Under a stable purchasing power, I would want a positive return on a loan (interest); otherwise what's the point in lending it out? I lend 100 gold dollars for 105 gold dollars in a year.
In a deflationary period, where purchasing power increases, I would want a positive return; if I held the money myself it would gain purchasing power, and if I loan it out I could earn purchasing power on top of that.
In an inflationary period, where purchasing power decreases, I would want a positive return; if I held the money myself it would lose purchasing power, and if I loan it out I could earn purchasing power to regain some or all of those losses. But would I always be able to demand an interest rate that at least covers the inflation rate? If 100 dollars today would have the equivalent purchasing power that 110 dollars in the future would have, would I loan out for 105 dollars or only for 115 dollars?
I think I have an answer to this myself, but I want to make sure of this because of a lecture I'll be releasing by someone else.
filc:AKA evenly rotating economy
Thanks,
filc:The problem though is that many do not know specifically what the percentage of loss will be in his purchasing power. He can only make a speculative guess.
That's why I said that Hoppe is talking about the ERE. In the ERE there is no more uncertainty.
In the real world, the problem you are talking about is not unique to inflation or interest rate. It is simply the "problem" of uncertainty. That's why the market is a process. A process of entrepreneurship.
Hoppe is correct then. Perhaps he should have said that the rate will tend to cover for inflation. But you know, economists like to simplify life sometimes by referring to the ERE.
DD5: Nielsio:What's ERE? Everlasting Rotating Economy. Or what the mainstream economists call equilibrium state. Nielsio:Why would you have to at least cover inflation in order to lend money from someone? A person will lend out money only for a positive interest. If he expects his money to lose in value due to inflation, he will factor that into his calculation. Arbitrage operations in the market between the various alternatives for investment will bring the interest rate to be uniform for all types of investments. This means that if there is inflation, then that will have to be factored into the interest rate.
Nielsio:What's ERE?
Everlasting Rotating Economy. Or what the mainstream economists call equilibrium state.
Nielsio:Why would you have to at least cover inflation in order to lend money from someone?
A person will lend out money only for a positive interest. If he expects his money to lose in value due to inflation, he will factor that into his calculation. Arbitrage operations in the market between the various alternatives for investment will bring the interest rate to be uniform for all types of investments. This means that if there is inflation, then that will have to be factored into the interest rate.
But *why*? Hoppe explains that if you sit on your money and there is no inflation/deflation, you have the same value. So to loan it out you want compensation. I understand that; simple. Now, under inflation, don't we also have to compare loaning out money with sitting on it? Because if we sit on it it will lose value. So wouldn't getting more monetary units back in a year be better, even if we can't beat inflation?
DD5:That's why I said that Hoppe is talking about the ERE. In the ERE there is no more uncertainty.
Ahh yes good point. I didn't think of that. On a side note though in HA Mises seem to warn against generally making widespread blanket assumptions based on the ERE model. Perhaps Hoppe is still making a generalization error.
Mises pretty states that Human action in and of itself necessarily implies a state of change, a state where there is no equilibrium, for if there was there would be no need to change, no need for human action. So he basically states that an ERE is great only is so far as it helps us understand various concepts. But as a whole is a fallacy, an economy changes just as human action implies change. Prices, action, exchange, and all variants of praxeology necessarily imply instability.
Considering that I somewhat missed the point I may be off basis but perhaps it's worth mentioning anyways. Thanks!
filc: So he basically states that an ERE is great only is so far as it helps us understand various concepts.
And this is why Hoppe is using it.
Nielsio:But *why*? Hoppe explains that if you sit on your money and there is no inflation/deflation, you have the same value. So to loan it out you want compensation. I understand that; simple. Now, under inflation, don't we also have to compare loaning out money with sitting on it? Because if we sit on it it will lose value. So wouldn't getting more monetary units back in a year be better, even if we can't beat inflation?
Errmm.. this is a fairly brilliant point I had never thought of. But when a consumer has a high expectation of heavy inflation he has incentive then to move his investments away from low yielding securities, into high risk high gain vehicles. The problem though is that IS additional incentive which also drives the malinvestment bubble. So not only is it the excess credit which drives too much risky investment, it's the incentive to no longer invest in lower yielding securities but instead send your money to more risky ventures. And since everyone is doing this it drives more risky entrepreneurial behavior.
