Multi-Disciplinary Reading – Book Reviews

The Price of Time, Edward Chancellor, 2022 – This is a topic I have pondered extensively on, from a micro (what makes us discount and is it same for everyone?) and macro perspective, so this book was thoroughly enjoyable and enlightening. It examines the origins of interest, how it was set and mostly on how things have devolved in the last 100 yrs of monetary experimentation. It is unequivocally against interest rates set at levels close to zero, or any level set below natural rate of growth or even the idea that it should be centrally managed at all and mirrors the Austrian school of thought.

What we have had in the last 15 years is so abnormal that we think of it as the norm purely from availability bias. The era of easy money, globalisation, low interest rates, cheap goods, low inflation and consequently the exceptional world peace might be at cross-roads. We needn’t throw the baby with the bath water but there’s always the risk of that

My notes –

• Interest constitutes a reward for idleness and is a basic cause of inequality and poverty (Proudhon, 1849)

• Interest is a fair reward for use of capital for a period of time, and time has value (Bastiat, 1849)

• To abolish interest on capital would result in annihilation of credit and the death of capital (Bastiat)

• A bad economist pursues a small current benefit for a large disadvantage in the future (Bastiat)

• It is important for health of economy that bad businesses (inefficient producers) be allowed to die (Hazlitt, 1946)

• Easy money encourages highly speculative ventures that cannot continue except under the artificial conditions that gave birth to them. It discourages thrift, saving and investment, slows down inc. in productivity (Hazlitt)

• GFC (2008) pushed central bankers to lower interests to levels not seen in five millennia. It encouraged households to spend more and save less and thwarted creative destruction and impeded reallocation of capital to productive resources (as Hazlitt predicted in 1946)

• Low interest rates PE barons and Wall St. to borrow for peanuts while incomes barely grew and low-paying jobs proliferated

• Interest rates on reserve currency cannot be below economy’s growth rates for long – it drives capital out to emerging markets (tightening causes flows to reverse and commodities to crash)

• Interest is intrinsic to human nature and impatience – it expresses their time preference (Bohm-Bawerk and Fisher)

• Nature’s productivity has a strong tendency to keep the rate of interest up (Fisher)

• 33.33% was the standard rate of interest in Babylon for Barley loans (2nd and 3rd mil. BC). Interest rates would vary based on purpose. After crop damage interest would be forgiven (Hammurabi)

• Babylon, Greece or Rome – interest have always followed a U-shaped curve over centuries – declining as civilization was rising and prospered and rising with its decline and fall. Very low rates were calm before the storm

• Drastic fall in Interest rates were preceded by sudden discovery of treasures – like Spanish and the Inca Gold or Augustus in Rome – housing prices rose. Periods of scarcity, interest rates rose and resources were rationed

• Lending is a inter-temporal transaction. While lenders surrenders exchange value of money, he retains its “store of value” through a collateral

• In 12th century Spain, penalty for a banker’s failure was beheading

• Usury redefined in middle ages – as loans on consumption than on productive ventures. Then as receiving gain on loans without risk

• A bird in the hand is worth two in the bush (earliest known time preference)

• In a steadily expanding economy, most people will become rich over time – with future income exceeding current income, people will value it less (hence ageing populations will have falling rates)

• Interest rate must be free to find its own levels (Locke). When free, it would find a level that’s in sync with the natural rate of growth (r*). Discrepancies between the two will show in the price levels (inflation)

• When bond yields far exceed the growth in national income, existing debt becomes burdensome and bankruptcy beckons (Debt trap. US can get into a vicious debt spiral in due course)

• When asset price bubbles proliferate, credit booms, finance crowds out honest endeavor, savings collapse and capital is misallocated on a grand scale, chances are market rates of interest are not aligned with natural rate (What has happened since 2008)

• John Law, a gambler and fugitive fled to France and somehow ended up controlling the central bank and his genius is what led to the Mississippi bubble. People even believed France had become incredibly rich under Law (it was all paper wealth)

• The newly minted millionaires of France under Law’s credit expansion and market manipulation embarked on an orgy of high living until bubble burst, currency tanked and funds fled France. Law banned owning precious metals.

