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Foreign. Principles of Economics. My complete guide to Understanding Economics is now available in hardcover, audiobook and ebook from seifeddin.com, amazon and many more booksellers worldwide. And now I am also teaching a course based on this book on my website seyfeddin.com Principles of Economics will run the whole academic year from September to June and will have a new lecture every two weeks as well as weekly live online discussion seminars open to learners from all over the world and from all walks of life. Whether you're a student, a professional, or a retiree, you are making economic decisions every day and this course will arm you with the wisdom of centuries of economists to improve your economic decision making. You'll also get a free book of Principles of Economics. If you sign up for the course, go to seifedin.com and sign up now. Hello and welcome to Lecture 14 of the Principles of Economics online course on seifooddeen.com Today's lecture's topic is credit and banking. So if you remember lecture 13, we started discussing time preference and it is very important to specify why we jumped to lecture 13 and time preference specifically after chapter 12 when we discussed the market economy. And I'll give you a little bit of an idea about my thought process about how I structured this book and it really took me a lot of time to figure out how to structure the book. So we did have a discussion on money in chapter 10 and this led naturally to the discussion this was led to naturally from the discussion of markets, how markets function, trade, and all of the tools that people economize while trade is one tool. And then the natural step after explaining trade is to explain how trade happens with a medium of exchange which is money. But then once we have money, I thought it would be best to sum up all of the first 10 chapters in chapters 11 and 12, which explain what a market economy is and how the market system functions and then what a capitalist economy is and what is capitalism. Once we've explained these, and we've explained how the economic system of a free market capitalist economy functions, then I thought it would be good to get back into discussing money in detail. I could have continued after chapter 10 and moved to chapter 13, time preference, and so on, but I thought it would be probably best to wrap up the part on economizing, individual economizing, and group economizing, wrap them up together with chapters 11 and 12 and then have a whole section of the book. This section, section four focused on money specifically, and to do that we'll be able to discuss all of the issues pertaining to money, beginning with time preference. And the benefit of it is that it's going to be a lot easier to explain the important concepts about money after we've discussed how markets work and after we've discussed how capitalism works. Because, as you're going to see in this chapter, in chapter 14, we utilize the analysis of chapter 10 in terms of thinking about markets and supply and demand for understanding the capital markets. And so it was important to mention the concept of markets in chapter 10 before we begin to dig in deep into the concept of money in these chapters, chapters 13 to 15. In this chapter, chapter 14, we discuss credit and banking. What is the importance of the function of credit in an economy and what is the function of banks and what is banking? And this is, of course, a hugely important issue in economics. So the starting point for understanding money, capital and banking from the Austrian perspective has to be time preference. If you start from time preference, you can build everything up logically. In other schools of economics, they don't give time preference this kind of central importance in this discussion. And so it's possible to begin discussing money without spending so much time on time preference. But for me, I think it is enormously important. And as we're going to be seeing in the distinction of the topics discussed in chapter 14 and chapter 15, the distinction between commodity credit and circulation credit is enormously important. And it's not possible to establish that understanding of the distinction between the two that Mises discusses without first mentioning time preference and the important role that time preference has. So we discussed time preference in the last lecture, we spoke about why it is so important, so pivotal. In this lecture, we build on that, and we start off from the point that time preference is the starting point of monetary economics, because it is only through time preference that we are able to lower, that we're able to accumulate savings and therefore have money and have credit and have banking. It's only because of time preference declining that it becomes possible to forego consumption and save, which makes capital available for borrowing. Without lowering time preference and saving, there can be no capital. If you consume everything, there will be no capital left. If you eat all of the corn that you have, you will have no corn to plant. And if you consume all of your income, you will have no income to save and therefore no income to invest. Misunderstanding. This is the cause of most of the world's heartache. And we're going to see how and why in the coming chapters. So let's remember what hoppa describes as the process of civilization. If you begin with the idea that time preference declines, declines. When time preference declines, people are able to save, they reduce their consumption, and so their savings increase. With more saving available, that means more capital is possible, more capital investment is possible. With more savings, it becomes more and more possible to take some of these savings and utilize them for capital investment. More capital investment results in larger productivity, higher productivity, increases in productivity, which results in better living standards. And then better living standards in turn lead to further decline in time preference. Because your life is now easier and better and more secure. Because of the capital investment, you're able to plan for the future better. And therefore you're able to think more critically and practically about what you want from the future. And that then allows you to plan for the future better. And that's what gives us this kind of virtual circle where time preference continues to decline, savings continue to increase, capital continues to accumulate, and productivity increases, and life just gets better. That's the process of civilization. Now, as the capital and money becomes more plentiful, managing it becomes a specialized job in the division of labor. So as this process unfolds, we have more and more savings, we have more and more capital available. And therefore, deciding how to manage those capital resources and deciding how to allocate savings toward different production goods becomes a specialized job initially. Think about this earlier example of one guy on an island, Robinson Crusoe on an island. He was the capitalist and he was the entrepreneur, and he was the worker, and he was everything in one person because he, there was only him. So he had to reduce his consumption of fish in order to spend time building a fishing rod and then use the fishing rod, which would increase his productivity and so on and on, all these different examples. But what they have in common is that the time preference declines. Now what happens as this process is taken further? More of this happens. More capital is accumulated, more people enter into the economy, and you become, you have, you have a sophisticated economy with more and more people that relies on money trade. In that situation, we get specialization. So Crusoe will specialize maybe in catching fish, but then there'll be other people who specialize in growing all kinds of crops and in building houses, and in making clothes and in making cars and making high tech devices. So as everything becomes more and more specialized, as Crusoe's job becomes infinitely more precise and specialized and more productive, it's only natural that the allocation of capital, the management of the capital that Crusoe has, is going to also become a specialized job. And there will be people that specialize in it. And that's going to develop into a job as part of the economy. Just like some people catch fish, some people build homes, some people make clothes, some people will manage money. And that business is called banking. And banking specializes in the management of money and has two essential services. Number one, deposits. Basically, specialization in maintaining savings. So you hold your savings, you don't want to spend them and you don't want to invest them, but you just like somebody to hold them for you so that that person keeps them safe. Well, what do you do? You give them to a specialist whose job it is to increase