- The reward for capital or business profits, which is often named interest on capital;
- The nominal rate of interest, which is the rate of interest on money expressed in money terms;
- The real rate of interest, which is the rate of interest on money after accounting for changes in the price level;
- A usurious rate of interest, which is a positive interest rate on money relative to the change in the amount of real money (M1).
A usurious interest rate contributes to financial instability. If the nominal interest rate equals the change in the amount of real money (M1) then there is no usury. In that case the real rate of interest tends to be near the rate of economic growth, provided that the velocity of money remains constant. If the amount of real money (M1) is constant as is the case with Natural Money, then the nominal interest rate should not exceed zero in order not to become usurious. Nevertheless Natural Money will encourage saving because the demurrage can be evaded on a savings account.
A combination of mechanisms will curb the increase of money substitutes (M2). First, banks must keep a reserve against savings that can be withdrawn immediately, so a growth in savings will reduce the amount of money in circulation (M1). Second, loans must be made out of savings so for every borrowing there must be a sacrifice in the form of saving. When the expansion of M2 produces price inflation there will be an increased reluctance to lend funds at a maximum rate of zero percent and there will be fewer funds available for borrowing. During a potential economic boom more funds will be invested directly in promising projects and the funds available for borrowing will reduce, so a potential economic boom will not be fuelled by lending and borrowing.
With Natural Money banks can lend money at a maximum interest rate of zero percent. For this banks can charge an intermediary fee to savers so savings have negative interest rates. For long-term deposits those rates tend to be close to zero. Interest rates near zero percent with Natural Money may be more attractive to savers than interest rates in the current financial system because they may be higher in real terms or they may offer a better risk/reward ratio. For example, if the money supply growth in the current financial system is seven percent and the long-term interest rate is three percent then the Natural Money interest rate of zero percent may be four percent higher in real terms assuming that economic growth is the same.
Financial instability caused by positive nominal-interest rates an d fractional-reserve banking as well as policy actions to deal with financial instability have been a boon to informed people in the financial sector. They operate at the expense of the real economy. Reducing financial instability and trading in the financial system to a certain extent may improve economic efficiency. Financial activities have become a plague in recent decades because of financial innovations that exploit the instabilities caused by interest and fractional-reserve banking as well as the policy actions to counter them.
An economy operating under the regime of Natural Money may be more efficient as it may be on the maximum sustainable-growth path most of the time while less productivity is lost on unproductive financial activities and government interventions. This may attract capital at the expense of economies allowing usurious rates of interest and managed economies that try to avoid usurious interest rates by fiscal and monetary policies. With Natural Money real returns could be higher if the natural rate of interest keeps the economy on the maximum sustainable-growth path. In the future all monetary systems may therefore be based on Natural Money.
Decentralisation of currencies and government
Natural Money currencies can be issued on the international, national, regional, as well as the local level. With Natural Money it may be possible to support national as well as regional and local economies and to decentralise economic decision-making. Regional and local currencies introduce exchange costs and will make it profitable to localise production when the benefits of the economies of scale are smaller than the currency-exchange costs. In such a situation local and regional currencies may reduce external competition, giving regions and communities the opportunity to become more self-dependent. Increased currency-exchange costs may cause higher interest rates and this could become an impediment to more regional and local self determination.
Government bureaucracies have a tendency to expand and waste resources as maximising profit is not a motive in government bureaucracies. The problem of bureaucracy is the belief that a government can solve many perceived problems, relieving citizens from their responsibility to deal with them. Citizens are not likely to counter this trend because the cost of a central government is spread over a large number of people. Delegating government responsibilities to the regional and local level may give people a greater incentive to strike a better balance between government action and citizen engagement as the cost of government can be more directly influenced by citizens.
For example, if benefits are paid for a significant part from local taxes then local employers may work together to hire difficult-to-employ people as a reduction in local taxes benefits those employers more directly. People may feel more pressure to find a job as their benefits are paid for by their community. Regional and local currencies can make an economy more efficient despite the increased currency-transaction costs because it can reduce the overall cost of government and enable marginally competitive people to find employment at reasonable wages without the need for government intervention. To offset arbitrariness, a central government may need to apply guidelines for the operation of regional and local governments as well as regional and local currencies.
Natural Money currencies are not attractive as currency reserves because of the holding fee. Exporting nations will dispose of received currency balances by matching exports with imports. As a consequence comparative cost advantages will become the predominant driver of international trade. Trade probably is more beneficial if it is based on comparative cost advantages. This requirement may restrict trade because of currency risk, but it also prevents the emergence of trade imbalances as currency values will adapt more quickly to a changing economic reality. Currency risk may cause higher interest rates and this could become a problem as Natural Money has a maximum interest rate.
In the past tariffs have been used to protect national industries. There is no magic formula for determining what tariffs on what products are needed or justified so decisions on tariffs have often been arbitrary and political. If fact, tariffs caused uncompetitive industries to be subsidised by competitive industries. Currency transaction costs do not have this disadvantage as they are indiscriminate. This may lead to somewhat higher prices for consumers because of reduced competition. On the other hand communities and nations may be able to achieve more self-sufficiency.
interest and cycles