Nielsio:Now, under inflation, don't we also have to compare loaning out money with sitting on it? Because if we sit on it it will lose value. So wouldn't getting more monetary units back in a year be better, even if we can't beat inflation?
Yes but there are many more alternatives then just the 2 options you mentioned. You can invest in stocks, commodities, real-estate, etc..
The interest rate is the price of future goods in terms of present goods for all types of investment, and not just for the loans market.
DD5: Nielsio:Now, under inflation, don't we also have to compare loaning out money with sitting on it? Because if we sit on it it will lose value. So wouldn't getting more monetary units back in a year be better, even if we can't beat inflation? Yes but there are many more alternatives then just the 2 options you mentioned. You can invest in stocks, commodities, real-estate, etc.. The interest rate is the price of future goods in terms of present goods for all types of investment, and not just for the loans market.
But those are higher risk, and who says I want to take that risk? Maybe I only want low risk, even if that doesn't cover inflation. Hoppe seems to dismiss that option out of hand. Personally, I don't beat inflation with my current interest rate. That doesn't mean I'm going to gamble all my savings in the stock market. BUT I am still going to decide to keep my money in a savings account (and the rest of society with me). How does that not invalidate what he's saying?
Nielsio:But those are higher risk, and who says I want to take that risk? Maybe I only want low risk, even if that doesn't cover inflation.
There is no risk in the ERE. There is no uncertainty.
Nielsio:Hoppe seems to dismiss that option out of hand
No he's not. He simplifies the analysis by referring to the hypotheical ERE. The problems you raise regarding risk, or more appropriately, uncertainty, are present in every type of investment. There is nothing special about a bank loan.
Nielsio:Personally, I don't beat inflation with my current interest rate.
There were times of low inflation and high interest rates where people, in retrospect, certainly managed to beat inflation
Nielsio:That doesn't mean I'm going to gamble all my savings in the stock market.
You mentally factor that in with your monetary income from interest. There is a psychic component to your income that is not monetary. Monetary income (or costs) is itself just a sub-component of the total psychic income. Good Austrians never forget the psychic component of economic analysis.
Since the pure psychic component is not subject to monetary calculations, It is simply dropped out for simplicity. It is also assumed that the monetary component is often the main component anyway.
Hmmm I maintain that even when used as an example an ERE is a dangerous tool. It's very premise is paradoxical.
If there is no uncertainty, there is no action, there is no economy. An ERE assumes action takes place, which assumes uncertainty.
The only way an ERE would make any kind of sense is if we replaced humans with pre-programed repetitive robots.
By and large I think the points Nielso is raising, whether or not they pertain to Hoppe's speech, are wholly relevant and worth considering.
Investment behavior under inflation, as Nielso points out, necessarily leads to risky behavior, and only supports the boom portion of the business cycle.
DD5: Nielsio:But those are higher risk, and who says I want to take that risk? Maybe I only want low risk, even if that doesn't cover inflation. There is no risk in the ERE. There is no uncertainty. Nielsio:Hoppe seems to dismiss that option out of hand No he's not. He simplifies the analysis by referring to the hypotheical ERE. The problems you raise regarding risk, or more appropriately, uncertainty, are present in every type of investment. There is nothing special about a bank loan. Nielsio:Personally, I don't beat inflation with my current interest rate. There were times of low inflation and high interest rates where people, in retrospect, certainly managed to beat inflation Nielsio:That doesn't mean I'm going to gamble all my savings in the stock market. You mentally factor that in with your monetary income from interest. There is a psychic component to your income that is not monetary. Monetary income (or costs) is itself just a sub-component of the total psychic income. Good Austrians never forget the psychic component of economic analysis. Since the pure psychic component is not subject to monetary calculations, It is simply dropped out for simplicity. It is also assumed that the monetary component is often the main component anyway.