the safety of holding savings, or at least a part of your savings. And this is very simple and basic market good. Your house is optimized for being comfortable, being in a nice location. You're optimizing it for being a pleasant house to live in. It's not optimized for security. So therefore, if you're holding all of your wealth at home, there is a risk that somebody might be able to break into your house and take your wealth. Well, that's why specialization is good. Someone will specialize in building a building that is focused and specialized in holding savings. And so it has all these incredibly secure safes. It has all kinds of video surveillance technology, it has all kinds of security guards around it and a very extensive security system in order to ensure the safety of those savings. And that is a legitimate business. That person is able to have a much lower chance of theft happening to their money that they keep because they specialized in keeping it safe. Then you would have your house, because you have friends coming in all out. You travel and you leave the house unattended. People can break into the house. There are all kinds of scenarios. So therefore, it's possible that you could benefit from paying somebody money to keep the money safe and therefore drastically reduce your odds of losing that money through theft. This is a very simple market good. And it would be extremely boring if it was just managed sanely, wherein you pay somebody money so that they can hold your money, and then that's it, the end. And then when you want your money, you go and take it out. But of course, banks, as we're going to be seeing in the second chapter, banks over the past few hundred years have made this into an enormously sophisticated and complicated and disastrous business, because they don't just let the money sit there, they want to have their cake and eat it too. They tell you your money is safe, but also your money is out there earning a return that is going to compensate you and therefore you don't have to pay us to keep your money safe. And that is a root of so much problems in the world. Now, the second job of banking is investment banking. And this is not when. This is when you don't want to just keep your money sitting there available for you for the future. This is when you want to invest the money into a productive business. You want to turn the money from savings into capital, and you want to allocate that capital where it could have the highest productivity to allow you an increase in returns. It's going to offer you a positive return. And of course it's going to involve a risk. There's no escaping risk. You could lose everything that you have. So deposit banking and investment banking are essentially the two essential functions of banking. If you followed my work, you know, I think that there are so many problems in the healthcare industry and particularly in the health insurance industry in America, which is a complete fiat travesty, ruining the lives of millions and generating perverse incentives for hospitals and doctors. Providers and insurance have such a strong fiat incentive to overcharge that in some cases what you pay when you are insured is larger than what you would pay when you are uninsured. The market has given us a wonderful solution to this problem, and that is crowd health. I'm delighted that Andy and The team at CrowdHealth are providing a fantastic option for those who do not want to take part in this insurance industry. Stop playing the rigged insurance game. Join CrowdHealth, a community of people funding each other's medical bills directly. No middlemen, no Networks, no nonsense. CrowdHealth specializes in getting the best deals from providers for its community. By joining, you get access to a team of health bill negotiators, low cost prescription and lab testing tools, and a database of quality low cost doctors vetted by Crowd Health this year. Take your power back. Join Crowd Health to get started today for $99 a month for your first three months using code safe@joincrowdhealth.com that's joincrowdhealth.com code safe. CrowdHealth is not insurance. Opt out. Take your power back. This is how we win. Join CrowdHealth.com so in commodity credit, the lender foregoes money in the present in exchange for higher payment in the future. So the lender has a lower time preference. You are giving up present consumption in order to have more consumption in the future. The borrower is the opposite. The borrower is the one that has the higher time preference because the borrower is taking on consumption today, is getting to consume today in exchange for paying a higher cost in the future. And so why does it make sense for the borrower? Because the borrower has a higher time preference that discounts the sum that he has to pay back in the future. And therefore, because of his higher time preference, the sum that he receives today becomes worth more to him than the sum that he is going to pay in the future. But for the lender, because he has a lower time preference, his discounting of the future sum that he's going to receive is low. So therefore the future sum turns out to be higher than the present sum that he foregoes. So effectively both benefit. As the lender, you are getting rid of money today and receiving money tomorrow that is worth more to you. As a borrower, you are getting rid of money tomorrow that is worth less to you, and you're receiving more money today. So both effectively win. And that's why people willingly enter into those arrangements. If you have a different discounting rate from another person, if your time preference is higher, then you can benefit from taking resources from them today and paying them a higher amount of resources in the future. Your time preference is higher. You value the resources today more than you are for the future. So the difference in time preference is what the creates is what creates the opportunity for trade. This is effectively a market for money or time. Same thing. Effectively you are trading money across time in the credit market. And since people have different time preference, different valuation of time, these opportunities for trade will continue to exist as long as these time preferences vary. So what would determine the price in the free market or what would determine the price of the credit? What rate of interest will the borrowers pay? The answer is that time preference of the borrowers and the lenders is what determines the interest rate. And we're going to see how it isn't productivity that drives time preference. There are infinite projects with varying degrees of productivity, but what determines how much of them gets funded is the time preference of the savers and the borrowers. So this is a huge debate in economics that's been going on for many decades, for centuries, on what is the determinant of interest rates? What is it that determines that you're going to be borrowing at 3% or 5% or 7%? Why that number among all other numbers? And the answer is, from the Austrian perspective, it's the time preference. From other schools perspective, it is the productivity. It's the productivity of the borrowers projects. I do not think this Makes sense. And I agree with the Austrians, obviously. I think the time preference is the determining factor because there is an infinity of potential projects out there with every rate of return imaginable. There are projects out there that offer you a rate of return of 0%, 1%, 5%, 50%. The variety of rates of return anticipated and in reality, you know, actually experienced rates of return or anticipated rates of return is huge. There are projects out there. If you look at the last year, there are projects that offered a return everywhere from negative 90% to positive 500%. None of these is going to determine the interest rate. What is going to determine the interest rate is the availability of capital. And the availability of capital is determined by time preference. The lower the time preference, the more capital we have available. The more capital we have available, the more projects we can invest in. And we're going to, collectively and individually, we're always going to seek the projects that have the highest expected rate of return. And so if people expect this project to have a 20% rate of return, it's going to get funded quickly. And then once all the 20% projects are funded, then people will start funding the 19%, 18%, 17%. They're going to keep going down. As the capital increases, we fund the lower and lower productivity projects with the small amount of capital we go to the highest productivity project. As the capital increases, we start hiring, we start investing in lower and lower productivity. So if we start off with 20, 19, 18, 17, and then if we have enough capital to finance all projects that are offering a hypothetical rate of return or expected rate of return of 5%, then we put, then the interest rate