeps the difference for taking that risk. Same concept as traditional economy.

Remember currency is just the medium of exchange. The total wealth of the world can keep increasing irrespective of the currency.
You did not understand the problem. If deflation is 20% a year you cannot lend from bank for anything under 20% in real terms. Such high interest would cause demand for credit to be very small and without demand there is now way bank can profit from lending.

It was a good answer to the original poster's question: 'How do banks pay their lenders?'  The OP seemed to be under the mistaken impression that a specific business (a bank) needs to increase the stock of money to to pay the interest off loans.  The truth is that profit can pay the interest.

Also, if the currency is increasing in value 20% per year, think about why that is.  It's because of economic growth.  If you can't have economic growth with the currency appreciating that much, then the growth slows, and the currency increases in value at a lower rate.

Yeah, that's exactly what I wanted to say. If you say that the units of currency are fixed, then with economic growth, the value of each of these unit will increase proportionally. The reason that doesn't happen with fiat currency is essentially inflation (inflation defined in terms of increasing the supply of currency, not CPI based inflation). In a Bitcoin economy, the value of 1 Bitcoin will be 1/21 millionth of the size of the economy. The economy grows irrespective of the currency units.

This is not accurate, as you are discounting the existence of credit-money, which is the essence of the question posed here.
Lenders / Banks which own Bitcoins may lend the right to them out as credit-money, letters of credit, or other instruments useful in trade.  The bank may charge some interest on this credit-money.  This is what happens today with fiat currencies.  It is the same mechanism.  It doesn't matter that the quantity of Bitcoin is fixed to an absolute number at any given moment.  Credit-money may expand the amount of circulating money beyond that fixed amount.

This is the same way that the amount of printed serial numbered paper dollars is different from the amount of "money" being used in commerce.  Much of it is a secondary ledger held in a bank accounting system and not physical paper fiat currency.

This is not a real problem, or rather it was a problem solved several thousand years ago, and really very well re-solved by Italian Banking to end the "dark ages".
The world was using gold and silver, also a fairly fixed quantity, with only tiny amounts of inflation/mining/discovery.  As well as plenty of losses in shipwrecks and such.

The only reason this is even a question is because folks have become so accustomed to inflationary fiat currency that doing without them is outside imagination.  But we used to all do without them very nicely.

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June 03, 2013, 03:47:32 AM
 #23

The question is If bitcoin is the only currency in the world (as most of you expect), How the Economy will grow if the interest rate is not stable and is very high?

If the economy is growing, one bitcoin has bigger buying power, then why do not the bitcoin owner hoard the money rather than send it to the bank? You can say the bank will pay for the interest. So the lending cost will be the interest + economic growth rate.

How can economy grow? By investing and developing new things/methods to satisfy human needs. No lending, no investing and as a result, no economic growth (even there is economic growth, this kinds of growth will centralize bitcoin to big monopoly enterprises). The ROI(return on investment) must be bigger than the lending cost. Which means the ROIs must exceed the economic growth rate.

Let's assume there is only one project for the whole world with an ROI 10%. Then if the project can be done by its own money, the ROI of the world will be 10% and so the economy growth will be 10%. So where is the interest?

If there are two projects for the whole world with the same size and ROI 15% 5% each. then the economy growth rate will be 10%. People will expect the 5% project can not pay back the interest and will stop investing in it. as a result, the economy growth rate will be 15%/2=7.5%.

If people are expecting economic growth too high, the required ROI will be too high and few projects can achieve that, which will lead to a frozen in the lending market. A frozen market will lead to the withdraw of industry and is harmful to the society.

So here is the conclusion, fixed money amount is not a good choice.

To be more accurate HARD money is not a good choice, money can be made soft by inflation OR by demurrage as in Freicoin.  Both have the effect of lowering interest rates and breaking the cycle you describe.  But we feel demurrage is superior for several reasons, first it is universal and constant on every coins and everyone that holds coins, where as inflation must ripple through the economy as prices rise from people bidding them up, a messy process that an easily overshoot.  I like to say demurrage moves at the speed of light while inflation moves at the speed of sound. 

Second demurrage eliminates the first-spender problem under inflation, when new money comes into existence the first person to spend it enjoys the still low prices before his own activity increases prices.  This is even the case if the new money is borrowed as most new money is under our current system, the borrower gets to spend high value money and repay with lower value money.  Under demurrage new money is typically given to pensioners or other charitable causes or used to pay for the system overhead costs.  Currently Freicoin directs demurrage to mining but we have plans for a PoS based voting system that will direct those funds in the future.

