THE THEORY OF INTEREST

§3. Limitations of Theory

We next inquire what limits, if any, are imposed onthe two rates of interest in the respective standards andthe rate of divergence between the two standards. Fromwhat has been said it might seem that, when the appreci-ation is sufficiently rapid, the rate of interest in the up-ward-moving standard, in order to equalize the burden,would have to be zero or even negative. For instance, ifthe rate of interest expressed in gold is 4 per cent, and ifwheat appreciates relatively to gold at 4 per cent also,the rate of interest expressed in wheat, if perfectly ad-justed, would theoretically have to sink to zero! Butzero or negative interest is practically almost impossible.If it were definitely foreknown that wheat was to ap-preciate as fast as 4 per cent when the rate of interestin money is 4 per cent, wheat would be hoarded and somany people would want it that its present price wouldtend instantly to come within 4 per cent of its next year’sprice. This would, from that instant, prevent the rateof interest in terms of wheat from passing below the zeromark.

For instance, if interest is 4 per cent, it is impossiblethat wheat should be worth $1 today and $1.10 nextyear foreknown today by everybody. For, if such priceswere possible, holding for a rise would give a sure returnof 10 per cent (neglecting storage charges and othercosts of carrying). The result of such perfect knowledgeof next year’s price would be that the lowest possibleprice of present wheat would then be the expected $1.10discounted at 4 per cent, or about $1.06.

This very limitation on the possible rate of interest—that it cannot theoretically sink below zero—carries with

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