becomes 5% because we have enough capital to finance that. If time preference increases, we reduce our savings, we have less capital left. What's going to happen? We can't provide financing for all of those projects. So which ones are going to be cut? It's going to be the ones that offer the lowest return. So 5 and 6% are going to lose. They're going to not get capital, and the interest rate will rise to 7% because those are the only projects that are going to be funded because time preference went up. So we have lower capital. If, on the other hand, time preference declines, then the availability of capital increases. And so we can start funding projects beyond just the 5% or below 5% productivity. So we can start funding projects that have 4% and 3% and 2%. And so the interest rate declines to 4 and 3 and 2 as the time preference declines. So I believe this is a much more logical way of looking at it from the productivity perspective. You assume that there is a fixed rate of productivity for the entire economy and that this is the interest rate and this is what determines the interest rate. But the rate of productivity and the rate of return for projects is widely varying. And so therefore you're going to have to choose, pick and choose, and you pick and choose based on the availability of capital. And the availability of capital is determined by the interest rate. Then we get to the concept of originary interest and that's what helps us understand how interest rate is formulated. The key thing to understand is that originary interest is, as Mises calls it, a category of human action. It's not that we have a discounting of the future because there is an opportunity cost of investing in capital goods which offers us a set market rate of return. The that gives us the idea, say if the interest rate is 5%, then the productivity view would say since the return on businesses is 5%. If you go and you invest in a business, you're going to expect to make 5%. Therefore you discount the future at a rate of 5%. Now for a quick word from our sponsors. 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Because why would you want to hold on to $100 today for next year when you can just go and put those hundred dollars in the business that's going to offer you a 5% return? So your time preference, your discount rate is 5%, because in order for you to borrow from me the hundred dollars, you need to pay me the market going rate, which is 5%. This is the productivity view, that there is this market rate that is determined by the productivity of the businesses. And then because of that market rate, that gives all of us a discount rate of the future. And so now if you want to take something from me, you need to give me a compensation that matches the rate of the market's return. Because otherwise why would I give up on my good? That's not how the Austrians look at it. From the Austrian perspective, as we said, the interest, the time preference, is what determines our rate of discounting. And then that is reflected in the discounting of all goods, including money. And that internal rate of discounting is what we call originary interest. It's the ratio of the value assigned to a present good and the value assigned to an identical future good. If you were given the choice between an apple today or the same exact apple one year from today, how much would you pay extra for having the apple today? There's always a price, there's always a rate of discount. And it's true for apples, it's true for oranges, it's true for homes, it's true for all kinds of goods. Because it all goes back to your ability to discount things for the future yourself. And so the percentage increase in the quantity that needs to be offered to that individual to delay their consumption of the good is that discount rate. And that exists across goods. It's a category of human action. As Mises puts it, we all have this thing inside us where we think we value the present more than the future, and that is reflected across all goods. And then it's also reflected on the market for money. So all economic phenomena have their root in human action, and interest is no different Time preference is what creates the phenomena of originary interest. The existence of time preference is itself the determinant and the originant of monetary interest. So money in the credit market harmonize originary interest across goods and individual. And so, because we have a big market system in which we are using money, everybody is trading goods and buying and selling, then we are able to harmonize the different time preferences across everybody into one general interest rate, roughly. Obviously, it's not a 1 fixed interest rate for everybody. But you can think of it as a benchmark reference. And then people's particular interest rate depend varies depending on their own credit worthiness and their own how good their business ideas for borrowing are. So borrowers and lenders enter into that market. Just like the market for apples or oranges. There are producers and there are sellers. And it's the preferences of the producers and the sellers that culminate together to give us the quantity, the equilibrium quantity and equilibrium price of apples, as we discussed in chapter 10. Well, something very similar happens with the capital market. The individual preferences of individuals across the world or across society interact in the market and give us a specific quantity and price of economic good. So future obligations of money are traded for present payments, establishing a general discount rate of the future, or what we call an interest rate. So time preference determines the quantity of loanable funds which will then go to fund the projects with the highest expected returns. The more funds are saved, the lower the interest rate, the more projects can be funded. And the lower the expected rate of return on the marginal product. So that's why, as I was mentioning earlier, that's why it's time preference that determines the interest rate. The lower the time preference, the more credits available, the more projects can be funded, and the lower the expected rate of return on the marginal product. So by deferring consumption to provide capital for investors, the capitalist incurs the cost of the operation in terms of time. The capitalist invests the time in the enterprise by sacrificing present goods for future goods. This allows workers and providers of input goods to get paid before production is concluded and the goods are sold on the market. This is really important as remember when we discussed the chapter on capital. The real tough thing about capital is that it requires the deferral of consumption. Now, not everybody involved in capitalist production can afford to defer consumption. So the job of the capitalist is to be the one that provides the deferred consumption for the production. So the workers don't have to defer consumption in order for the job to happen. As a Worker, you get paid before the products are sold. Similarly, if you're selling input goods to the producer, you get paid before the product is sold. Sold. So you are getting paid at the end of your workday, or at the end of the work week, or at the end of the work month, even though you could be working on producing something that's going to take years to get on the market. So there are engineers, as in the example that I mentioned in the chapter on capital, There are engineers today in Boeing working on designing an airplane that's not going to go out into the market until five, six, seven, eight years from now. So how are you going to pay those workers? How are they going to eat? They can't wait eight years for the airplane to be sold. There needs to be a capitalist, somebody who provides the workers with the money that they need today in order to work so that they don't have to wait eight years. And then the capitalist will get the return in eight years. And so for deferring the consumption, for putting his resources in that capitalist production process, rather than putting them in the. Rather than consuming them, rather than enjoying them, for doing that, the capitalist is the one who's going to earn the interest rate. So the interest rate is effectively the price of the time. In the same way that a fisherman living in isolation needs to sacrifice catching a fish to build a fishing rod, someone needs to sacrifice consumption for Boeing to operate. The entrepreneur uses the resources sacrificed by the capitalists to pay the workers, the landowners, and input goods sellers. In the present, the entrepreneur only gets paid after production takes place and goods are sold, if at all. Of course, entrepreneurial production can fail. He might not get paid, he might lose all of his money. So he takes on the risk, so the profit. This is an important distinction to understand of the distinction between the profit and the interest. The profit is derived from the