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

0:002. The Determination of the Pure Rate of Interest, The Time Market It is clear that the rate of interest plays a crucial role in the system of production in the complex monetary economy. How is the rate of interest determined? The pure rate of interest, with which we are now concerned, 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. The level of the pure rate of interest is determined by the market for the exchange of present goods against future goods. A market which we shall see permeates many parts of the economic system.

0:49And the establishment of money as a general medium of exchange has greatly simplified the present-future market as compared to the laborious conditions under barter where there were separate present-future markets for every commodity. In the monetary economy, the present-future market, or what we may call the time market, is expressed completely in terms of money. Money is clearly the present good par excellence. For aside from the consumption value of the monetary metal itself, the money commodity is the one completely marketable good in the entire society. It is the open sesame to exchange for consumption goods at any time that its owner desires.

1:38It is therefore a present good. Since consumers' goods, once sold, do not ordinarily re-enter the exchange nexus, money is the dominant present good in the market. Furthermore, since money is the medium for all exchanges, it is also the medium for exchanges on the time market. What are the future goods that exchange for money? Future goods are goods that are now expected to become present goods at some future date. They therefore have a present value. Because of the universal fact of time preference, a particular good is worth more at present than is the present prospect of its becoming available as a present good at some time in the future.

2:31In other words, a good at present is worth more now than its present value as a future good. Because money is the general medium of exchange, for the time market as well as for other markets, money is the present good, and the future goods are present expectations of the future acquisition of money. It follows from the law of time preference that present money is worth more than present expectations of the same amount of future money. In other words, future money, as we may call present expectations of money in the future, will always exchange at a discount compared to present money.

3:17This discount on future goods as compared with present goods, or conversely the premium The system commanded by present goods over future goods is the rate of interest. Thus, if on the time market 100 ounces of gold exchange for the prospect of obtaining 105 ounces of gold one year from now, then the rate of interest is approximately 5% per annum. This is the time discount rate of future to present money. What do we mean specifically by prospects for obtaining money in the future? These prospects must be carefully analyzed in order to explain all the causal factors in the determination of the rate of interest.

4:06In the first place, in the real world, these prospects, like any prospects over a period of time, are always more or less uncertain. 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. In order to separate the time market from the entrepreneurial elements, we must consider the certain world of the evenly rotating economy, What, then, are the specific types of future goods that enter the time market?

5:06There are two such types. One is a written claim to a certain amount of money at a future date. The exchange on the time market in this case is as follows. A gives money to B in exchange for a claim to future money. The term generally used to refer to A, the purchaser of the future money, is lender or creditor, while B, the seller of the future money, is is termed the borrower or debtor. The reason is that this credit transaction, as contrasted to a cash transaction, remains unfinished in the present. When a man buys a suit for cash, he transfers money in exchange for the suit.

5:54The transaction is finished. In a credit transaction, he receives simply a written IOU, or note, entitling him to claim The transaction remains to be completed in the future, when B, the borrower, repays the loan by transferring the agreed money to the creditor. Although the loan market is a very conspicuous type of time transaction, it is by no means the only or even the dominant one. 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.

6:40This is the purchase of producers' goods and services, which are transformed over a period of time, finally to emerge as consumers' goods. 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, A Capitalist Entrepreneur hires labor services, and suppose that it can be determined that The Theory of Money and Credit

7:59The Capitalist, the full 20 ounces now, in advance, he will receive his net earnings discounted by the going agio, the rate of interest, and the interest income will be earned by the capitalist who has assumed the task of advancing present money. The capitalist then waits for five years until the product matures before recouping his money. The pure capitalist, therefore, in performing a capital advancing function in the productive system plays a sort of intermediary role. He sells money, a present good, to factor owners in exchange for the services of their factors, prospective future goods.

8:46He holds these goods and continues to hire work on them until they have been transformed and into consumers' goods, present goods, which are then sold to the public for money, a present good. The premium that he earns from the sale of present goods compared to what he paid for future goods is the rate of interest earned on the exchange. The time market is therefore not restricted to the loan market. It permeates the entire production structure of the complex economy. All productive factors are future goods. They provide for their owner the expectation of being advanced toward the final goal of consumption, a goal which provides the raison d'etre for the whole productive enterprise.

9:39It is a time market where the future goods sold do not constitute a credit transaction, as in the case of the loan market. The transaction is complete in itself and needs no further payment by either party. In this case, the buyer of the future goods, the capitalist, earns his income through transforming these goods into present goods, rather than through the presentation of an IOU claim on the original seller of a future good. The time market, the market where present goods exchange for future goods, is then an aggregate with several component parts. In one part of the market, capitalists exchange their money savings, present goods, for the services of numerous factors, future goods.

10:34This is one part, and the most important part, of the time market. Another is the consumer's loan market, where savers lend their money in a credit transaction in exchange for an IOU of future money. The savers are the suppliers of present money, the borrowers the suppliers of future money in the form of IOUs. Here we are dealing only with those who borrow to spend on consumption goods, and not with with producers who borrow savings in order to invest in production. For the borrowers of savings for production loans are not independent forces on the time market but rather are completely dependent on the interest agio between present and future goods as determined in the production system, equalling the ratio between the prices of of Consumers and Producers' Goods and Between the Various Stages of Producers' Goods