Assume a closed system (island) with 100 people each owning 100oz of gold. Each have deposited their gold in banks paying 1% interest. At the end of one year there will be 100 bank accounts, each showing 101oz of gold on their balance sheet. If all depositors asked for their gold back, where would the banks (physically) find the extra 100oz (interest) to pay ALL of their depositors in full?
The above scenario leads to the conclusion that charging/paying interest would be BOTH impossible AND unnecessary under a 100% gold standard. Depositor’s savings would “grow” by their mere increased purchasing power. The investment of their savings would create more goods (value, wealth) in the system which – under the fixed money supply assumption – would mean lower prices, thus higher wealth for each depositor.
So why and (more importantly) HOW does interest even enter the picture?
Interest enters the picture when the banker loans out the gold (or a receipt promising to pay) at interest. If the population increases (we all know this happens) then there will be a shortage of money in which the banker will gladly fill by loaning a promise to pay. If the banker can capture through interest just 10% of the money supply and loan that back out with the magic of compound interest, it would take him no more than 25 years at 10% interest to own all the gold.
Now that the banker has removed all the money from circulation you’re completely at the mercy of the banking system who only loans a promise to pay you that is not court enforceable but you’re promise to pay him is. He has become your master.
This is why interest must be outlawed and destroyed.
its called net consumption (net investment may also be involved.
it involves the true facts that money circulates; and more particularly capitalists spend. they don’t just make loans and call them in, they actually spend money on goods.
In this hypothetical closed system, 100 people will not eat or otherwise consume anything for a whole year, and at the end of the year there will be 100 bank accounts each showing 101oz of gold on their balance sheet, and, thankfully, not a soul to collect.
As you can see, absurd premises equal absurd conclusions. In reality a banker’s ability to pay interest represents his using the money in the meantime to earn a return greater than the interest rate he is paying.
People have to consume in order to continue living, and in order to do that they have to make exchanges. In order to make exchanges in a money economy, people have to have money. If people have to have money, they can’t put it all in the bank.
Interest enters the picture as a portion of profit which is paid back by the entrepreneur to those who provided the capital. So long as there is profit, there will be interest.
Paying interest on deposits arose only because of fractional reserve banking. The banks decided that, in order to convince depositors to remain with them, they had to share with them a slice of their fractional reserve inflation, thus in a sense limiting their exposure to fractional reserves.
Needless to say without fractional reserve banking paying interest on deposits is both pointless and impossible.
This question has come up before, but in reverse. The previous scenario was that all the gold in existence belonged to the banks and was loaned out at interest, so there couldn’t possibly be enough gold to pay back all of the principle plus the earned interest. The answer to that scenario was simply that some of the loans would go into default. A bank is a business like any other and some of their decisions will turn out to have been bad ones.
In your hypothetical scenario the first question to ask is what will the banks do with the deposits they are paying interest on? If you allow the banks to loan the deposits out at interest then the answer is the same as in the above scenario, except that now some of the depositors are going to lose their deposits. Making a deposit in a bank is a business decision and it involves risk. If on the other hand you don’t allow your hypothetical banks to loan out the deposits then you need to explain why would the banks accept the deposits and agree to pay interest on them in the first place?
I have to say that this is still far from clear to me.
I’m sorry, but could you please clarify?
Why can’t there be profit (increase in wealth) without interest? Why is interest even necessary? If money is there to act ONLY as an exchange mechanism, why can’t there be just a fixed amount of it, with its value (measured in other goods) constantly increasing – i.e. prices of those goods constantly falling – as new wealth/value/goods are being created?
Let’s not even go to hypothetical/absurd situations. Let’s just make a somewhat more realistic assumption that we’ve dug out all the gold available on this planet (we’re increasing its amount out at a rate of 1-2% annually, anyway) – currently about 150,000 tons or a cube of 25x25x25 meters worth about $5.7 trillion. The planet switches to a gold standard. 6 billion people have gold deposits in their banks and in their homes, free to be spent or saved (lent out). Banks and individuals lend those deposits to businesses in which these 6 billion people (business owners and workers) go to work every day and create new value/wealth/goods with their labor. After a year, the planet is richer because of the new value created BUT there’s still only 150,000 tons of gold. If the bank deposits were earning interest (or, businesses were charged interest on their loans) – say, rates were 5% globally – where would these NEW tons of gold appear to cover that interest? Isn’t the ONLY logical conclusion that interest rates would have to be (or converge to) zero under a 100% gold standard?