difference between the market valuation of the input goods and the market valuation of the final goods. So there is a market valuation of the input goods that go into the production, and there's a market valuation for the input goods for the final goods that come out of the production. The difference between the two is the profit. The interest is a different category. The interest is merely the payment for the time input provided to the production process by the capitalist. And this is really, I think, a good way of thinking about it, that in order to engage in economic production, you need labor, you need machines, you need land, you need all kinds of things, but also you need time. Time is an input. You need time. And not just the time that it takes to produce the work. You need the time in the sense of somebody foregoing the consumption in the future in order to provide the resources today. That is an input good. Someone has to give up on consuming things in order to make the capital goods available today. And in order to do that, you need to sacrifice consumption. So the interest is the price that that person gets for sacrificing their consumption today in order to finance production today instead of consumption. So the profit is the difference in market valuation of the inputs and outputs, and the interest is one of the inputs. The interest is an input into the production process because it is the cost of the time, the capital saved that went into the production process. And this is what gives us the market for capital. Individuals have value scales ranking present goods against future goods. Present goods are more valuable than identical future goods because time preference is always positive. And so individuals compare their own discount rate for goods to the market interest rate. And that's how the market for capital happens. Just like with the market for apples. You compare your valuation of apples to the price of apples and you conclude that you want to buy or you want to sell. If you're in a situation where you find that an apple on the market is worth a dollar and you value an apple more than a dollar, you go and you buy an apple. But if you happen to have apples and you find that your valuation of these apples is less than a dollar and the market price is a dollar an apple, then you sell apples to the dollar, to the market. Same thing for capital. You have a market, you have a discount rate for time, you have a valuation of time, you have a time preference, you have a discount rate of future goods against present goods. And you just like with chapter 10, when we develop a value scale ranking goods against ranking present goods against future goods. 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If you want to give someone the gift of bitcoin, get them this professional service that will ensure they start off knowing exactly how to manage their coins and not lose them. Go to the Bitcoin way.com and start bitcoining more confidently. Just like in that present goods are more valuable than identical future goods and there is a discounting rate that is available on the market. And so if your discounting rate of present good of future goods to present goods is different from the market, then you have an opportunity for trading with the market. And so we'll see how it we'll see in this example how it works. So if your personal discount rate is higher than the market interest rate, you would borrow from the market, right? So think about an individual whose discounting rate is 10%. She discounts the future at 10%. If you borrow $100 today, you have to pay back one, but the interest rate is 5%. So the market interest rate is 5%. But your personal discount rate is 10%. So if you borrow $100 today, you pay back $105 next year, but you discount money next year by 10%. So how much do you value the 105 that you have to pay next year? Well, you value it discounted by 10%, so you value it at 94.$5 today. So for you, if you're going to be borrowing from a market that offers a 5% interest rate while you have a 10% in personal discount rate, if you borrow $100, you'll pay back $105 next year. But in reality, you're taking $100 today and you're paying something that you value at $94.50 today, right? That's 105. Discounted by 10% is 94.5. So is that a winning trade? Yeah, you're getting $100 and you're paying 94.5 dollars today. So if you have a higher interest rate than the prevalent market interest rate, or if I should say if you have a personal discount rate that is higher than the market's interest rate, then you borrow. You borrow $100 today and you pay back what you value today at 94.5. So that's a winning trade. In other words, in this situation, this person values the repayment of the principal and interest in the future less than the principal in the present. Your valuation of the principal and interest that you have to pay in a year from now discounted today is lower than the principal in the present. So if, on the other hand, your personal discount is lower than that of the market, she would lend cash savings on the capital market. In other words, if the interest rate is 5% and your personal discount rate is 2%, if you borrow $100 today, you will pay back 105 next year, but you value the 105 next year at a discount of 2%. In other words, you value $105 next year at $102.9 today. So does it make sense for you to borrow? No, it does not. If you borrow, you take $100 today and you have to pay back something that you value today at $102.9. So why would you want to engage in that? You're losing money by engaging in that trade, by borrowing, because your valuation of the loan is 102.9 today of the repayment of the loan is 102.9 today, which is higher than the value of the loan. So borrowing is a losing game for you. But what is a winning game in this situation is lending. So if you have cash in this situation, you would lend it because you lend $100 today and you get 105 next year, but you value the 105 next year at 102.9 today. So in other words, lending the 100 today gets you 2.9 of added. Of added benefit, profit, effectively. So we see, we can then see how this Is illustrated graphically here. You can think about this individual and this is the interest rate that is on the market and this is how much they would lend. So in this situation, imagine the the interest rate is at 5%. If the interest rate is at 5%, what does this person do at an interest rate of 5%? She does not lend in this example. This is different from from the example that we mentioned earlier. At interest rate of 5%, here, she does not lend or borrow because her discount rate is also 5%. And so on the market it's 5%. So she will not be lending or borrowing. If on the other hand, the market interest rate goes up, then what happens? Her supply of loans increases. Right? You see on the right side of this curve, as the interest rate goes above 567, the supply curve is on the positive side. So if the interest rate is at 6%, she will be lending a thousand dollars. If the interest rate is at 7%, she will lend $2,000. And the reason for that is as the interest rate goes up, her own discounting rate at 5% is lower than the discounting rate of the market. And so therefore it makes sense for her, since she has a lower time preference, to give up money today in order to benefit from it tomorrow, to have more money tomorrow, because she's going to give that money to people who value that money more because they have a higher time preference. And something the opposite would happen if the interest rate on the market drops, if her own discount rate is 5%, then if the market interest rate is 3%, well, now she has a higher time preference than the market. And so therefore in this situation, does it make sense for her to borrow? No, as we mentioned earlier, it doesn't. It makes sense for her to lend. And so in this situation, if the interest rate is on the market 3%, she would, sorry, she would borrow, not lend. She would borrow $2,000. It doesn't make sense for her to lend. Her discount rate is higher. And so therefore she should take the money today from people who have a lower time preference and pay back next year because she discounts the payment next year more than today. And so we see how this works. The people who have a lower time preference are the ones on the right side of this graph. They supply loans to the market. The people who have a higher time preference are on the left side of this left side of this graph. They demand loans for from the market. And then we have a similar, we will have a similar thing with the demand and the supply curve. So you can take this graph and turn the supply. Turn the right side of the graph, the stuff that's in the positive quadrant on the right of the zero, that's like a supply curve. And then the stuff that's on the left of the zero line is the demand curve. And you can put the two together and figure out the quantity of the supply and the