If we were actually on a real gold standard, there's no way that interest rates for demand deposits would be as high as 3-4%. This is particularly true in the middle of a big depression. - Bilow You are mixing two concepts here: the monetary standard and the interest rate pricing. Let's focus on interest rates. In a free market, you are correct that interest rates typically fall during a big depression. It is even fairly common during a recession. You can see it in any long term interest rate chart that shows shading for recessions. What is most interesting is what happens after the recession/depression is over, in response to central bank manipulations. Typically, during recessions/depressions, the central banks lower rates and engage in massive monetary stimulus, such as QE or other similar methods. That doesn't typically result in inflation during a recession/depression, but rather it artificially lowers the price of money, which typically spurs increased investment or other uses of that money. Inflation only comes later, after the economy has picked up steam from all the mal-investment. Then the low interest rates and increased money supply can serve to drive up prices across the board. It's a loaded spring. It's similar to what happened in the lead up to the 70s and 80s. Eventually, rates got out of control. Hopefully, this time, the Fed gets ahead of the curve, but I don't give them too much of a chance to be prescient. They have a dismal record at that.
There is no "fair" interest rate. Instead, when you put money into a bank, the bank is able to pay you interest *only* because there is another person who takes money out of the bank. - Bilow This is simply not true. A fair rate of interest is determined by the willingness of the borrower to pay and the assessment of the risk of lending to the borrower by the bank. In a free market, millions of borrowers represent demand for loans and the banks determine how much interest they charge those borrows based on macro variables, as well as borrow specific variables, such as credit rating. Central banks distort the free market price of money, or interest rate, but artificially setting rates that they will lend at. When they set the rate lower than the fair market rate, they are adding stimulus to the economy.
A deep depression like the one we're in now is caused by the rich people deciding that they do not want to spend money. Instead they decide to save it. This causes funds to build up in banks and as a result interest rates drop automatically. - Bilow This is pure Keynesian horse shit. Depressions are not caused by rich people deciding not to spend. Depressions are caused when a long period of malinvestment creates speculative bubbles and overcapacity, and those bubbles then burst, creating a period of adjustment as the malinvestment is cleared from the economy. An example is all of the fiber optic cable that was built in the late 90s and early 00's as the massive build out of the internet was going on. Prices for all that internet capacity were rising steadily, as demand for internet bandwidth skyrocketed from all the new internet companies and user community, causing firms to over invest in fiber networks. Eventually, too much was built by firms believing the party would never end. Greenspan helped prick the bubble by increasing rates to 6.5%, because he was worried about "irrational exuberance". When the bubble burst, that overcapacity drove prices down and bankrupted many companies or caused them to merge, until supply and demand reached equilibrium at much lower prices. The deep recession was caused by speculative activity enabled by cheap money from VCs and banks, leading to over-capacity. The low prices stayed until demand grew enough to start soaking up all that new capacity. With so many fewer companies demanding loans, banks had to lower rates to attract new borrowers. In addition, Greenspan helped the process along by lower rates dramatically. That's why rates decreased in that recession.
Now, here's a question for you. In the above graph you can see the zero percent interest rates prevailed for about a decade from around 1930 to 1942. That's a lot longer than we've experienced so far. And was there a massive burst of inflation at the end of that period??? There was not. In fact, the US remained on a nominal gold standard throughout these years. - Bilow Yes, actually, there was. There were two major inflationary spikes in the 40s, as you can see from this chart. The first was an inflationary burst above 10% in 1942, and the second almost hit 20% in 1947. Truman had to combat inflation as price controls were lifted and consumption spending increased dramatically with the returning soldiers from the war. It was quite an ugly period with inflation hitting 6% in one month during the Truman Presidency (http://en.wikipedia.org/wiki/Harry_S._Truman#Strikes_and_economic_upheaval).
In 1964 I could have gotten into a movie for about 8 quarters. Those silver quarters are now worth considerably more than $8. Does that mean that the Federal Reserve has done the opposite of theft? That they've given me money? - Bilow Again, you get it entirely wrong. The fact that the value of the dollar declined relative to silver is a case in point on how the Fed destroys your wealth through inflation. You have proved my point for me.
But most paper money decreases in value with time. And that is a sort of theft. But in the absence of inflation, you'd never see short term interest rates of the "3-4%" you're quoting. What you're doing is trying to have your cake (high interest rates) without eating it (and having inflation). - Bilow I think we finally agree on a few things in this portion of your post. You are correct in saying that as interest rates rise, so does inflation seem to be correlated with that rise. The reason for this is that in a free market, there are many variables and those variables are constantly working within the system to reach equilibrium, until new forces push it out of whack and the process starts again. If a good becomes popular and demand rises faster than supply, then prices go up. As long as demand continues to increase faster than supply, prices will continue to increase, until supply catches up with demand and surpasses it, bringing prices back down. As things start to look frothy, central banks try to intervene by increasing interest rates. Thus, you tend to see inflation of prices coinciding with increased interest rates by central banks.
My key point is that if the central bank NEVER intervened, the market would do it for them. When prices rise high enough, many new companies will enter the market to take advantage of the huge spread between market prices and the cost of supply, until eventually supply over takes demand. Then they have to sell off all that excess supply against smaller demand, which brings prices back down. Sometimes, it happens swiftly, which is felt as a recession or depression. Other times, it happens in a more orderly manner. The speed is dependent on how much speculative excess was involved. Typically, when central banks are manipulating rates, there is a bullwhip effect to the economy, which gets whipsawed back and forth due to the mistiming by central banks. I far prefer to let free markets price interest rates, because I believe the self-interested actions of millions of market participants is always a better pricing mechanism than a central banks engaging in price controls through manipulating the price of money, other wise known as the interest rate. |
