Make it difficult for people to use the towels:

Turn it into a coat rack:
{{!gwi}}

Maybe you would be okay with guests using Turkish towels? I have never had them, but I imagine they would just get softer with washing.

The link is to West Elm because I recognize them, I guess some of the etsy, etc sources would have more authentic items.

Here is a link that might be useful: West Elm turkish towels

Not this exactly...Something else to work from..

You've received some great suggestions for alternate uses for the towel bar. My suggestion though is to try buying a different brand of towel. I've several different towel brands over the years, all 100% cotton, some solid and others with geometric patterns, and all look the same after washing as before. I've found that our towels usually look very good for a couple years or more--YMMV. Otherwise your guests or family have to either drip dry or use things you don't think look good enough to display....unless I'm missing the point of this.

I tend to agree with jujafr.

Either use it as a towel bar, with towels you would be OK for guests to use.

Or remove it.
It's not hard to remove You would just have a few small holes to cover and patch. And presumably you would then hang decor/art over the spot anyway. Or remove the bar and the hardware, don't even patch the holes, and hang art over the spot. This way the bar can easily be reinstalled if you change your mind.

I trust you have obvious accommodation for guests to dry their hands....otherwise they will use the towels you have.

I can't imagine putting anything in my powder room that I wouldn't expect guests to use....I have mouthwash with plastic cups, hand lotion, soap, towels, tissues, spare TP...it's all for them.

I've thought about using the paper guest towels, but we are on a septic system and I'm afraid people may try to flush them and cause all kinds of plumbing issues I'd rather not have....so instead I have plenty of towels to be used.

Otherwise, as suero suggests, tie them up. Perhaps you can compromise with usable towels...perhaps in white cotton so they can be washed many times without issue... paired with a tied up decorative.

You have hit upon a pet peeve of mine, since my mother did something similar when I was a child - there were towels we were forbidden to use (5 people, one bathroom, what was she thinking?). They went with the little soaps in the dish that were faded and caked with dust. But I digress.

If it really bugs you, it would be a lot easier to remove the towel bar. A couple simple tools (screwdriver and allen wrench, Spackle, sandpaper and matching paint. Or take it down and put a picture there.

If not that, perhaps one of those boxes of Kleenex paper hand towels that is designed to sit on the rod?

Or, put your pretty towels on the rod and then drape small hand towels over the pretty ones. Most people will reach for the small towel.

Thank you for the suggestions. Our half bath down stairs bath is used by visitors and I don't have anything in there that they could not use. But, our full baths upstairs are primarily used by overnight guests (and this is usually family). In both upstairs bathrooms there are white embroidered towels hanging from the towel bars. There is also a linen closet inside each bathroom. When guests (usually family) arrives I show them where everything is, including opening the linen closet so they know all of what is in it (towels of all sizes and all bathroom necessities). I may just have to start taking the towels down and putting them away when we are expecting overnight guests.

My guest bath is on the main floor and I typically have lovely, seasonal, decorative towels hanging on the bar. There's a towel ring next to the sink with a normal hand towel, as well as paper guest towels alongside the sink, for us and visitors. But when overnight guests come, i figure that's their bathroom and I replace the decorative towels with their towels, along with putting out little toiletries. All part of making them feel at home. I do keep the decorative soaps in the shower and sink, and they get used. It used to bother me, but I have so much decorative soap (usually a gift from my guests!) now it makes me happy to see it used :)

Oh, and I love the baskets hanging from the bar! Imagine adding seasonal flowers or greenery!

Place paper hand towels in a stack next to the sink. Guests will opt to use those over a cloth towel.

bpathome, I also love the baskets hanging from the towel bar idea. What a great use of space! and it looks great.