• The idea that national bank could drive down interest rates by purchasing govt. debt probably originated with Law in France (Newton took it up later in England, then Keynes advocated it and our Fed repeated the mistakes)

• The stock market bull seeks to condense time into a few days to discount the long march of history, and capture the value of all future riches. At low rates, the speculator becomes a psychopath

• As national bank turns on the printing presses to buy govt. debt. The newly created money is trapped in the financial system, where it inflates financial assets rather than consumer prices and only slowly seeps into the wider economy (Cantillon, 1720)

• Interest is the barometer of trust and it rises and falls with the cycle. Lax financial behaviour, alongside too much trust thus peaks the cycle. 2% interest leads to financial folly (Bagehot)

• When investors are used to a certain level of return on investments and can’t attain it, they are inclined to take more risks (Bagehot). (This could be the fuel for several blowups we are bound to see in a high rate environment)

• When Britain expanded its rail network by 50% in 1865, lot of capital was wasted in the investment mania. Contractors were paid in bonds and bills and dumped them and rates went up

• Panics don’t destroy capital, they merely reveal the extent to which it was already destroyed in unproductive ventures

• During a crisis, central bank must lend against high-quality collateral for the shortest possible term (lender of last resort concept started with Bagehot, 1876. It was first used though to finance the boom in stock market between 1924-1928 when bank credit doubled with interest set at half of the growth rate – 4% interest against 8% growth)

• More skyscrapers went up in the 1920s than in any other decade in the century

• 1928 Moody’s declared stock prices had ‘over-discounted anticipated progress’. “Discounting the future” had become a buzzword

• During a single week by end of 1927, more shares changed hands in a week than in any week in exchange’s history. Broker loans went up 30% in the year. Rates went up from 3.5% to 5% in July ‘28 but it was barely enough as markets went up another 30% by Aug ‘29. Higher rates reversed flow of funds and money from Germany and Britain flooded US and both had to raise rates (Not very dissimilar now)

• Keynes was very confident in 1929 saying market was very appealing and prices were too low. The greatest attempt at price stability though resulted in the Great Depression (Keynes got the great depression so wrong its unbelievable)

• There’s nothing so unstable as a stable price level (John Grant, 2014)

• Gold standard regulated interest rates automatically. Whenever spending and investment exceeded income and savings, gold left the country and central bankers were forced to raise rates

• Gold Exchange Standard (more elastic) vs Gold Standard – govt. securities, alongside gold were considered reserves. This led to credit imbalances lasting longer as rates were no longer determined just by bullion flows.

• Central banks targeting price stability to avoid both deflation and inflation originated with Wicksell. He suggested Central banks work together to achieve this (hence ECB, BOJ, RBI all following suit to what Fed does)

• Attempts to avoid a good deflation only make a bad deflation more likely (Hayek). Deflation restores the health of the monetary system (Schumpeter). Good deflation arises from productivity improvements, bad deflation from a credit bust

• When a measure becomes a target, it ceases to be a good measure (Goodhart’s Law)

• Inflation in financial assets is a better measure than consumer prices. Japan missed the mess it created because it kept rates low in the 80s and 90s in the absence of inflation (Fed did the same mistake in 1920s)

• Greenspan created the 90s bubble keeping interest rates lower than growth which ended when the fed funds rate rose to 7% in 2000. He created another in 2003 keeping rates at 1% (EMs like India saw the golden period of this profligacy)

• Lower and lower interest rates are needed in a debt supercycle to sustain the volume of debt. This makes it impossible to raise rates as raising with result in a debt trap

• Low interest rates in the US spurred massive flows of yield chasing money across borders. Foreign central banks, printed money in local currency and increased their reserves of treasures to prevent their currencies from appreciating. Thus raising rates threatens globalisation with an epoch-defining seismic rupture

• The great depression propelled productivity improvements across everything from warehousing to airlines