So far, this was the closest to how I understand the situation. Good to know I’m not alone in coming to this conclusion.
Looks like you’re assuming a zero-sum situation: In order for SOME to get their deposits with interest others MUST have a loss. Why is this zero-sum assumption necessary? Is it even correct, as it simply brushes off the ACTUAL wealth/value/goods created by business and workers over the year? Is it impossible to conceive a scenario where this planet is actually better off OVERALL after a year’s worth of business and commerce performed by 6 billion people?
To me, it is obvious that this planet DOES actually get richer with every passing year, on average. I don’t see why a fixed amount of 150,000 tons of gold couldn’t be used in perpetuity as an exchange mechanism between agents, and covering an ever increasing amount of wealth/value/goods/services. Without interest, banks would simply be safe-keepers for people’s deposits, for which service they would CHARGE a small fee (say, 0.05%/year). For a depositor, his 100oz of gold would become 99.95oz after a year, BUT they would be buying MORE goods/services than his 100oz bought last year, thus making him richer WITHOUT anyone neither earning nor paying any interest.
I’m just letting my mind roam here, and I’m sure there are holes to be poked. For instance how would competition for savings/loans work without interest rates acting as a way to PRICE loans? So poke away…
Why would you need new gold to cover new debt or pay interest? Is everything on earth bought with all the gold on earth all at one time, once a year? No. In the real world, any currency can be used more than once. So the problem you see is a nonproblem.
As for “Why do we even need interest?” Interest is the fee a user of capital pays the owner of the capital in order to use it–it’s a function of time-preference–the interest rate is determined by individuals’ time preferences, IE how much they prefer goods now to goods in the future. Have you read the relevant material in, for example, Human Action, or Man, Economy and State?
There’s a strong correlation between the forbidding of the charging and payment of interest (usury) and economic stagnation–The Dark Ages. Interest is a good thing, and a necessary thing. Do a little self-education and I’m sure you’ll agree. :]
George Reisman, in his work Capitalism: A Treatise on Economics (1996), disputes current and past theories of aggregate profit by turning them on their heads. He calls profits the original and primary form of income from which wages are deducted, thereby providing a powerful answer to the Marxian exploitation theory. He delimits time preference to the role of determining the rate of net consumption, which last, he argues, is the primary direct determinant of aggregate profit. He promotes net investment as a secondary determinant of aggregate profit because net investment tends to relate directly to an increasing quantity of money in the economic system. Through his “springs to profitability” he demonstrates how the elimination of profit due to a financial contraction must be temporary. And, by showing that under an invariable money, a one-time increase in the rate of saving is sufficient to stimulate an increase in the supply of capital goods indefinitely, he provides an answer to the argument for the declining rate of profit in a progressing economy.
Again, my disclaimer that I am not trying to argue a point here. Just trying to understand things. So if the totality of ALL gold (i.e. cash, under a gold standard) deposits in ALL banks on this planet earned SOME (non-zero) interest under a 100% reserve system, you don’t see the need for new gold to cover that interest? If the value of all accounts was 100,000oz, earning interest of 5%, wouldn’t the value of all accounts be 105,000oz after a year? Wouldn’t the value of those accounts (in gold) grow each and every year?
Can’t the same time preference be expressed without any interest? As prices would inevitably be mostly falling wouldn’t I still be able to express how much I prefer (less) goods now to (more) goods in the future?
No one mentioned forbidding anything. I was only wondering if/whether (gold) interest rates wouldn’t logically converge toward zero in a free market under a 100% gold reserve system.
Nir, I’ll check out that link. Thanks.
Still, those 100 people are not sitting on their sofas all year. New wealth/goods are being created, so at least in this sense it is NOT a zero-sum, but definitely a positive-sum system. The only thing that’s not changing is the total amount of gold. Wealth/goods grow every year, obviously, so it is conceivable that all 100 people can end up winners (better off than last year) without ANY losers to “pay” for their wins.
You didn’t ask about wealth. You asked about gold. Your question was: "If all depositors asked for their gold back, where would the banks (physically) find the extra 100oz (interest) to pay ALL of their depositors in full? ". The answer to that question, assuming there is no gold mine on the island, is that some banks will not be able to pay.