demand at any particular interest rate. And that gives us the equilibrium. The. The supply of loans increases as the interest rate rises. As the interest rate increases, people are more tempted to lend. More people have a lower time preference than the market interest rate, and so more people will lend and vice versa. As the interest rate increases, the demand for loans declines. So demand curves slope downwards, supply curve slope upwards. That means they can only intersect at one point, if at all. And if they intersect at one point, that gives us the equilibrium interest rate and the equilibrium quantity of lending. And that's how the market for capital is cleared. Now, it's important here to remember again, I always have to put this disclaimer. When we look at these graphs and we look at these charts, we're not saying that these are. And a precise presentation of the market. There is no fixed interest rate for the market. There's no equilibrium interest rate. It's better to think of it as an equilibrating process, as I discussed in detail in chapter 10, that this is a constantly dynamic process that's constantly changing over time. And this is how it is playing out. People are always calculating. The important thing to understand is not that a specific interest rate emerges. The important thing is to understand how this process functions in that as the. As people's preferences and time preference changes, the supply curve for loans and the demand curve for loans shift around. And that is constantly creating an equilibrating process that is driving the market toward clearing. Although it's a constant process that never gets into a kind of, you know, happy ending. It's constant, constantly changing every day, because people are constantly changing every day and time preference is changing every day. So this is why interest emerges on the market. And this is the Austrian explanation for interest that is all based on time preferences. So this is why I wanted to get time preference out of the way first in this section on money. Now, this drives us to a very, very interesting and important historical question that has vexed the minds of philosophers and economists throughout human history and religious authorities too. Can interest be eliminated? Should we try to eliminate interest? Is there a case to be made for banning usurious lending? The Austrians, I think, make the best Case for why interest is a natural market phenomenon, As I was mentioning earlier, just like people have different valuations for apples and different cost of producing apples, and these differences in the cost and the valuation are fleshed out on the market where everybody's able to buy or sell depending on their valuation. And as a result we get a vibrant large market for apples. The same thing is happening in the market for interest. It's just the market for time. It's the fact that people have differing time preferences that creates this opportunity for trade. Some people have a high time preference, some people have a low time preference. The two would benefit from trading with one another, for trading money across time with one another, because they have differing valuations on the money in the future. So the trading works for both parties, as I mentioned earlier, because both benefit from it, because they both have different discounting rate. So as an individual, I discount the future more than you. Therefore I don't care if I pay you more money in the future because I discount it more. I want the money now, so I benefit. And you don't care about the money now because you have a low discounting rate. You care more about the money in the future, so you value the bigger sum in the future more than you value the smaller sum today. And so the Austrians really make the best case for why interest is a natural market phenomena. Originary interest exists and without it nobody would consume anything. There's a good quote by Means as it describes this. If there was no originary interest, why would you consume anything? If you value food today the same as you value food 100 years from now, then you wouldn't consume any food today. You are indifferent between eating today and eating in 100 years. Is that the case? Obviously not everybody needs to eat today or else you die. You need shelter today or you die. You need clothes today or you freeze to death and you die. So we have this pressing need to discount things in the future because we have a pressing need for things in the present. So there is a discount rate. And so therefore this originary interest exists and without it nobody would be able to consume anything. So it's clear that ordinary interest exists and it's clear that originary interest can't be be harmonized across all of society. People are going to have different interests just like they have different. I mean, people are going to have different time preference just like they have different preferences for all kinds of different things. And that's going to create an opportunity for trade. So if you ban interest lending, you're not going to eliminate originary interest. People are still going to prefer food today to food next year. There's still going to be a discounting for food, food next year, and discounting for money next year. It's always going to be the case. So if you banned it, as many religions and governments have done over time, where you say you cannot lend with interest, what are you going to be doing? Are you going to stop people from discounting the future? Of course not. You can't stop people from discounting the future. In fact, you're going to have a negative impact, like any kind of coercive intervention in the market, because what you're doing is you're banning people from benefiting from having a lower time preference. You're incentivizing them to have a higher time preference. Because in a situation where I can lend because I have a lower time preference than you, since I have a lower time preference than you, I can lend, then it makes sense for me to lend, it makes sense for me to develop this lower time preference, and it makes sense for me to accumulate capital so that I can lend, lend it, to benefit from it. So this encourages people to have a lower time preference and to save more because they can lend it and they can make a return on it. If you take away their ability to make a return on their lower time preference, you are effectively punishing them for having a lower time preference, and therefore you are encouraging them to have a higher time preference and so they consume capital more. And that's what Mises says. Banning individuals from trading financial assets based on on their time preference will not eliminate their time preference, which will continue to direct their consumption and production decisions. So capital owners with a positive time preference who no longer have access to the option of lending at interest find themselves with a stronger incentive to consume their capital stock. And consuming capital stock causes the time preference to then increase. So banning interest will prevent borrowers from accessing free funds. That would make them better off subjectively, and it would prevent lenders from benefiting from capital accumulation. And so it lowers the incentive to accumulate capital. So effectively, it hurts the borrower and it hurts the lender. This is the case for interest. From the Austrian perspective, I think it's extremely compelling, but I respectfully disagree. And this is really the main disagreement that I have with Austrian economists. Pretty much everything in the book so far, I don't think there would have been a disagreement. There has been maybe a shift in the emphasis. So in chapter three, I focused on time in a way that's not very Conventional for Austrian economists to place as a founding fundamental of an economics textbook. In chapter eight, I focused on energy, which is different from how you would expect a regular Austrian economics textbook to be written. But these are not really disagreements. So I think most Austrian economists would read those chapters and they won't have, I presume, any kind of serious fundamental disagreement with anything in those chapters. They're still more or less very, still very Austrian in their approach and they still stick with the Austrian methodology. But here I'm going to disagree with the Austrians on something very fundamental and this the time preference interest. The time preference theory of interest is one of the most Austrian things and it's something that they fought against the mainstream over for more than a century now. So it's no joke that I, I don't do this lightly to write an Austrian econ textbook and disagree with Mises on this. Of course, in my defense, I'm not disagreeing in a Keynesian manner. I'm not going to be arguing like a Keynesian on this. My perspective is different from the Keynesians here. However, I still think there is a case