In ancient times, people hoarded whatever they could. Salt, and later silver, worked well because they are nonperishable, widely accepted in trade, and easy to store. People accumulated stockpiles, buying a little at a time. Then in retirement, they sold some each week to pay for food and other expenses.
Hoarding works, though there is a major drawback. You can never be sure that you have enough. You can outlive your savings. To try to avoid this disaster, you have to spend as little as possible. Neither the worry, nor the austerity, make for much fun in your golden years.
People eventually discovered a better way. Lending is a win-win deal that makes life a whole lot better. A business needs capital to increase production. It borrows money, and in exchange offers to share some of its new profit with the lender. The lender is a saver or retiree who is glad to put his money to work. He is earning money on his money—interest. Interest greatly accelerates wealth accumulation during his working years. Interest allows him to live in retirement, without literally eating his capital.
It is impossible to overstate the importance of interest. It literally built our civilization. From the voyages that discovered and colonized the New World to the industrial revolution to the large manufacturers in the 20th century, there is one thing in common. They would have been impossible without raising capital. This capital was invested to obtain a return.
Unfortunately, the Fed has been waging a war on interest for decades, pushing it down. Now the interest rate is nearly zero. The Fed’s economists tell us that this somehow helps employment. It doesn’t, but it does inflict collateral damage.
For instance, it harms the saver. Zero interest drags down his rate of capital accumulation. At least the saver is still working, but those who can no longer work are even more vulnerable. Economist John Maynard Keynes called for the “euthanasia”—his term—of those who depend on fixed income, like retirees.
Having one’s income cut off can feel like being strangled. Most people won’t sit there passively. If they can’t earn interest, then they turn to an alternative. They’re forced to speculate. This creates bubbles—rising asset prices—like real estate in the 2000’s. There’s always a good bubble inflating somewhere, and people pile in.
Bubbles pop and speculators take big losses. However, there’s an even more important, but subtler, point. An entire generation can’t pay for retirement by speculating their way to wealth. Let’s look at why not.
Bubbles do not produce new goods and services. They don’t create new wealth. For example, there was a copper bubble from 2009 to 2011. The price of copper more than tripled from $1.40 a pound to $4.60. Lots of people bet on it.
Consider the fictional case of Joe, who bought $100,000 worth of copper. A few months later, he sold some. He took a profit, yet he still has $100,000 worth of metal.
There is an old saying that you can’t have your cake and eat it too. And yet here’s Joe, who still has his money and he bought a motorcycle also.
It’s not possible to consume without producing. Yet, while Joe’s copper wager produced nothing new, he consumed the bike. Logically, if Joe did not consume new production then he must be consuming old production.
Joe consumed part of his savings.
Joe doesn’t see the loss, because he is only thinking in dollars. Instead of looking at the trade in terms of paper, let’s focus on the loss of metal. Joe starts out with 15 tonnes of metal. He sells four to buy that new Harley, and has 11 left. Joe spent a big chunk of his copper, and now he has less.
Most people don’t want to eat their capital. However, in a bubble they’re tricked. They think copper went up, but it’s just a mirage. In reality, the copper only went out—out the door. Now it’s gone.
Speculating may seem similar to earning interest, but it achieves the opposite result. Interest creates new income by financing new production. Speculative gains come from paying out existing capital as income, and consuming it. We are all harmed by this destruction.
Interest rate suppression undermines our civilization. It destroys the capital on which it depends.
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