Though they ALL would be able to pay back if bank deposit rates were zero. At the same time, seeing how prices of goods are falling (as they must be due to growing goods and fixed amount of gold), it is conceivable that depositors would be happy getting no interest on their deposits at all. As a matter of fact, there’d be no need for banks as we know them today. They’d be reduced to mere vaults, charging depositors safe-keeping fees, and that’s about it. Now if I wanted advice on how to invest or lend out my gold, there’d be experts ready to provide it to me for a fee, as well. No need for the bank (vault) to be bothered with that function at all.
I think I’m beginning to form an answer here. We’ve been seeing banks as we see them today for such a long time that we’ve grown accustomed to their DUAL functions of safe-keepers AND lenders of depositor’s money. The only way banks can guarantee their deposits while, at the same time, exposing them to risk is through a fractional reserve system backed by a fiat money central bank. So everyone’s being bamboozled into thinking that we can all have our cakes and eat them too, to eternity. [:)]
Under a 100% reserve gold standard you wouldn’t allow your money to be lent out (exposed to risk) without something (interest) in return, that much is clear. But you would be wise to make a distinction between a safe-keeping deposit (by which you specifically contract the vault to safe-keep your gold for a fee) AND a lending “deposit” (by which you specifically contract someone’s services to advise you on the best way to expose your gold to risk through investing/lending and, of course, seeking profit/interest in return).
How much of the total gold would be safe-kept (at zero interest) and how much of it would be lent/invested would be decided by the market, and it would be this supply of funds (gold) available for risk-taking against the demand for it (businesses, entrepreneurs, needing it) that would drive the interest rates to some (non-zero) market levels.
So the answer to my question would look like this:
If all gold deposits were exposed to risk (lent out) at all times, then, yes, they would all be demanding interest BUT some of them would not get their deposits + interest back – which is how RISK is supposed to work.
I thank everyone for the discussion so far. Always open to more views and explanations.
are you ascribing all ‘originary interest’ or the economy wide ‘rate of profit’ to the phenomenon of risk? thats a component only…
aren’t you looking for an explanation of how business can year after year have revenue that exceeds costs. accounted in money terms. even under invariable money supply.?
the answer is convincingly given in Reisman’s work.
of course if you were not thinking of ‘originary interest’ in that way; feel free to ignore the above.
unlimited, certain, present disposal of a good P limited, uncertain, postponed disposal of a good.
Temporal disposal has goods-character, and is valuable. I prefer to pay interest for a long time, rather than buy goods on my own lump sum, for instance. Lump sum exceeds any one interest payment. Sum of interest payments may, in fact, exceed lump sum, but they are not a sum: they are distributed in time.
Everyone has time-preference: commodity-money WILL circulate; there will not be accounting such that the interest is simply in EVERYONE’s storage. For there to be loans, there are always a preference ordering outlined above, and its reverse.
I don’t know the meaning of ‘originary interest’. But, yes, those are all very good questions, and, as I wrote, I’ll check out Reisman. Thanks.
So far, I think the picture I have is close to complete, and I learned about some new angles on money in this thread. But there are likely components that I could still be missing. It’s amazing how such (an initially simple-looking) concept can in reality be so complex and have so many facets.
Why does the wealth represented by the interest payments have to come from outside the economy? Consider your example: The fact that the bank is paying interest on deposits implies that there is economic activity on the island and thus material wealth is growing (assuming the presence all the prerequisites like natural resources). Now ignoring interest for the moment, if we observe that the monetary base is constant and there is trade (as is the inevitable result of any kind of voluntary human association), we can conlude, as Mises does, that prices for goods and services will deflate, ie: the purchasing power per unit of money goes up.
In trade the end goal is to profit, to attain for yourself a material state preferable to your previous one. An entrepreneur has to decide wether he can generate enough revenue in order to cover both his costs and paying back the loan before he decides to accept a loan contract (hopefully he’ll turn a profit too). Assuming he accepts the loan and indeed uses the capital to turn a profit he can now pay back the loan with interest. Notice that, under 100% reserve, every rise in your cash balance necessarily implies a corresponding drop in the cash balance of another party and thus profit can be generated without any additional money having entered the system. If profit can be generated, interest can be paid on loans which the bank can then use to pay interest on client’s deposits.
The interesting implication from this scenario is that it is not at all necessary to deposit your money in a bank in order to keep your wealth from shrinking.