to be made made against interest and it isn't necessarily a case for banning interest. My idea is that interest rates would be eliminated in a free market without government edicts. I think a truly free market would eventually arrive at a point where we have no more interest lending. And the reason for that is that it is precisely the Austrian theory of interest rates. I agree with the Austrians that it is time preference that determines interest rate. But I take this a step further and I also agree with Austrians that civilization is the process of declining time preference and declining interest rates. I just ask one important question. What happens if we extend this process over time? So the process of civilization, as we mentioned in chapter 13 in the previous chapter on time preference and why I thought it was important again to cover that. First, the process of civilization is initiated with the lowering of time preference, which results in capital accumulation, increased productivity and improved living standards, in turn encouraging further reductions in time preference in a continuously amplifying spiral. Now you remember we said wars, diseases, natural disasters, increased future uncertainty, crime, growing, un uncertainty over property rights. All of these things forestall this process. All of these things stop your time preference from declining and stop you from accumulating capital and cause your time preference to rise and stops you from improving your living standards. So historically we see that interest rates have declined historically over 5,000 years. And there's a great study that I referenced in this chapter by homer ancilla. It's 5,000 year history of interest interest rates, where they've collected historical data on 5,000 years of people borrowing and lending and looked at interest rates over time. And what do they find? There is a strong downward trend in interest rates over 5,000 years, which is constantly getting interrupted by calamities. So there's the Black Death in Europe. Interest rates shoot up. There's world war, interest rates go up, massive plagues or massive disasters happen, interest rates shoot up. Then you get a century of peace. During that century of peace, what happens? Interest rates continue to decline slowly over time. So as Hopper says it, a tendency toward falling interest rate characterizes mankind's suprasecular trend of development. Minimum interest rates on normal safe loans were around 16% at the beginning of Greek financial history. In the 6th century they fell to 6%. During the Hellenistic period in Rome, minimum interest rates fell from more than 8% during the earliest period of the Republic to 4% during the first century of the Roman Empire. Then of course, Rome collapses, interest rates go up again. Then in the 13th century Europe, the lowest interest rates on Safe loans were 8%. In the 14th century they came down to about 5%. In the 15th century, 4% 17th century to 3%. And at the end of the 19th century, minimum interest rates had further declined to less than 2.5%. So we don't really have a record of 2.5% lending a thousand years ago or 5,000 years ago. But we see this trend, constant decline, I shouldn't say constant, mostly declining with occasional spikes upward. So then we get to the end of the 20th century, end of the 19th century, and we are at around 2.5%. And then what happens? And then humanity takes a detour toward insanity and it tries fiat money and world wars and all of these crazy things. And what happens? Interest rates shoot up in the 20th century. So this trend of decreasing time preference and decreasing interest rates stopped in the 20th century with fiat money. So my hypothetical question is here, what would have happened if we stayed on the gold standard? There was no fiat money and time preference continued to decline and interest rates continued to decline on gold. What if humanity remained on gold standard and people maintained the ability to save for the future? Capital continued to become more abundant and productivity increased. How low would interest rates go? That's a very good question. I think the Austrians don't really ask it. Let's just assume that there's always going to be a time preference that's higher than zero. So there's always going to be a time preference. So there's always going to be an interest rate that's higher than zero. However, we have to remember that even if it stays higher than zero, this is a point that the Austrians don't make. Even if the originary interest stays higher than zero. So we can accept Mises contention that originary interest will never drop to zero. Even if that were the case, market interest rates can drop to zero even if originary interest remains positive. And the reason for that is that money has a carrying cost that is always larger than zero. There's always a cost for holding money. Whatever form of money you use, it always costs something to hold it. And there is always a non zero risk of it being stolen or destroyed. So whatever form of money you use, if you're using paper money, it can get stolen, it can burn, it can be ruined in one way or the other, and so you could lose it. If you're storing it at home, you need to buy a safe and the safe costs money. So there is a cost to the safe, there is a risk to it being lost. So therefore, the cost of carrying the money, the cost of holding a thousand dollars at home could be something like 1%. If you factor in the cost of holding it and then the risk of losing it, something like 1% per year, for instance. But it's also true for gold. If you hold the gold, it could get stolen. Or if you put it some with, if you hold it with somebody else, you have to pay a storage fee. The same true for paper money, you have to pay a storage fee, or with gold you have to pay a storage fee. And in this situation, of course, if we live in this hypothetical, remember, we have a hard money. We're starting from the point that we have a hard money. So therefore you can't have the funny business that we have today where you put your money in the bank and the bank pays you money while keeping it available for you on deposit. This is unworkable. The bank can't pay you a fee just to hold the money for you. The reason they do this now is because they have government guarantee that destroys the value of the currency in order to bail out banks if the banks mess up. And so therefore this wouldn't apply in this situation, because in this situation, we're beginning with the starting point of the hypothetical being that the money is hard and nobody can print that money to bail out banks. So therefore, if you're going to put your money in the bank and you want it available for you on deposit, and you don't want to take A risk with it. In order to make a return, you're going to have to pay the bank. The bank is not going to pay you. So there's a carrying cost to holding money and it is always large, larger than zero. Whatever form of money you use, it'll always cost something to hold it. So if money has a holding cost, then not lending money has a non zero cost. In other words, the alternative to lending money is not that you just keep your money. The alternative to lending money is that you're losing some small percentage of your money every year in storage costs and in the risk of storage. So originary interest doesn't have to decline to zero in order for the market interest rate to drop to zero. Originary interest just needs to decline to the point of the cost of holding money, at which point lending at zero becomes profitable for you. So if the cost of holding the money is 1%, you need to pay 1% of your money in order to hold it every year and have it stored safely. Then if your originary interest drops below 1%, then in this situation, lending at zero nominal interest rate is profitable for you, right? Because your discounting rate of the future is less than 1%. And 1% is the price that you would pay if you just held on to the money. But if you lend the money to somebody else, that person has to manage the storage of the money, or if they're going to be spending it, they're going to have to hold the responsibility of paying you back. So lending money has a non zero cost, which means that originary interest will continue to decline until it hits that point of the cost of holding money, the percentage it takes to hold the money. And then at that point it becomes profitable to lend at 0% nominal interest rate. So if holding money has a nominal return of negative 1%, then a 0% nominal return by lending is preferable. And so the market interest rate can drop to zero. Rather than requiring abolition by decree. The continued process of civilization, capital accumulation and lowering of time preference could naturally eliminate lending with interest entirely. I think this is an enormously mind blowing conclusion and I not heard anybody mention this before. So I'm really curious to see what more