 
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anaikh
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June 03, 2013, 04:45:04 AM
 #24

The question is If bitcoin is the only currency in the world (as most of you expect), How the Economy will grow if the interest rate is not stable and is very high?

If the economy is growing, one bitcoin has bigger buying power, then why do not the bitcoin owner hoard the money rather than send it to the bank? You can say the bank will pay for the interest. So the lending cost will be the interest + economic growth rate.

How can economy grow? By investing and developing new things/methods to satisfy human needs. No lending, no investing and as a result, no economic growth (even there is economic growth, this kinds of growth will centralize bitcoin to big monopoly enterprises). The ROI(return on investment) must be bigger than the lending cost. Which means the ROIs must exceed the economic growth rate.

Let's assume there is only one project for the whole world with an ROI 10%. Then if the project can be done by its own money, the ROI of the world will be 10% and so the economy growth will be 10%. So where is the interest?

If there are two projects for the whole world with the same size and ROI 15% 5% each. then the economy growth rate will be 10%. People will expect the 5% project can not pay back the interest and will stop investing in it. as a result, the economy growth rate will be 15%/2=7.5%.

If people are expecting economic growth too high, the required ROI will be too high and few projects can achieve that, which will lead to a frozen in the lending market. A frozen market will lead to the withdraw of industry and is harmful to the society.

So here is the conclusion, fixed money amount is not a good choice.

To be more accurate HARD money is not a good choice, money can be made soft by inflation OR by demurrage as in Freicoin.  Both have the effect of lowering interest rates and breaking the cycle you describe.  But we feel demurrage is superior for several reasons, first it is universal and constant on every coins and everyone that holds coins, where as inflation must ripple through the economy as prices rise from people bidding them up, a messy process that an easily overshoot.  I like to say demurrage moves at the speed of light while inflation moves at the speed of sound.  

Second demurrage eliminates the first-spender problem under inflation, when new money comes into existence the first person to spend it enjoys the still low prices before his own activity increases prices.  This is even the case if the new money is borrowed as most new money is under our current system, the borrower gets to spend high value money and repay with lower value money.  Under demurrage new money is typically given to pensioners or other charitable causes or used to pay for the system overhead costs.  Currently Freicoin directs demurrage to mining but we have plans for a PoS based voting system that will direct those funds in the future.

Actually, I think demurrage is a very interesting idea. However, firstly, is it legal or moral to deprive money from its owners?  secondly, how to set up the demurrage rate? The rate should be able to push users to spend their money and not push to hard. thirdly, even with the demurrage thing, economy has to develop, as a result, some new products will enter the world and they need money too. If the total amount is fixed, then some other products must lower its value. This will also cause deflation. Imaging you produce A @ 1000BTC in year1 and you produce all of them into your inventory. Then as the shortage of money supply, you have to lower its price to 900BTC in year2. However, your COGM (cost of goods manufactured) is 950BTC in year1. Your inventory price is also 950BTC. So in Year1 you can gain 50BTC revenue but in year2 you will loss 50BTC. This happens to all manufaturing business as they have to buy raw-material first and then produce the product. If the production time is too long, it will be not profitable. The business operators will lose confidence in the production.

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June 03, 2013, 05:05:47 AM
 #25

The question is If bitcoin is the only currency in the world (as most of you expect), How the Economy will grow if the interest rate is not stable and is very high?
Well, setting aside that nobody with a lick of sense thinks bitcoin will be the only currency in the world (or even that cryptocurrencies will be the only thing used as money), the simple answer is that it won't. Which is why the interest rate will be low, and fairly stable.

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June 03, 2013, 05:20:18 AM
 #26

The question is If bitcoin is the only currency in the world (as most of you expect), How the Economy will grow if the interest rate is not stable and is very high?

For the record, I personally don't believe that bitcoin (or any other crypto-currency) will be the only currency in the world.  I suspect that most bitcoin supporters believe it will become a world currency but not the only world currency.

For the purpose of discussing bitcoin interest rates, I am also ignoring interest rate manipulation by central banks.

If the economy is growing, one bitcoin has bigger buying power, then why do not the bitcoin owner hoard the money rather than send it to the bank? You can say the bank will pay for the interest. So the lending cost will be the interest + economic growth rate.

