It is the creditor's prerogative to insist that when he lends money how he shall be repaid.

One only needs to draw up the loan agreement in such a manner that the loan is done with physical gold. When agreements are made in gold terms, the borrower has to repay the gold borrowed, plus the agreed to interest amount which he must obtain from the open market.

A successful entrepreneur/borrower will be able to put the borrowed money/gold to better use than the creditor, that is why he is prepared to take the risk to put up collateral and agree to pay interest on the borrowed amount. The creditor in turn recognizes the skill and ability of the borrower and in turn takes the risk of losing his capital in order to earn interest. The whole interplay of present value and future value of money, or time preference.

The whole process of producing more goods than one consumes results in profit. The larger the profit, the bigger the ability to re-invest in plant, raw materials etc. and the ability to repay borrowed capital plus interest. In the days before paper money, interest would simply be repaid with the additional gold that the entrepreneur would obtain in the market by selling his goods at better prices (more value) than his competition.

Today we have banks and other institutions that act as intermediaries between creditors and borrowers. Paper claims that supposedly reflect money/value circulate in the economy to facilitate transactions.

In order to facilitate the lending/borrowing transaction, and that less conversions of gold to money and money to gold need take place, the borrower needs only to purchase the interest amount in gold from the market. In that manner, as the balance sheet of the lender changes to accommodate the accrual of interest, the monetary amount is backed by gold. The big mistake bankers and others made was that the borrower didn't repay the interest in gold but in circulating money which meant that the money supply was not adjusted in terms of gold. Bankers also didn't go and purchase the additional gold needed to adjust their balance sheets, because they now had more paper money to lend out with the borrower under the false impression that all the paper money was backed by gold.

A banker that lent out say 100 oz. @ 10% should at final completion of transaction have 110 oz. of gold in his possession.

When paper comes into the scenario, the banker would lend $100 (1oz.=$1) and expect $110 at final termination of contract.

At the beginning the banker had 100 oz. in his vault, now he still has 100 oz. in his vault, but $110.

The additional $10 dollars came from circulating money which for now we will assume is backed by 10 oz. of gold by some other bank or creditor in an honest system.

The only way that the bank can have $110 and 110 oz. to balance his books, is to purchase the physical gold with the $10, bring it into his vault, then create his own paper again to reflect the additional $10.

It stands to reason that only successful transactions can add to circulating currency. Gold or honest money can be transferred but NEVER destroyed ( See 'Can Wealth be Destroyed or only Transferred?' )

In instances where the lending bank made an error in assessing the borrower, the paper claims will land up with various raw material suppliers and other entities that the hopeful yet failing entrepreneur had dealt with. These claims are redeemable at the issuing bank and would deplete its gold stocks if the credit criteria were too lax.

In other words it takes gold-backed money (reflecting weight) to purchase gold, thus put more (paper) money into circulation.

Market participants will learn to price goods in a gold weight standard, which over time will reflect the additional purchasing power of gold. The more successful entrepreneurs (those that needed to borrow) there are in producing goods more effectively, the higher the demand for gold to repay the interest on loans, which would drive up the purchasing power of gold. That is the relation between gold and interest.

A lender cannot work on the assumption that gold purchasing power will appreciate at a certain pace. He needs to protect himself by making sure that he has more of the entity that he has lent at the end of the transaction than at the beginning.

It is convenient for the powers that be that people believe that gold does not pay interest and that it just lies there. All capital will just lie there unless it gets put to work and with that expose it to risk. Like cash under the mattress doesn't earn interest. Risk is the factor that makes it possible to demand interest.

Gold does pay interest. Interest rates will remain low in percentage form, but purchasing power will increase to allow for slower availability of gold as time progresses. The market will make the necessary adjustments.

André D. F. Oosthuizen
20 December 2005