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NOTE 6.02. The Determination of the Pure Rate of Interest: The Time Market

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2. The Determination of the Pure Rate of Interest, The Time Market

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It is clear that the rate of interest plays a crucial role in the system of production in the complex monetary economy.

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How is the rate of interest determined?

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The pure rate of interest, with which we are now concerned,

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The market, we have seen, will tend to be equal throughout all stages of all production processes in the economy, and thus will be uniform in the ERE.

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The level of the pure rate of interest is determined by the market for the exchange of present goods against future goods.

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A market which we shall see permeates many parts of the economic system.

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And the establishment of money as a general medium of exchange has greatly simplified

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the present-future market as compared to the laborious conditions under barter where there

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were separate present-future markets for every commodity.

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In the monetary economy, the present-future market, or what we may call the time market,

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is expressed completely in terms of money.

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Money is clearly the present good par excellence.

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For aside from the consumption value of the monetary metal itself, the money commodity

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is the one completely marketable good in the entire society.

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It is the open sesame to exchange for consumption goods at any time that its owner desires.

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It is therefore a present good.

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Since consumers' goods, once sold, do not ordinarily re-enter the exchange nexus, money

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is the dominant present good in the market.

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Furthermore, since money is the medium for all exchanges, it is also the medium for exchanges

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on the time market.

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What are the future goods that exchange for money?

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Future goods are goods that are now expected to become present goods at some future date.

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They therefore have a present value.

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Because of the universal fact of time preference, a particular good is worth more at present

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than is the present prospect of its becoming available as a present good at some time in

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the future.

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In other words, a good at present is worth more now than its present value as a future

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good.

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Because money is the general medium of exchange, for the time market as well as for other markets,

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money is the present good, and the future goods are present expectations of the future

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acquisition of money.

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It follows from the law of time preference that present money is worth more than present

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expectations of the same amount of future money.

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In other words, future money, as we may call present expectations of money in the future,

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will always exchange at a discount compared to present money.

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This discount on future goods as compared with present goods, or conversely the premium

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The system commanded by present goods over future goods is the rate of interest.

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Thus, if on the time market 100 ounces of gold exchange for the prospect of obtaining 105 ounces of gold one year from now,

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then the rate of interest is approximately 5% per annum.

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This is the time discount rate of future to present money.

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What do we mean specifically by prospects for obtaining money in the future?

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These prospects must be carefully analyzed in order to explain all the causal factors in the determination of the rate of interest.

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In the first place, in the real world, these prospects, like any prospects over a period of time, are always more or less uncertain.

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In the real world, this ever-present uncertainty necessarily causes interest and profit and loss elements to be intertwined and creates complexities that will be analyzed further.

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In order to separate the time market from the entrepreneurial elements, we must consider the certain world of the evenly rotating economy,

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What, then, are the specific types of future goods that enter the time market?

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There are two such types. One is a written claim to a certain amount of money at a future

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date. The exchange on the time market in this case is as follows. A gives money to B in

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exchange for a claim to future money. The term generally used to refer to A, the purchaser

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of the future money, is lender or creditor, while B, the seller of the future money, is

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is termed the borrower or debtor.

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The reason is that this credit transaction, as contrasted to a cash transaction, remains

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unfinished in the present.

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When a man buys a suit for cash, he transfers money in exchange for the suit.

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The transaction is finished.

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In a credit transaction, he receives simply a written IOU, or note, entitling him to claim

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The transaction remains to be completed in the future, when B, the borrower, repays the loan by transferring the agreed money to the creditor.

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Although the loan market is a very conspicuous type of time transaction, it is by no means the only or even the dominant one.

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There is a much more subtle but more important type of transaction which permeates the entire production system, but which is not often recognized as a time transaction.

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This is the purchase of producers' goods and services, which are transformed over a period of time, finally to emerge as consumers' goods.

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When capitalists purchase the services of factors of production, or as we shall later see, the factors themselves, they are purchasing a certain amount and value of net produce,

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A Capitalist Entrepreneur hires labor services, and suppose that it can be determined that

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The Theory of Money and Credit

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The Capitalist, the full 20 ounces now, in advance, he will receive his net earnings

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discounted by the going agio, the rate of interest, and the interest income will be

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earned by the capitalist who has assumed the task of advancing present money.

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The capitalist then waits for five years until the product matures before recouping his money.

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The pure capitalist, therefore, in performing a capital advancing function in the productive

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system plays a sort of intermediary role.

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He sells money, a present good, to factor owners in exchange for the services of their

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factors, prospective future goods.

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He holds these goods and continues to hire work on them until they have been transformed

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and into consumers' goods, present goods, which are then sold to the public for money,

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a present good.

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The premium that he earns from the sale of present goods compared to what he paid for

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future goods is the rate of interest earned on the exchange.

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The time market is therefore not restricted to the loan market.

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It permeates the entire production structure of the complex economy.

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All productive factors are future goods.

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They provide for their owner the expectation of being advanced toward the final goal of

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consumption, a goal which provides the raison d'etre for the whole productive enterprise.

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It is a time market where the future goods sold do not constitute a credit transaction,

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as in the case of the loan market.

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The transaction is complete in itself and needs no further payment by either party.

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In this case, the buyer of the future goods, the capitalist, earns his income through transforming

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these goods into present goods, rather than through the presentation of an IOU claim on

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the original seller of a future good.

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The time market, the market where present goods exchange for future goods, is then an

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aggregate with several component parts.

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In one part of the market, capitalists exchange their money savings, present goods, for the

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services of numerous factors, future goods.

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This is one part, and the most important part, of the time market.

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Another is the consumer's loan market, where savers lend their money in a credit transaction

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in exchange for an IOU of future money.

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The savers are the suppliers of present money, the borrowers the suppliers of future money

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in the form of IOUs.

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Here we are dealing only with those who borrow to spend on consumption goods, and not with

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with producers who borrow savings in order to invest in production.

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For the borrowers of savings for production loans are not independent forces on the time

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market but rather are completely dependent on the interest agio between present and future

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goods as determined in the production system, equalling the ratio between the prices of

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of Consumers and Producers' Goods and Between the Various Stages of Producers' Goods