Human action and the interest rate
People value present goods more highly than future goods. For instance, an apple available today is considered more valuable than the same apple available in, say, one month. This is expressive of time preference — which is an undeniable fact, a category of human action.
The sentence “Humans act” is a logically irrefutable truth. It cannot be denied without causing a logical contradiction. By saying "Humans can not act”, you act and thus contradict your very statement.
From the true insight that humans act we can deduce that human action takes place in time. There is no timeless human action. Were it otherwise, people’s goals would be instantaneously reached, and action would be impossible — but we cannot think that we cannot act.
The market interest rate is expressive of time preference, and as such, it is also a category of human action. If determined in an unhampered market, the (natural) market interest rate denotes the discount that future goods are subject to relative to present goods.
If one US-dollar available in a year is trading at, say, 0.95 US-dollar, it means that the market interest rate is 5.0% (the calculation is: [0.95 / 1 – 1]*100).
Should people start valuing present goods more highly than future goods — which is expressive of a rise in time preference —, the discount on future goods vis-à-vis present goods and thus the market interest rate go up.
If peoples’ time preference declines, the discount on future goods vis-à-vis present goods drops, and so does the market interest rate — meaning that people wish to save more and consume less out of their current income.
The interest rate and central banking
In an unhampered market, the market interest rate reflects peoples’ time preference. Nowadays, however, the market interest rate is no longer determined in an unhampered market. It is dictated by the central bank.
Central banks set short-term interest rates by providing commercial banks with credit. In doing so, they exert a strong influence on short-term interest rates. In more recent years, central banks have also been determining long-term interest rates through bond purchases.
The rather uncomfortable truth in this context is that central banks, in close cooperation with commercial banks, keep issuing new money produced through bank credit that is not backed by real savings.
The purpose of such a money-increase-through-credit-creation-scheme is to bring down the interest rate: to deliberately suppress it to a level that is lower than the level of the market interest rate determined in a free market.
This has far-reaching consequences. The artificially lowered market interest rate tempts people to save less and consume more – compared to a situation in which the market interest rate had not been artificially lowered.
As savings decline and consumption increases, the lowered market interest rate causes new investment, and the result is an artificial economic upswing. However, such a “boom” is not sustainable, and at some point it will have to turn into a recession (“bust”).
This is, in a nutshell, what the Austrian Business Cycle Theory (ABCT) says about the consequences of the central banks' meddling with the market interest rate. However, there is much more that the ABCT reveals.
Central banking and valuation
In fact, the ABCT tells us that central banks, by manipulating the market interest rate, tinker with humans’ valuation scales. Pushing down the market interest rate does not only result in declining borrowing costs or rising stock and housing prices.
These are merely symptoms of a more profound and most elementary cause — namely central banks influencing the way people value the present satisfaction of wants relative to the future satisfaction of wants and act accordingly thereupon.
Through artificial depression of the market interest rate, people are compelled to value present consumption higher than future consumption. In fact, they are compelled to care less about the future and more about the present.
Saving for future needs is discouraged, consuming in the present is encouraged. Furthermore, artificially lowered interest rates persuade people to give up a debt-free life and run into credit to bring forward future consumption to the present.
The disconcerting insight is that such an increased valuation of present needs relative to future needs affects all fields of human action — such as peoples' valuation of, e.g. education, family, manners, you name it.
The artificially lowered market interest rate makes it less attractive for the individual to spend hours learning, as it would mean reducing present consumption in the form of leisure time. As a result, the quality of general education can be expected to decline.
Starting a family appears to become more self-sacrificing and burdensome — as parents have to forego present consumption. Also, divorce increasingly seems to be an appealing way out of current relationship problems.
Having good manners — getting out of somebody's way, saying good morning, helping a stranger across the street, and so on — is considered less rewarding, as it often means restricting present consumption, forgoing potentially higher consumption in the future.
Valuation and human action
By directly influencing peoples' valuation scales through the manipulation of market interest rates, central banks affect every aspect of peoples' lives. It amounts to a "Revaluation of all Values", to use a term coined by the German philosopher Frederick Nietzsche.
It should be easy now to see that the root cause of many severe defects in social matters can be directly or indirectly traced back to central banking. There should not, actually cannot, be any presumption of innocence as far as central banking is concerned.
As a final point, let us address the issue of “speculative bubbles” in financial markets. Of course, prices sometimes overshoot or undershoot, inflate and then deflate, as investors try to bring a financial assets' price in line with its estimated value.
Fear and greed, panic and optimism, stupidity and wisdom, all play a role in forming financial asset prices — as people are what they are. However, it is central banking that drives peoples' dispositions and actions to extremes.
By pushing down the market interest rate below its natural level — which becomes chronic if and when the money supply is increased through bank credit expansion not backed by real savings —, central banks inevitably coax investors into becoming overly high-spirited.
In that sense, central banks are to be held responsible for aggravating, or even inducing, speculative bubbles. To make it even worse: Once the speculative bubble pops, people become dispirited. They blame the free market or capitalism for their plight.
They do not see — often misguided by mainstream economics — that the root cause of the trouble is central banks' downward manipulation of market interest rates in the first place, which is made possible by central banks running an unbacked paper money system.
To conclude: The indisputable insight that central banking brings about a "Revaluation of all Values", which is neither in the economic interest of the people nor ethically justifiable, should encourage efforts to put an end to central banking.
Any such effort must propagate the intellectual insight that central banking is very harmful to the society, and it also requires truly bold and determined action, for "We know that no one ever seizes power with the intention of relinquishing it,” as George Orwell put it.1
1. Orwell, G. (2008 ), Nineteen Eighty-Four, Penguin Books, p. 276.
Dr. Thorsten Polleit, Chief Economist of Degussa and macro-economic advisor to the P&R REAL VALUE fund. He is Honorary Professor at the University of Bayreuth.