Austrian economists would say about this. I've not heard a, I've not heard an objection so far. From the people that have read my book and the people that have discussed this with me. I've not heard a, a serious objection to it. So if you have one, please do bring it up in the seminar or do email me about it. I'm very curious about this topic. In other words, what we're concluding here is that a continuously advancing civilization would witness its time preference decline, leading to more future provision and more moral concern for the future generations, which results in capital being widely abundant. As people own larger quantities of capital, the demand for borrowing declines as well. At a sufficient level of abundance, the return on lending becomes lower than the cost of carrying the money. At which point a borrower can secure a loan from the many lenders available by simply promising to pay it back in full. But as interest rates decline with time preference, the asymmetry of the loan deal becomes increasingly unappealing to the lender. I think once you're lending at 0% and if you're not guaranteed guaranteed the 0% because nothing can guarantee lending. And here of course, worth also remembering the difference here is that today people labor under the delusion that there is such a thing as a risk free lending. A lot of people think that lending to the government is risk free. And I frankly find that hilarious because there's always a risk involved. And putting money in the bank is also not risk free. There's always a risk involved. And to the extent that that risk is hidden from from you, it is hidden from you because it is socialized. When your bank goes bankrupt, the government devalues everybody else's money in order to bail out your bank. And this is not just something that happens when the banks publicly announce that they're bankrupt. It's something that's happening at all times. The government is constantly subsidizing them by giving subsidizing banks by giving them lower interest rates and by offering them quantitative easing and all these other kind of ways in which they are effectively getting bailed out. So when that is not an option, you don't have this safety net of someone destroying the currency in order to bail you out. You're always taking on risk. And so if you're lending to somebody, there's no magic money printer that's going to come and make it right if that person messes things up. So you are exposed to the full downside. If their business goes bankrupt, you don't get paid back. So in this situation, you find yourself sharing fully in the downside, but not sharing in the upside. You're going to get the same sum of money that the person is going to borrow from you. He's going to pay it nominally in real terms. This is a real return of say something like 1%. But your downside is unlimited. You could lose 100%. There's an earthquake. And the earthquake destroys his house, destroys his business, and now he can't pay you back anything. So you're sharing in 100% of the loss. But you're only going to get 1% as a return, regardless of what he makes as a return on his business. So this becomes less and less attractive. Why take on the risk of losing all the capital in exchange for such a measly return? It's a nominal return of zero, a real return of something like 1%. So the loan contract limits the upside benefits to the lender. But there is no force that can truly guarantee that the lender will get their money back. So currently the risk of lending is protected through the destruction of currency. Banks are insured by the central bank which bails them out by expanding the money supply. But remember, in this hypothetical we are in a world of constantly declining time preference. The money must be hard, which makes these bailouts impossible. So there is no possible protection of the lender. If money could be expended to guarantee savings the deposits, it would not be hard. And time preference would not drop to the point where originary interest is lower than the carrying cost of money. If there is no downside protection, lenders would prefer to share in the upside fully. So equity investment financing would likely replace interest lending financing. This is how I see it. I don't see lending continuing without a theory. The high time preference differential that makes a Some people have a high time preference and there's a big differential that allows a big profit opportunity. And I don't see it continuing without the destruction of currency. That allows the lender to lend thinking that they are protected and that there is no risk because the government can destroy the currency to do that. If you take away the ability to destroy the currency, then you are also going to bring everybody's time preference down. And then when the time preference declines below the rate, below the carrying cost of money, then at that point I don't see why interest lending would survive in such an economic environment. I think the world would shift toward equity financing rather than interest lending. In other words, we it would look a lot like what Islamic banking is supposed to be. So with real abundance of capital, it would be easily, it would be easy for trustworthy people to secure zero nominal interest rates, loans for emergency or hardship. I think in this kind of world, if your cousin gets into an accident and needs money for a surgery or whatever, somebody's house burns down and you want to help them get back on their feet. In this world where money is constantly Appreciating. Everybody has a lot of savings. Everybody has an abundance of capital. If you're a trustworthy person, if some people trust you and like you, you should have no problem securing 0% nominal interest rate credit for consumption, for getting back on your feet. If it's not a business idea and you need the money and you're trustworthy, I think it would be very easy for you to get zero percent interest. Why? Because you're saving people on the carrying cost. So I'll give you the money so you'll give me the whole money next year. Because if I kept that money in the bank, I would have paid 1% or maybe 2%. So I would lose 1% by keeping the money in the bank. But I keep that 1% if I just lend you. So in this kind of world, I think 0% lending for individuals, for personal reasons, for emergencies, I think it would be prevalent, it would be very easy to secure. If you're trustworthy. All of your friends and family and cousins are going to have big piles of money and they're going to be jumping on the opportunity of giving you some of that money to save the 1% carrying cost. But business investment will likely take the form of equity. In the case of. If you have a business to run, if it's not an emergency, it's not your brother or cousin or friend or something, if it's not an emergency, somebody has a business idea, well then why would you give them at a normal 0% nominal interest rate while taking on the entire risk of the business collapsing? I think in that kind of world, you're going to get, you're going to get equity investment. So I'm happy to provide you the money that you need to start your business, but I will share in the downside and in the upside. And we agree a certain formula wherein I put this much money and I get this much of the profit. So in this world, banking is very neatly divided into deposit banking and investment banking with equity equity investment banking. So the Austrian theory of interest rate explains interest rate, but also explains the religious case against it. I think even though Mises is constantly explaining why it is ridiculous for religions to try to ban interest rate, I think he helps us understand why religions want to ban interest rate. Religious religions are. I think if you study economics, you can arrive at the conclusion that religion is a mechanism for lowering people's time preference. Religion tells you to think about the afterlife. It tells you to think about an eternity. Your actions today are not just about today. The payoff of Your action is eternal. And so you don't steal, you don't lie, you don't cheat, you don't do bad things because you will pay for those things for eternity. And so if you believe in religion, if you believe in what your holy book tells you, you wouldn't commit the crime because you're being told that the payoff is eternal. And so therefore eternal damnation, no matter what your time preference, eternal damnation is worse than eventually it's going to outweigh whatever benefits you get from stealing or committing a crime today. And so therefore over time you're going to discount, that's going to lead you to act in a way that is going to be low time preference. You're going to be thinking about the distant future, you're going to be thinking about eternity, you're not just thinking about today and tomorrow and the next day. So you start thinking about your life and your family and the life of your children