Farmers Law
A consumer has the choice to either save or to invest. If they decide to save now, effectively the consumer decides to postpone consumption to a later date. Due to fractional banking, banks will lend out more than client deposit with them. For example:
The population owns 50 of some money. Let’s say the consumers deposit 10 (Ms) with the bank and consume another 40 (Mc). The banks are in a position to lend out say 100. In this case a Multiplier (Mu) of 10. The total money supply increases from 50 (Ms + Mc = M) to 140. For now we assume the money lend is invested, some way or another.
Although the legal entities receiving these loans are different than the entities depositing the loans, we assume that from a top down level (helicopter view), this money is lend to the economy or public at large. At an interest rate of 10% (R) (we ignore the horizon at this moment and assume savers do not receive interest at their deposits) the public at large will need to pay back 110. This is 100 nominal and 10 interest.
The consumers had 50 and are left with 40, which can be saved or consumed. This would be fine if the 40 can buy more than the 50 held previously. This would be the case for instance if productivity has increased so much that prices have dropped more than 20% (P). We assume here that this price drop is realized by an equal increase in productivity (P), which resulted from well executed investments, made possible initially by the savings.
If we all summarise in a formula:
M – Mu * R * Ms > M * (1 – P) or (1)
- Mu * R * Ms/M > - P so, (2)
R * Mu < P * M/Ms (3)
Under a Gold Standard economy, fractional banking is not allowed. The multiplier is 1 at most. If then under the gold standard M1 = M (all the money we have is saved) and Mu = 1 (all money saved is invested in a better future) then:
R < P (4)
In words: if all is saved (and invested) and noting is consumed, the interest rate charged should be less than the productivity increase. If this is not the case, the consumers are worse off than before, and the investments were not executed properly.
This is the very basic Farmers Law: to maintain wealth and purchasing power, we should invest our money properly.
This means, increasing productivity more than the (interest) costs of investments.
This means, increasing productivity more than the (interest) costs of investments.
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