A Free Market in Interest Rates

Unless you’re living under a rock, you know that we have an administered interest rate. This means that the bureaucrats at the Federal Reserve decide what’s good for the little people. Then they impose it on us.

administered interest rate

In trying to return to freedom, many people wonder why couldn’t we let the market set the interest rate. After all, we don’t have a Corn Control Agency or a Lumber Board (pun intended). So why do we have a Federal Open Market Committee? It’s a very good question.

Someone asked it at the recent Cato Monetary Conference. George Selgin answered: no matter if the Fed stands pat or does something, it’s still setting rates. This is a profound truth, which brings us to a fatal flaw in the dollar.

In our irredeemable currency, interest cannot be set by the market. There’s literally no mechanism for it. To understand why, let’s start by looking at the gold standard.

Under gold, the saver always has a choice. If he likes the rate of interest, he can deposit his gold coin. If not, he can withdraw it. By withdrawing, he forces the bank to sell an asset. That in turn ticks down the price of the bond, which is the same as ticking up the rate of interest. His preference has real teeth, and that’s an essential corrective mechanism.

Unfortunately, the government removed gold from the monetary system. Now you can own it, but your choices have no effect on interest. If you buy gold, then you get out of the banking system. However, the seller takes your place, getting rid of his gold and thereby taking your place in the banking system. The dollars and gold merely swap owners, with no effect on interest rates.

The Fed has kicked savers to the curb, along with gold. Now the dollar is considered to be money. And what is it, exactly? The dollar is the Fed’s IOU. If you have dollars, then you are funding the Fed. You—along with billions of others around the globe—are empowering the Fed. It can lend at any rate it wishes, because it has a seemingly unlimited credit line. The Fed is lending your wealth to profligate borrowers who use it for nonproductive purposes—and that’s putting it mildly.

The Fed can buy mass quantities of long term bonds. Obviously, this has a profound effect on the interest rate. However, it has a more important way of influencing rates. The Fed dictates the rate for short-term borrowing. This enables banks to borrow short-term, at nearly zero interest, and use the proceeds to fund the purchase of long-term bonds.

Normally that’s unstable, because the bank’s funding keeps expiring. Imagine buying a house, using a loan with a balloon payment after one month. Every month, you would be sweating bullets about getting a new loan. Banks don’t have to worry about this, with the Fed as lender of last resort. They love this trade, because they pocket the difference between the interest rate they pay (near zero) and the interest rate they earn on long bonds (over two percent). It’s a crony handout, unfair to the people.

More importantly, the banks are pulling the long-term rate down near the short-term rate.

Getting back to the question about an interest rate market, we have to ask: how else could the present system work? The Fed is the source of what passes for money. Even if it could just stop lending—and this would quickly lead to disaster—that would still be a monetary policy.

So long as we use the Fed’s IOU as if it were money, then the Fed is in charge of our interest rate. It’s that simple.

Keith Weiner is president of the Gold Standard Institute USA in Phoenix, Arizona, and CEO of the precious metals fund manager Monetary Metals. He created DiamondWare, a technology company that he sold to Nortel Networks in 2008. He has his PhD from the New Austrian School of Economics. He lives with his wife near Phoenix, Arizona. In March 2015 he moved his Gold Standard column from Forbes to SNBCHF.com.
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1 comment

  1. thom stines

    While this is some good info, the theory herein is as flawed as is reliance on the Fed.

    Gold, as a resource and asset, is limited and can thus, and will be hoarded by a relatively few.
    That hoarding allows a few to control the mechanisms of that resource (like interest rates).

    As a limited, and thus scarce resource, though in practice ANYONE could just go out and mine/pan for new gold, at some point the return on such activity would not be prudent/profitable, thus not worth the time/labor involved engaging in that activity.

    The various gold rushes of America have proven this (relatively few “prospectors” made enough money to make it worth their while).

    This is flawed in much the same way our current system is flawed.

    In your own words, “By withdrawing, he forces the bank to sell an asset. That in turn ticks down the price of the bond, which is the same as ticking up the rate of interest.”
    Thus by hoarding more gold, and preventing massive withdrawals (or initiating such), a few can still manipulate interest rates.

    Recent history of Bitcoin shows the failure of even “decentralized” “currencies”….and all things of perceived “value”.
    The majority of Bitcoin were held by few. By hoarding (supply side), thus restricting access (demand side), this drove prices upward (via supply/demand), creating the bubble that finally burst.
    And this boom to bust didn’t take all that long.
    Those that sold high made a killing off those that bought high.

    There are so many resources available to humans. To place extraordinary or inequitable value on just a few is ALWAYS problematic.

    “Value” of anything is really just a psychological state/phenomenon.

    People that live for money live to create “value” in that which they seek to profit from, enticing others to “value” those things, transferring that “value” in the form of wealth to those that created it.

    Gold is no different.

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