The flip side of falling interest rates is the rising price of bonds. Bonds are in an endless, ferocious bull market. Why do I call it ferocious? Perhaps voracious is a better word, as it is gobbling up capital like the Cookie Monster jamming tollhouses into his maw. There are several mechanisms by which this occurs, let’s look at one here.
Many people agree that it’s important to move to a free market in money (i.e. the gold standard). They also say that it’s just as important to fight bad taxes and regulation. In their view, government interference in the economy is like friction in a car. The more friction you add, the slower the car goes. One source of friction is much the same as any other.
Let me explain why money doesn’t quite work that way, using a few examples.
Money, Banking, and the Business Cycle provides a comprehensive defense of Austrian business cycle theory (ABCT). It shows that a free market in money and banking will create the most stable banking and monetary system that is possible.
If you borrow then it’s not income. This is why no one in his right mind borrows to buy consumer goods. Those who try cannot sustain it for long… But what if someone else borrows?
Central bank apologists assert that zero interest will help the economy. It hasn’t yet, and it never will. However, the main concern by both Fed defenders and foes alike is the worry that prices might rise. Well, prices aren’t rising now. So the former are smug and the latter are frustrated.
They miss the real harm of zero interest.
To make people eat their seed corn, we need to add the essential element: a perverse incentive. Let’s look at monetary policy in this light.
I wrote a story about poor Clarence who retired in 1979, and even poorer Larry who retired last year. I created these characters to challenge the notion of calculating a real interest rate by subtracting inflation. The idea is that the decline of a currency can be measured by the rate of price increases. This price-centric view leads to the concept of purchasing power—the amount of stuff that a dollar can buy. It’s the flip side of prices. When prices rise, purchasing power falls.
A woman will be on the new $10 bill, bumping Alexander Hamilton aside.
The notion of nominal interest paints a misleading picture of losing purchasing power..