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In A Gold Standard, How Are Interest Rates Set?

Posted by
June 7, 2012
in Blog

Submitted by Keith Weiner, President of the Gold Standard Institute, USA

Today, short-term interest rates are set by the diktats of the central bank.  And long-term interest rates are set in a “market” in which the central bank is obliged to keep coming back to buy ever more bonds, and speculators front-run the central banks to buy ahead of them.  The result has been that, for 30 years and counting, the bond price has been rising, which is the same as to say that the rate of interest has been spiraling into the black hole of zero.  When it gets there (and probably sooner) the entire monetary system will collapse.

This is the terminal stage of the disease of irredeemable paper currency.  They have banished money (gold) from the monetary system, and the result is a positive-feedback-loop that destabilizes the rate of interest.  The rate of interest has a propensity to fall, just like the value of the paper currency itself.

This leads to the question of how interest rates are set by a free market under a gold standard.  This is a non-trivial question, and the answer is profoundly important as we debate what sort of role gold ought to play and evaluate the various gold standards being proposed.

If people are free to own gold coins directly, then the mechanics of setting the rate of interest are simple.  Let’s define a term.  The marginal saver is the saver who could go either way, either holding a bond or a gold coin.  If the rate of interest ticks downward, he will sell the bond (or withdraw his money from the bank, thus forcing the bank to sell the bond) and buy the gold coin.  He would rather hold the gold than commit to the time and risk for such a low interest rate.  If the rate of interest ticks upward, he will buy the bond (or deposit his coin in the bank).

The marginal saver sets the floor under the rate of interest.  It cannot fall below his preference or else he will vote with his gold.  His preference has real teeth (unlike today)…

Continue reading at zerohedge.com…

image: flickr.com/401k