Minggu, 07 April 2013

Interest vs. discount

There are two broad approaches to the world of science; the traditional way, the sense of natural philosophers is one. Galileo, Newton, Darwin, Adam Smith and many other greats of the past have been considered ‘ natural philosophers ‘. Natural philosophers, observing nature and formulate hypotheses and theories based on their observations. Can use mathematics to describe and clarify their observations and hypotheses, but to the natural philosophers math is simply a tool used to describe nature.

A second approach, very different, first popularized by Einstein. He calls this approach “gedanken experiment ‘ … in other words, an experiment ‘ mental ‘. The idea came first, followed by the experiment. Quadratic equations … Math … came first, then came the observation; Natural philosophy has been turned on its head.

Einstein was a scientist well enough to understand that the experiment would you prove or disprove the hypothesis and theory and mathematics; Unfortunately, many of the followers of Einstein have missed this important nuance. Today, there is a widespread belief that mathematics is the science, that the numbers are. Tests that do not support the prevailing paradigm is discarded, ignored and vilified … all at the expense of scientific progress.

This distortion of the scientific method has invaded the economy; most economists think the main stream economics is mathematics … and the only problem is to discover the right equations. This is a misconception, in economics as well as in physics … If not more. People’s behavior, unlike the behavior of subatomic particles, cannot be described by equations; There are no equations to quantify free will.

So what has this to do with the interest vs. discount ‘? A lot … it’s easy to mathematically convert the discount on a real account as a percentage; to annualize discount, making it easier to compare the discount with interest paid by bonds or mortgages; but the mathematics is not the economy. Convert the numbers don’t change the meaning behind the numbers or economic realities.

The bonds carry an interest rate … and forces that determine interest rates are completely divorced from the forces that determine the discount rate of real bills. Interest rates reflect the cost of borrowing … the cost of debt. Real bills represent the commercial credit and have nothing to do with the loan or debt.

Interest rates are determined by two sets of forces; one sets the interest rate floor and to the ceiling. The plan is set for arbitration between the bond and cash markets gold … If prices are too low, owner of marginal bond will sell its bonds now overpriced and keep cash gold instead. Bonds are overpriced because the price of a long bond varies inversely with current interest rates. low interest rates = high bond prices and vice versa.

This is the Austrian formula for interest rates; is a reflection of time preference, expressed in technical terms. More simply, a person with wealth (money to lend) does not lend it … except maybe the family … unless he is compensated (from interest payments enough) to make immediate use of its gold. This is the time preference, and the floor is absolute; as interest rates approach zero, zero nears loan.

Conversely, as interest rates rise, more gold holders will choose to buy bonds; that is, pay their money gold in order to gain income. In fact, if rates go high enough … probably not under a Gold standard correct but theoretically possible … then all gold cash available (disposable income) will be invested. If interest rates go up again somehow, there will no longer be available for purchase bonds of gold … Bonds are a tool of paper, with no precise limit … Unlike a very definite limit to the amount of gold in existence. This is where the other force that sets the interest rate ceiling on kicks.

This force is arbitrage between equity markets and bond markets. As interest rates rise, marginal entrepreneur sell his possessions and buy risk free bonds at low prices. Once this refereeing kicks, bond to buy picks, forcing bond prices up and interest rates down. In addition, if entrepreneurs drop out production company bonds, the question of bonds goes down too. In a real economy, vs. Fiat economy, entrepreneurs use borrowed funds to finance production company .

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