Will Gold or Silver Pay the Higher Interest Rate?

This question is no longer moot. As the world moves inexorably towards the use of metallic money, interest on gold and silver will return with it. This raises an important question.

Which interest rate will be higher?

The Wrong Approach

It’s instructive to explore a wrong, but popular, view. I call it the purchasing power paradigm. In this view, the value of money—its purchasing power—is 1/P (where P is the price level). Inflation is the rate of decline of purchasing power.

This view treats the quantity of goods you can buy as intrinsic to the money itself. This is a mistake, and it leads to a false theory of interest. Before I can present this wrong theory, let me define some terms.

The Nominal Interest Rate means the rate at which lenders lend and borrowers borrow in the market. The Real Interest Rate is the Nominal Interest Rate – inflation. Notice the switcheroo. The actual rate charged by actual lenders to actual borrowers is dismissed as merely nominal. A fictitious rate which is not used in any transactions is elevated to the status of real. Got that?

The theory asserts that interest is determined by inflation, that is, real interest> 0. With nominal rates below zero in Europe and elsewhere, this view is tempting and convenient.

According to this view, which metal has the higher interest rate comes down to which will have a faster-rising purchasing power. Most people would say silver, especially when silver is so cheap compared to gold by a long-term historical perspective.

Suppose silver’s purchasing power rises at 5% per annum (i.e. deflation) over the long run, then a nominal interest rate of 2% gives a real rate of 7%. If gold’s purchasing power is rising at only 3%, then its nominal rate must be 4%, if both metals have the same real rate.

First, and it should be obvious that, no one knows how prices will change in the future. Anyone who knew could make billions trading commodities futures. In any case, prices may change, but that is not the measure of the value of money. Consumer prices have many nonmonetary forces pushing them up (such as regulations and taxes) and down (such as improved manufacturing efficiency). At best, prices are a weak proxy for the value of a falling paper currency.

I don’t take the purchasing power approach….

Source: Will Gold or Silver Pay the Higher Interest Rate? | Zero Hedge


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