I wish to talk to you today about interest.

While the position I will present to you, may carry controversy,
I can assure you that I hold this view with absolute conviction,
and the analysis and rigor to back it up.

To understand interest, we must first understand the brutality of
a gold standard and the chaos of taxation and property historically. Contrary to what austrians may sugest, the pedigree of property has never been clean or clear cut, it is mired in war, subterfuge, lies,
theft, betrayals, and greed above and beyond what is healthy.

We come to today, and we have tools to conduct our accounting
with precision, when we afford ourselves of that priority, and
as a result, the amount of violence and the incentives for cheating
have been steadily declining. It is not so much that people today are more honest, there is simply a much greater advantage for those who are honest, conversely, those who lie and cheat, in general must be much better than ever.

In a Gold standard, there is chaos, but it is controlled chaos. The system is dominated by whoever can hold all the gold, and they will employ whatever means you can imagine, to obtain it. Again, all of the above indiscretions and transgressions are a part of the system.

The industrial applications of Gold in electronics are surprisingly
modern. Gold did have useful properties for pre-industrial
craftsmen, but this was mostly in terms of its maleability and
resilience. Unlike other metals, it does not rust, and it can
be worked into intricate shapes, so it makes an ideal metal for ornamentation. Tools and weapons, not so much.

The allure of gold, as a symbol for greed and the hollowness of
material lust, has a timeless mythological pull. There are
countless stories from king midas and others, which capture this mystique.

So what does it mean to “raise interest rates”?

What did it mean historically, under mercanitilist empires,
where collecting gold and controlling foreign wealth was
a principal aim? What does it mean today, when we no longer
tie ourselves to gold?

With a gold standard, the unique aspect of currencies, is that
they are all tied to a common unit of account. So when one currency rises or another falls, it necessarily happens through an explicit redenomination with the metal unit of account.

Similarly, when one country offers to pay interest in terms of
gold or commodities, the rate another country offers can be compared directly, because while the price of gold may change, the common unit of account means that these relative debts can be compared directly.

Without a common unit of account, one country can offer more interest, in their own currency, but who’s to say, whether that will currency will retain its relative value against other currencies? The rate of interest cannot be directly compared, and it must be guessed at.

But even under a gold standard, interest offered is not a sure thing either.

The most extreme example of this, is what we commonly refer today, as ponzi schemes. You offer large, or even impossible returns, and then use new investors to pay out old ones, relying on people reinvesting and constantly selling or betting to cover any gap.

Recently, I built a martingale betting simulator, and came up with the phrase, “interest rate half life”, to describe when the median gambler trying to fake a return, ultimately fails. This half life, in fact, depends on the betting strategy. If you take all your money and put it down on a double or nothing bet, then the median gambler will last as long as it takes for the real investor to geniunely double their money.

So at an interest rate of 5%, when it takes approximately 14 years to double an initial investment, the median gambler, with no ability to generate a return, can “stay alive” for 14 years. If you are impressed by a 5% return, and it has been less than 14 years, remember that at that point, it is more likely than not, that a gambler would still be around.

Now, if our gambler has modest investing skills, then this “interest rate half life”, can be extended even longer. If he/she can generate 3% returns, and only gambles to cover the last 2% of surplus returns, then they can last a whopping 35 years, by winning one double or nothing bet.

So interest based returns can never be considered a sure or self evident thing. It is extremely difficult, if not impossible, to distinguish reckless luck and survivorship bias, from an authentic strategy.

So now, back to our gold standard. What does a “normal” rate of interest sound like? Is it 3%? 5%? 8%?

Writing and history, which began with accounting, extends over a period of approximately 5,000 years. If we just look at half this time frame, we can get a very quick and rough “reality check” on any particular rate of interest.

1.02 to the power of 2500, a 2% rate of interest over 2,500 years, gives us approximately 3.17 sextillion. So one kg of gold, at an interest rate of 2%, would require 1 part in 1,887 of the earth’s mass to be gold. This is comparable to the ratio of a proton to an electron, and certainly the earth does not have this much gold, much less that is accessible.

Whether we could achieve such a rate of growth in the future, may be speculated, but certainly, for the majority of human history, we did not have an average growth of wealth of 2%. With a higher rate, this gets exponentially worse.

So a rate increase, becomes a game of brinksmanship. One could contend that this applies with or without the common unit of account under a gold standard. But certainly, a rate increase under a gold standard, seeking out depositors like a hungry ponzi scheme, quickly becomes an unsustainable game of financial brinksmanship.

But the magic of it is, you don’t have to survive that interest rate forever, like friends running from a bear in yellowstone, you simply must hope your gluttonous friend ate more hamburgers than you did, and so he ends up a bear meal, and not you.

With an elevated interest rate, you don’t have to be able to sustain that rate indefinitely, only longer than the next country or financial institution. And if they fail, you can loot them and cover your interest payments.

So under a gold standard, or any fixed unit of account, where rates are directly comparable, rate increases become a game of brinksmanship. You raise rates to hopefully force the other guy to fold, and then you can take the pot. It is a “double or nothing” bet. Just like ponzi schemes are not truly sustainable,
neither is elevating the interest rate, supposedly for the sake of
“financial discipline”

That is the big picture, here. There are a lot more details with banks.

Banks fulfill several roles, which have a natural synergy, they hold deposits,
they make loans, and they clear payments. Payments are handled through net
end of day settlements between banks. If Alice sends $100 from her JP Morgan account to a recipient with an account at Bank of America, and Bob sends $100 in the other direction, then these two payments net out.

Simply by making interbank payments, banks issue credit to one another.

The interest rate banks pay to each other, is simply the marginal cost of payment imbalance. There are a lot of ways you could settle these imbalances, by pledging collateral or cash flows. Because this particular market has become highly regulated, the interest is very uniform. It is not uniform
because it is competitive. It is uniform because it is regulated. Banks are not jumping at the chance to lend and borrow from each other, they are forced to lend and borrow to operate payment systems.

Furthermore, the interbank rate need not have any connection to the rates banks lend to homebuyers and business enterprise.

Credit is a relationship that not only depends on risk, but also trust and accountability, which are in fact quite different things. In a well regulated system, such concerns can be simplified as risk, but without such simplification, trust and accountability, and risk, are not the same things, except in the sense which you call any breach of contract or failure a “risk”.

The term risk is exceptionally broad, enclosing all sorts of issues like asset price changes, external natural events, intentional non-compliance, and much
more.

So a few things should be clear:

• Raising interest rates is not just about banks or “the price of money”, it is a deliberately destabilizing financial tactic to allow some financial entities to squeeze and gain an advantage over others.
• Raising rates, whether on a common unit of account or not, involves promises and speculation which are uncertain. If a common unit of account is used, these promises tend to be more “all or nothing”.

Once countries begin using distinct unit of accounts, there is no way to predictably or consistently collate or predict the rates available from one country to the next. Countries may offer a higher rate to increase their “real borrowing”, but in general, other countries do not have to compete on a common scale. Finally, it is roughly equivalent to have a higher nominal rate, as to have a better performing currency, for
the purpose of comparing securities. Although it is important to note, that historical returns are not necessarily a good predictor.

A declined currency, like any financial asset, may either be a “bargain buy”, or part of a continued trend. The valuation of the national debt is the only meaningful metric of a currency’s overall worth. A more valuable national debt means a more valuable currency. This may give it further to fall, but a higher valuation also presents an opportunity to spend more with less market friction and hopefully a smaller price impact for the marginal spending.