I don't see how any of this addresses my questions and my points. All I'm seeing are non-sequitors. Now, maybe I'm dumb. But this isn't helping me.
1. Hoppe doesn't bring up ERE, whatever that may mean. This means that this shouldn't have to be included for his explanation to work.
2. Yes, people may have beaten inflation with low-risk savings. So what? What does that have to do with the fact that currently I am not keeping my savings under my mattress and not investing with higher risk for higher reward? I am asking specifically how that doesn't invalidate his claim, and then you bring up some other situation. ???. Maybe I'm misunderstanding his claim. If that's the case please explain it in words that anyone can understand.
3. 'Good Austrians never forget the psychic component of economic analysis'. So what? What does that have to do with what I'm saying?
filc: Investment behavior under inflation, as Nielso points out, necessarily leads to risky behavior, and only supports the boom portion of the business cycle.
Well, I'm not necessarily saying that's true. But that would appear a result on what Hoppe is saying; if he thinks only inflation-beating loans would be extended.
filc:Hmmm I maintain that even when used as an example an ERE is a dangerous tool. It's very premise is paradoxical.
"Recourse to the imaginary construction of an evenly rotating economy is, as has been pointed out,[1] an indispensable mental tool of economic reasoning." (Mises, Ch 26,2 , Human Action)
filc:The only way an ERE would make any kind of sense is if we replaced humans with pre-programed repetitive robots.
Nobody is denying this.
Mises continues:
"But it is a grave mistake to consider this auxiliary tool as anything else than an imaginary construction, and to overlook the fact that it has not only no counterpart in reality, but [p. 702] cannot even be thought through consistently to its ultimate logical consequences."
filc:By and large I think the points Nielso is raising, whether or not they pertain to Hoppe's speach, are wholly relevant and worth considering.
There is nothing special about a bank loan with regards to the question of whether as part of the interest rate, inflation is covered for or not.
DD5:There is nothing special about a bank loan
Oh I agree. Investment is investment.
Am I the only one thinking that the reason the interest rate tends to stay above the inflation rate is because if it didn't (ie lending out would equal a loss in purchasing power) potential borrowers would just switch to commodities (i.e. gold) to at least retain most of their purchasing power? Of course governments can try (and often will) counter this to a certain point with taxes on commodities, but the point stays that if the inflation rate is continually higher than the interest rate, switching to gold would in the long run pay off even with a high tax for the initial purchase. I mean - this is basically why so many Austrians are currently investing in PMs.
LibertarianfromGermany: Am I the only one thinking that the reason the interest rate tends to stay above the inflation rate is because if it didn't (ie lending out would equal a loss in purchasing power) potential borrowers would just switch to commodities (i.e. gold) to at least retain most of their purchasing power?
Am I the only one thinking that the reason the interest rate tends to stay above the inflation rate is because if it didn't (ie lending out would equal a loss in purchasing power) potential borrowers would just switch to commodities (i.e. gold) to at least retain most of their purchasing power?
No, and you are correct- I believe.
For example, in around 1981-2, at the peak of the last severe bout of inflation[ roughly mid 70's through '81--2], interest rates on US treasuries climbed over 15%.
Meanwhile, gold peaked at around $800 per oz., and stocks "languished" so to speak.
Of course, lacking predictive capabilities, many gold bugs refused to sell at that '81 peak price , thinking the price would go higher still,[when it did not], and many other persons [again lacking those mythical predictive powers] refused to buy stocks [when the at this point ravaged stock market was preparing to go on a 20+ year joy ride!], or to consider buying US treasuries, which were [given the existing inflationary environment at the time] widely viewed as a way of guaranteeing future loss of purchasing power, it being assumed by many that the super-inflationary environment [comparitively speaking] of those years was bound to continue. Boy, were they wrong.
As they say: "hindsight is 20-20"
P.S. in a rare instance of prescience I am still unjustly proud of, I issued a "buy" signal to clients for gold in the mid '90's , when it was down around $250 per oz.
The truth is, I'm NOT prescient- I just got lucky that one time.
Regards, onebornfree
For more information about onebornfree, please see profile.[ i.e. click on forum name "onebornfree"].