How can economy grow? By investing and developing new things/methods to satisfy human needs. No lending, no investing and as a result, no economic growth (even there is economic growth, this kinds of growth will centralize bitcoin to big monopoly enterprises). The ROI(return on investment) must be bigger than the lending cost. Which means the ROIs must exceed the economic growth rate.


Well, I would wager that some form of banking will persist.  Regular people may use banks to safely store their bitcoin and for easy lending.  Plus banks may offer some other bitcoin-centric services.

But even if the traditional bank went the way of the dodo, lending could continue.  Using the internet, it's actually much easier to find borrowers today then it was 10 years ago, and it will probably become easier still.  I mean, using the internet these days I can loan money to farmers in Africa if I wanted.


Let's assume there is only one project for the whole world with an ROI 10%. Then if the project can be done by its own money, the ROI of the world will be 10% and so the economy growth will be 10%. So where is the interest?

If there are two projects for the whole world with the same size and ROI 15% 5% each. then the economy growth rate will be 10%. People will expect the 5% project can not pay back the interest and will stop investing in it. as a result, the economy growth rate will be 15%/2=7.5%.

If people are expecting economic growth too high, the required ROI will be too high and few projects can achieve that, which will lead to a frozen in the lending market. A frozen market will lead to the withdraw of industry and is harmful to the society.

If people are expecting higher economic growth, other things being equal, then they will probably want to save (invest) in order to buy more goods for less money.  In fact, one of the arguments against a fixed money supply is that the value of the money goes up so quickly that nobody wants to spend.  I say that it's unlikely but not impossible.

If phenomenal growth is already locked in and businesses don't want any more investors (0% interest rates), then people will either hold on to their money (because they are perfectly content) or spend some money on things that they want now.

There is nothing inherently wrong with slowing investment when growth is high.  When people don't want any more investment, more investment is bad.  It sounds like you are worried that lending will stop when it is too high.  Of course!
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June 03, 2013, 05:28:09 AM
 #27

anaikh:  We get asked this question frequently

We believe that no one should be deprived of the VALUE of their money by the monetary system, but neither should money earn interest that gives one more value, demurrage in our view a means to make money held by a person completely constant in value once the wider economy is factored in.  All money has by necessity of being money high liquidity (indeed an accurate definition OF money is what ever thing in society has highest liquidity).  That liquidity has a value over time which gives rise to interest and which someone with money can gain more value from without engaging in any risk.  Gaining without risk is considered usury.

The ideal rate of demurrage is the rate that matches and counter-acts the liquidity premium.  We used a 5% per year rate in Freicoin as this is the figure Gesell's believed (siting earlier research) was a long term historical rate and we do not believe it will be significantly different now, a floating rate was considered but no technical solution was evident so a fixed rate was employed.  Rates of demurrage intentionally set far above the liquidity premium would be unfair by this standard.

A person stuffing money under a mattress would indeed lose 5% a year to demurrage, but that person would be very liquid and enjoy the safety that liquidity provides.  On the other hand someone placing money in a long term savings account with a bank would be giving up most of their liquidity and the bank would pay a rate to him that effectively lowers their demurrage loss.  The more liquidity one gives up the less demurrage one should pay, the longest term lending should be very nearly at par.

Your also naturally correct about money supply needs to be managed to keep valuation constant, this is another area ware FRC developers acknowledge a potential flaw in the economics of the coin as-launched but hope that the core demurrage concept will prove itself to be useful regardless and that improvements can be made by future hard-forks.  My personal opinion is that an internal futures market could regulate the quantity of coins such that they keep a deflation rate sufficiently low as to avoid hoarding.

 
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June 03, 2013, 05:42:09 AM
 #28

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June 03, 2013, 08:20:46 AM
 #29

anaikh:  We get asked this question frequently

We believe that no one should be deprived of the VALUE of their money by the monetary system, but neither should money earn interest that gives one more value, demurrage in our view a means to make money held by a person completely constant in value once the wider economy is factored in.  All money has by necessity of being money high liquidity (indeed an accurate definition OF money is what ever thing in society has highest liquidity).  That liquidity has a value over time which gives rise to interest and which someone with money can gain more value from without engaging in any risk.  Gaining without risk is considered usury.

Hope So  Wink

The ideal rate of demurrage is the rate that matches and counter-acts the liquidity premium.  We used a 5% per year rate in Freicoin as this is the figure Gesell's believed (siting earlier research) was a long term historical rate and we do not believe it will be significantly different now, a floating rate was considered but no technical solution was evident so a fixed rate was employed.  Rates of demurrage intentionally set far above the liquidity premium would be unfair by this standard.

