Time preference is an extremely important term that the vast majority of modern economics professors do not teach in their lectures. It is the level of discounting of future consumption compared to the present. Since humans always prefer present consumption over future consumption, our time preference is always positive. This means that when we have one unit of food at our disposal today or the same unit sometime in the future, we will always choose the first option, because the present is already here, but the future is unpredictable. We want to satisfy the needs as soon as possible, because no one knows how much time they have available in their life.
Humans act to satisfy our needs, because the amount of goods and our time in the world is limited, but the amount of our needs is not. Human needs are endless, so we must economize our time to provide the most important first, and only then attend to others. Each individual has a different scale of needs, so they will also have a different order of satisfying them. The highest value for an individual is provided by goods that enable him to satisfy his most important needs. From this we can quickly conclude that value is not something objective and uniform for all individuals, but rather subjective for each individual. This is the starting point of praxeology – the science that studies human behavior.
Praxeology represents the foundation of Austrian economic theory, which is based on the subjective value of goods that serve to satisfy human needs. This method is the most effective way of studying economics and enables the explanation of many hitherto unexplained phenomena in the market, such as price theory, inflation, the paradox of diamonds and water, the interest rate, etc. Because our time on earth is limited, we humans act by trying to efficiently satisfy as many of our needs as possible. Human civilization and the economy develop from this, which is the mechanism by which we solve the problem of lack of goods.
So, as we have already established, time preference is always positive, as it is the relationship between the importance we attribute to the present compared to the future. Nevertheless, we must pay special attention to the difference between high and low time preference.
HIGH TIME PREFERENCE
A high time preference means that the present is much more important to us than the future, as a result of which we will have a short-term view of the world and want to consume as much goods as possible in the shortest possible time. Animals, due to their instincts, have an extremely high time preference, because due to their lack of consciousness, they have no idea of the future. For this reason, they mostly prefer to consume the entire catch in the present without saving anything for the future. Likewise, animals very often choose conflict with other members of their species instead of cooperation, as they profit by doing so at that moment, either with a greater amount of food or a greater choice of sexual partners.
People who have a high time preference live in a similar way. They steal rather than buy, consume today rather than leave something for tomorrow, create conflict rather than build long-term relationships and consume rather than save. The problem with this kind of behavior is that it prevents cooperation and encourages conflict, so that people do not share their work with others and do not devote themselves to the activities in which they are the best (specialization), but instead have to produce most of the goods themselves and make sure that no one else steals. This produces a much smaller amount of goods and increases the prevalence of violence and conflict, and civilization has no chance to flourish.
LOW TIME PREFERENCE
This brings us to another view of the world, viz. low time preferences. A low time preference means that the present is only slightly more important to us than the future, and we have a more long-term view of the world. People with a low time preference prefer to buy goods rather than steal them, thereby supporting the economy and providers. They prefer to eat only as much food as they need and save the rest for rainy days. They prefer to invest in long-term relationships and save their assets rather than start a conflict with others. They prefer to focus on the activities they are best at and share the work with others instead of stealing from them. So everyone produces what they are most efficient at and buys the rest on the market from others. This produces a greater amount of diverse goods and encourages mutual cooperation, allowing human civilization to flourish.
Thus, we can see that, despite the positive time preference, a civilization that pays attention to the future functions more optimally than one that focuses only on the present. A low time preference is both a condition for the emergence of civilization and the main factor that distinguishes us from the primitive people of antiquity. A society with a dominant high time preference, on the other hand, is directed back to a primitive state, as it impulsively consumes capital and encourages violence. The story of human civilization is thus the story of the gradual lowering of time preference and the accumulation of capital, the division of labor with specialization, and the development of new technologies.
MONEY AND TIME PREFERENCE
So what role does money play in determining a civilization’s time preference? The central one. Since money is the driver of the economy and one half of every economic transaction, it is the central asset that enables the creation and existence of civilization. When humans discovered or invented money, we were able to divide our labor and specialize in the activities we were better at than others. With this, we started to produce a larger quantity of goods, which we were able to invest in more extensive production processes, which brought us an even larger quantity of better quality goods.
The quality of the money that stored our production value determined the purchasing power that individuals had available to invest in larger production processes. The more value we could save, the better goods we could produce. This is most reflected in the inventions of the 19th century, when the vast majority of the developed world was on the gold standard. Gold enabled the greatest flourishing of human civilization in history – the Industrial Revolution. It stands behind all the modern inventions and goods that the digital age brings us.
Money is thus the main factor that determines the time preference of a civilization, and the ethical standard of society is closely related to it. The more resistant money is to inflation and confiscation by the authorities, the better it enables us to save assets and thus lowers our time preference. This comes from the awareness that our savings will be rewarded with higher purchasing power in the future, which allows us to devote ourselves to investing in processes that will pay off over time rather than immediate consumption.
Understanding the importance of time preference leads to an explanation of the formation of the interest rate on the free market. The money market, where demand and supply of loans meet, is strongly marked by a dominant time preference. The lower the average time preference, the more people are willing to lend money to businessmen who will invest it in the hope that their business will be profitable. Time preference also expresses the relative predictability of the future. The more stable the economy, the more predictable the future, which allows us to take a long-term view of our lives. Thus, lenders increase the supply of loans, which lowers its price, i.e. interest rate.
The interest rate reflects the additional price that borrowers have to pay to lenders to lend them capital today instead of borrowers having to save it themselves. Interest is thus a compensation to the lenders for investing their savings in the production processes performed by the borrowers. By decreasing the time preference of lenders, the interest rate of loans on the market also decreases, since only they are more willing to invest their savings in long-term production purposes than to spend them in the present, as they believe that this will pay them more interest. If the borrower makes a profit, he can repay the loan and enrich the lender by paying the interest.
Thus, we can see that the interest rate is not something that is determined by the central bank, but simply the price of loans on the market, which at the same time reflects the time preference of society. The history of civilization shows a long-term downward trend in the interest rate, which reached its lowest point sometime around the turn of the 19th and 20th centuries, when most industrialized countries were on the gold standard. The trend reversed with the transition to the era of easy fiat money at the beginning of World War I, when central banks took control of the money market and began centrally planning the interest rate.