Interest Rates and Time Preferences

The concept of time preference relates to the fact that we generally prefer early consumption to late consumption, so we expect to be rewarded for any deferred consumption. However, there's a limit to how much we can consume in the present, and there's a constant need to save for the future. We are therefore willing to accept a loss in future purchasing power if consumption in the present is of little value.

The need to save for the future doesn't go away just because central bankers decide to set interest rates lower than inflation. All that happens is that it becomes less profitable to save currency. However, there are alternatives, and the closest alternative we have to currencies is gold.

An interesting feature of gold is that it is a commodity required in the manufacturing of jewellery, and therefore a part of the value hierarchy of the real world. If the world economy does well, gold does well. If the world economy does badly, gold does badly. If dollar prices go up for real world goods and services, the dollar price of gold goes up. The price of gold will fluctuate with sentiments related to jewellery, but will by and large follow the world economy.

One way of looking at this is to view gold as a type of bond tied to the world economy. It has a natural interest rate equal to the growth rate of the world. This natural interest rate is reflected in the price of gold, measured in currencies such as dollars and euro. While these prices swing a lot in the short term, they are remarkably stable over time.

Over the last 20 years, gold has had an average natural interest rate of about 10% per year relative to the dollar. Of this, much is due to the falling purchasing power of the dollar. But a part is due to growth in the world economy. Gold has tracked the world economy, and can be expected to do so for ever due to its use in jewellery.

The prudent saver, with a long time horizon, can for this reason save in gold with no worries about its eventual purchasing power. Unlike unbacked currencies, gold will never become worthless. On the contrary, it will keep its relative position in the value hierarchy of things.

Jewellery

By George E. Koronaios - Own work, CC0, Link