A person stuffing money under a mattress would indeed lose 5% a year to demurrage, but that person would be very liquid and enjoy the safety that liquidity provides.  On the other hand someone placing money in a long term savings account with a bank would be giving up most of their liquidity and the bank would pay a rate to him that effectively lowers their demurrage loss.  The more liquidity one gives up the less demurrage one should pay, the longest term lending should be very nearly at par.
I don't know whether 5% is responsible or not. But your coin's foundation is hoarding coins for the first 3 years...I do not like that.

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June 03, 2013, 05:52:53 PM
 #30

Question on demurrage:
What do you do with those lost coins? If they are annihilated than it just changes amount of money without affecting value. If it is distributed to everyone then nothing changes. I guess it is being distributed to miners so it is effectively exactly same as just giving miners new money. Miners simply increase their share of currency vs everybody else. Old school inflation have one big advantage of being compatible with human psychology. No one wants to see his account shrinking in real-time.


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notme
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June 04, 2013, 04:25:44 AM
 #31

Question on demurrage:
What do you do with those lost coins? If they are annihilated than it just changes amount of money without affecting value. If it is distributed to everyone then nothing changes. I guess it is being distributed to miners so it is effectively exactly same as just giving miners new money. Miners simply increase their share of currency vs everybody else. Old school inflation have one big advantage of being compatible with human psychology. No one wants to see his account shrinking in real-time.

But that is exactly what is happening with old school inflation.... but most people are unaware.  At least with demurrage, it is an honest shrinking of your purchasing power rather than a sneaky one.

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June 04, 2013, 04:47:48 AM
 #32

Question on demurrage:
What do you do with those lost coins? If they are annihilated than it just changes amount of money without affecting value. If it is distributed to everyone then nothing changes. I guess it is being distributed to miners so it is effectively exactly same as just giving miners new money. Miners simply increase their share of currency vs everybody else. Old school inflation have one big advantage of being compatible with human psychology. No one wants to see his account shrinking in real-time.

But that is exactly what is happening with old school inflation.... but most people are unaware.  At least with demurrage, it is an honest shrinking of your purchasing power rather than a sneaky one.
Demurrage does have that going for it, But it's still a drain on purchasing power, and a currency with demurrage will never survive next to one that doesn't in a competitive market.

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June 04, 2013, 04:49:17 AM
 #33

Question on demurrage:
What do you do with those lost coins? If they are annihilated than it just changes amount of money without affecting value. If it is distributed to everyone then nothing changes. I guess it is being distributed to miners so it is effectively exactly same as just giving miners new money. Miners simply increase their share of currency vs everybody else. Old school inflation have one big advantage of being compatible with human psychology. No one wants to see his account shrinking in real-time.

But that is exactly what is happening with old school inflation.... but most people are unaware.  At least with demurrage, it is an honest shrinking of your purchasing power rather than a sneaky one.
Demurrage does have that going for it, But it's still a drain on purchasing power, and a currency with demurrage will never survive next to one that doesn't in a competitive market.

I agree.  I'm no fan of demurrage.  I just see it as slightly more honest than willful inflation.

https://www.bitcoin.org/bitcoin.pdf
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June 04, 2013, 04:59:37 AM
 #34

I agree.  I'm no fan of demurrage.  I just see it as slightly more honest than willful inflation.
Oh, it's much more honest. I mean, when your money has an expiration date, any fool knows not to hang on to it lest he get stuck holding the bag.

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June 04, 2013, 05:06:41 AM
 #35

Inflation isn't the only component in interest rates.  Take a CC for example it is 20%+ even in an economy where inflation is ~3%.  Even a mortgage generally run 1% or so higher than the 10 year treasury bond (which rarely current QE fun aside) has negative real interest rates.

The issue would be that Bitcoin is currently experience very high deflation relative to the dollar and other major currencies.  However that trend will not hold forever.  I mean at only 24% USD:BTC growth we would be looking at the Bitcoin money supply worth  ~2T in a decade, then what 20T by the next decade, 300T by the decade after that.  

As the Bitcoin economy gets larger its growth rate will slow.  Bitcoin will not have extreme price deflation.  Under a scenario where the purchasing power of a Bitcoin is increasing by say 1% a year I would expect interest rates to be very similar to inflationary interest rates but 2% to 4% lower because the inflation component has been replaced with a deflation component.

