Why Does Money Earn Interest? Part One

Is it better to have money now or in the future? Most people would unhestitatingly say that it is better to have it now. But why? Are our present needs more important than our future needs?

The most common explanation given for the fact that money earns interest is because we prefer present consumption to future consumption. Therefore, in order to compensate people who are willing to delay their gratification they must be offered a financial reward for doing so. But does this logic really make sense?

Certainly, if someone offered you a choice between $100 today or $100 a year from now you would choose to receive the money now. That's because if you had the money now you could invest it and earn interest and have more than $100 in a year's time. So obviously having money now is preferable to having it in the future because money earns interest. But do you see that this is a circular argument? To put it in in other words, money earns interest because money earns interest.

So, let's set money aside for a moment and ask ourselves the same question as it applies to a variety of real goods and services. After all, money only has value because it allows us to obtain goods and services. Therefore, if it is true that money today is preferable to money in the future, it should also be true that goods and services today are preferable to goods and services in the future. But is that actually true?

If someone gave you 100 apples today, how many could you eat before they went bad? 10? 20? Certainly not more than 50, right? So wouldn’t you be better off receiving 60 apples at regular intervals in the future than 100 apples right now? Does that mean that apples are an exception to the law of interest?

What about steaks? Do steaks earn interest? Would you rather have 100 juicy steaks today or one juicy steak every day for the next 100 days?

Would you rather have 50 gallons of milk today or a gallon a week for the next year? (Do you have room in your fridge for 50 gallons of milk?)

Would you rather have 5 new automobiles today or one new car every 5 years for the next 25 years?

Would you rather have 500 gallons of gasoline now or would you prefer to fill your tank once a week for the next year?

Would you rather have 5 new iPhones today or a new iPhone every 2 years for the next 10 years?

Would you rather have 50 piano lessons today or one lesson a week for the next 50 weeks?

Would you rather receive 100 massages today or one massage a day for the next 100 days?

Would you rather have 20 new pairs of jeans today or one new pair every 6 months for the next 10 years?

Would you rather have a lawn care company mow your lawn 50 times today or once a week for the next 50 weeks?

Would you rather have 100 rolls of toilet paper today... oh wait, never mind. (pandemic humor)

So, it appears that the underlying principle of interest doesn’t apply to real goods and services. Goods and services in the present are not necessarily preferable to those same goods and services in the future. In fact, the opposite is often true.

So why is money different?

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For anyone who is interested in some additional reading on this subject, here is a thought provoking excerpt from Silvio Gesell’s book, The Natural Economic Order, in which he addresses the phenomenon of interest:

A Story of Robinson Crusoe