after you, and you effectively think about life forever. And so that lowers your time preference. And so usury being against usury is, I believe, just perfectly on brand for religions because religions want you to lower your time preference. And usually, as the Austrians explain, as Mises himself explains in Bomberk and Menger, well, maybe not Menger, Bomber and Mises and Rothbard, as they explain interest rate is a function of time preference. And so they if you want people's time preference to be as low as possible, you would get to a world of zero interest rate. Religions effectively impose this reality in on believers through divine dictates. In other words, the religion doesn't explain time preference to you. Most religions don't really put it in such explicit terms, but this is what they're doing. They're telling you to not lend because this is something that is high time preference. If everybody had a low time preference reference, everybody would think about the very long term. And therefore in that kind of world, everybody would have a very low discounting rate and that the originary interest would be lower than the carrying cost of money and therefore nobody would lend at interest. Now, effectively we have two different approaches to this issue. We have the religious approach, which is just let's mandate and tell people you can't lend at interest. And then there's the market approach, which is what I'm arguing here, which I believe is original, is that markets themselves are arriving at that point. If we just stop messing with money, if we stop being inflationary, if we go back to hard money and we go back to being a civilizational process, in a civilizational process rather than a decivilization process, which is what we're doing now. We're going to discuss later in the last chapter of the book, if we go back to a civilizational process, we're going to witness money appreciate and we're going to be witnessing time preference decline. And then eventually we're going to see interest rates drop to zero. Effectively. Capitalism freely delivers what religions naturally seek to impose or what religions seek to impose effectively. So I think this is a pretty startling conclusion to arrive at that effectively just letting people have a high time preference and lending is going to eliminate lending. I, and this is, I'm, you know, I'm still playing with these ideas in my mind. Schumpeter and has said that interest rate reflects people's intelligence, moral strength and cultural level. He says you look at a society and you look at their interest rate and you can tell from the interest rate how intelligent, moral and cultural these people are. A society that is intelligent, that has high moral strength and that has a good cultural level is a society that has a low time preference. So it accumulates a lot of capital, so its interest rate drops to zero. So the more moral intelligence and culture of the society, the more it will accumulate capital and the lower its interest rate. What's the end point? How much lower time preference can you get? How much more intelligent and moral can you get? The more intelligent, the more moral, the lower the time preference. Eventually the time preference, the interest rate eventually has to drop to zero. I think this is really the idea and I think you can't really argue with this as an Austrian. That's what the Austrians say. You want interest rates to be low. Obviously not low as in manipulated and mandated by the government, but you want them to be low because people's time preference declines. Subjectively speaking, I'd rather live in a place that has a, as low an interest rate as possible because the lower the interest rate, the more intelligent and moral the people around you are. So isn't there an end point at which their intelligence and morality arrives at a point of being lower than the carrying cost of money? Well, then that's 0% interest rate. So the interesting question here with which I end this chapter, and it's something that I think about a lot and I haven't made my mind up, is does banning interest lending cause time preference to decline or rise? In other words, you could see the case, well, okay, what religion. You could make a case perhaps that, well, religion is saying that people can't lend now because People can't lend at interest. High time preference borrowers can't get to borrow to satisfy their high time preference. And therefore they're going to need to bring their time preference down and they're going to need to figure out how to make do with the money that they have today because they can't find somebody to lend them. You could, I guess, make a case for why that is better and why that makes society have a lower time preference. And the answer here, and the reason is that the unavailability of capital forces people to get their time preference down, to start thinking more about the future because they can't continue to escape irresponsible decisions by borrowing and bailing themselves out at the expense of the future. One way of looking at it. But then of course there's the alternative way of looking at it, which is from the lender's side. By banning the lender from lending, you are banning the lender from monetizing their low time preferences. So therefore you're taxing their low time preference and you're incentivizing them to have have a higher time preference. So maybe there's the opposite impact here because you're doing it this way. You're creating a bigger incentive to keep time preference high because you're preventing people from lowering it. Maybe it might be the case that it is only interest rate lending that allows the elimination of interest rate lending. In economics, sometimes people say this saying, which is that the cure for high prices is high prices. If there is a shortage, let's say there's an earthquake, there's a natural disaster, prices of goods go up significantly. Why do they go up significantly? Because the prices of goods are going to, the goods are not available a lot. So if the price goes up, sometimes governments will come and say, no, you can't charge extra. Well, if you can't charge extra, you're not going to get more goods. If you can charge extra if the prices go up, well then you've created a huge incentive for everybody involved and everybody from outside the area to bring their goods into this area. So if there's a city that was witnessed a flood or an earthquake or some natural disaster and the price of food in that city has gone up by five fold, everybody in all the cities surrounding it is going to start taking their food from that city and taking it to the city that has been flooded because that city is going to be paying a lot more. So that's how you get rid of it. And then eventually so much food comes in that the price goes back to normal and the thing recovers. And all the extra money that's being used by all of those people earning the extra money to provide the food, they're going to spend it on buying capital infrastructure that is going to allow them to provide more food. So the supermarkets that are going to charge you more are going to, because they charging you more more. They're going to be able to start sending more cab, more trucks to other towns to get more resources. They're going to be able to rebuild the vital roads that they need. They're going to use that money in order to fix things. And eventually the high prices are going to subside and they're going to bring back the low prices once we've recovered. But in order to have that recovery, we need the high prices. And if we stop the high prices, as usually happens in these disasters, you exacerbate the disaster. If you say, all right, no, you can't charge more than the regular price that was there. The supermarket can't raise its prices of its good. What's going to happen? Everybody's going to go to the supermarket in the first day. They're going to clean up the shelves of the supermarket and then the supermarket is not going to be able to refill because it's much more expensive to get goods into a flooded city that's been destroyed or into an earthquake zone. And so without enough money, the supermarket cannot get the resources. And so you're going to continue to have high prices and shortages and all kinds of problems in black markets for a while if you don't allow the price to fix it. Maybe we have something similar with interest. So maybe the case is that religious banning of interest does not succeed in creating low tide preference because it's does not allow people to monetize their time preferences. So therefore it does not allow the time preference decline. Or it could be the other way around. This is something that I think about a lot and I'm interested in hearing your thoughts. So please do come to the discussion session or email me with any ideas about this or if you've come across any literature that discusses this, please let me know. Thank you very much.