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June 04, 2013, 07:06:59 AM
 #36

Inflation isn't the only component in interest rates.  Take a CC for example it is 20%+ even in an economy where inflation is ~3%.  Even a mortgage generally run 1% or so higher than the 10 year treasury bond (which rarely current QE fun aside) has negative real interest rates.

The issue would be that Bitcoin is currently experience very high deflation relative to the dollar and other major currencies.  However that trend will not hold forever.  I mean at only 24% USD:BTC growth we would be looking at the Bitcoin money supply worth  ~2T in a decade, then what 20T by the next decade, 300T by the decade after that.  
You mean the price pf Bitcoin is rising?What does your money supply mean?


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June 04, 2013, 07:38:53 AM
Last edit: June 04, 2013, 08:17:15 AM by Impaler
 #37

Inflation is not at all a component of REAL interest which is what were really concerned with, real interest arises purely from liquidity premium, aka the value of liquidity.  The only argument among economists is to what the source of that liquidity value is.  The general Austrian answer (which myrkul endorsed last time we debated) was a time-preference in which most people wants to engage in shortsighted consumption in the present.  Thus the 'good' savers who resist the temptations of immediate gratification are entitled to extract interest from the shortsighted gluttons, basically a kind of sick morality play designed to justify usury upon ones fellow man.

The reality is that liquidity is in the nature of money and it has value because liquidity is insurance against any possible calamity as well as a ticket to any opportunity that may arise.  And their is nothing wrong with people acting on the real opportunities or calamities that may be occurring, it is not a moral failing on their part to seek liquidity, but it is an impediment to the economy when they are forced to pay for it.  For liquidity is not created by the money holder, it is created by the marketplaces willingness to accept money and thus give it liquidity, a publicly created good like liquidity should not be monopolized but instead it should be available to all but it should cost you what it's worth. 

Getting something for nothing is never fair, as they say their is no such thing as a free lunch and liquidity under a hard currency is a glaring example.  How ever free the lunch might seem someone else always bears the cost and no self-respecting believer in fairness should endorse such a thing.

 
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June 04, 2013, 07:56:11 AM
 #38

I like to add to the discussion that even in a deflationary currency negative interest rates occur. Germany had them last year on their bond offerings.
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June 04, 2013, 08:02:33 AM
 #39

Hi,

I have searched the forums and haven't found a satisfactory discussion, please correct me if I'm wrong.

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

Further explanation:
Let's say we have 21M bitcoins and a free-market economy based on them. Everyone has some of those bitcoins and are exchanging them with each other for services and goods. Now, if I am a bank, how do I get more money to pay my lenders? I understand that the things you can buy with your coins grows overtime, but how do you get more money itself? If everyone lends to everyone (like kind of what happens today), then we would want the number of coins to grow, or someone would not be able to get enough to pay back, despite being able to purchase more stuff (his intrinsic wealth growing). On a further note, even a 1% interest would be actually compounded by the deflationary trend, making it quite lucrative. Is it possible that negative or zero interest would be lucrative (just to keep your money safe?)

Perhaps my questions are simplistic, but then again so is my knowledge in economics.

Thanks for reading

Borrowers earn coins by providing goods and services to the lenders, which is paid from the interest received.  This happens until the debt is fully repaid or partially canceled.

Note that a short squeeze can be applied onto the borrower if the lender keeps hold of the interest.  The result is that the borrower must scramble to make a repayment or default, in a secured or unsecured way.
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June 04, 2013, 08:03:10 AM
 #40

Inflation is not what causes interest, interest arises purely from liquidity premium, aka the value of liquidity.  The only argument among economists is to what the source of that liquidity value is.  The general Austrian answer (which myrkul endorsed last time we debated) was a time-preference in which everyone wants to engage in shortsighted consumption in the present.  Thus the 'good' savers who resist the temptations of immediate gratification are entitled to extract interest from the shortsighted gluttons, basically a kind of sick morality play designed to justify usury upon ones fellow man.
Wow, talk about distorting a viewpoint to suit one's own needs. If you were anyone else, I'd call that out as a textbook strawman.

No, my friend. Time preference is merely that: a preference. Austrians make no moral judgment as to whether or not savings is good and borrowing bad in a personal finance situation. It is what it is. Time preference is the value a person places on having money now as opposed to waiting. No more, no less, and no more "good" or "bad" than sexual preference.

The borrower and the lender come to an agreement that satisfies both the borrower's preference to have money now, and the lender's preference to have money later. As long as everybody's happy, there's no need to put any moral judgments on either side of the equation.

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