• The riches of a nation can be measured by the violence of the crises it experiences

• Capitalism without bankruptcy is like Christianity without hell

• Monetary policy cannot be a substitute for political and economic reforms essential for survival of a single currency (Eurozone)

• Bad money drives out good (Gresham’s law). Adverse selection – Loss-making Japanese firms enjoyed better bank credit than profitable ones (Money chased loss-making fintechs instead of steel mills and fertilizer factories)

• Unicorns feed on interest rates, the tinier the better

• Recessions induce a shakeout of less efficient firms, inducing works to relocate between businesses (Mild recessions dont do this)

• US capital stock declined and grew rusty despite low interest rates. Most capital chased financialization and spurious growth (like buybacks, mergers). Low interest rates → low investment → falling productivity

• Fed’s dual mandate is that of arsonist and fireman

• The rentier state is a state of parasitic, decaying capitalism

• Cartels tend to form when rates are low and breakup when they are high

• Rising industry concentration was associated with higher pay for senior execs, decline in worker’s bargaining power and falling investment and R&D

• From the turn of the century cost of debt was held below cost of equity – this funding gap provides impetus for buybacks (it works against long-term investment) and mergers ($7 trillion of goodwill sits on companys’ balance sheets)

• Growth in a country’s financial system is a drag on real productivity growth (manufacturing and R&D is starved of credit). Even companies like John Deere (1/3rd of rev in lending) and GE took up to financialization (GE Capital and 100 quarters of consecutive earnigns growth under Welch). Only 1 in 10 workers was employed in industry. 50% was in FIRE (finance, insurance, real-estate)

• Apply a discount rate of zero and you arrive at an infinite valuation (under ZIRP/NIRP regime). Bulls/Bears ratio was highest in decades, so was house prices/rent. Manias resulted from hyperbolic discounting in concept stocks and ICOs and several non-income generating assets like gold, vintage cars, contemporary art and cryptos (the everything bubble)

• Life is a struggle for energy and capital was really a form of stored energy

• Financial repression – holding short-term rates below rate of inflation (negative real rate)

• Savings in US and UK are very low because of decades of very low interest rates which disincentivised saving

• The Great Depression kicked off a multi-decade decline in inequality (Great Compression). The Greenspan, Bernanke, Yellen and Powell bubbles have increase inequality to levels never seen before across the world. Over 3/4th of Americans live paycheck to paycheck and middle class declined across developed world

• Elite overproduction – $1.5 trillion in student debt and yet 40% of graduates were underemployed as they couldn’t find work that matched education level (Only China seems to have cracked vocational training at scale)

• Duration risk – Fixed income bonds exposed to future change in interest rates (Pension liabilities at risk)

• Carry trades have asymmetric risk – lot of small gains with exposure to sudden major losses (nickels in front of steamrollers). They tend to blow up after periods of easy money when leverage and other risks pile up

• The notion that negative yielding bonds denominated in a fiat currency were deemed “safe” assets belongs in the next edition of Extraordinary popular delusions and the madness of crowds

• There is no such thing as liquidity of investment for the community as a whole (Keynes)

• When insurance rates are set too low, people build houses on flood plains (When volatility is managed and rates set too low, people take inordinate amount of risks)

• Cheap trade credit encouraged firms to construct longer and longer supply chains, which in turn reduced price of traded good (Biggest risk to globalisation from higher rates is this). A feedback loop thus exists between globalization and interest rates (cuts both ways)

• Fed’s mandate of inflation and employment doesn’t consider impact on foreign currencies and countries (power without responsibility)

• China’s massive purchases of US treasuries put downward pressure on US long-term interest rates (China dumping treasures is causing it to rise now)

• Capital gets misallocated in China on a scale not seen since the heydey of the Soviet Union (Evergrande ran up liabilities that were 3% of GDP. China has 50% of global corp debt)

• An economy that can’t grow faster than its interest costs is said to have entered a ‘debt trap’

• Evergreening is a common practice in China where short-term uncollectible debt gets swapped for (uncollectable) long-dated debt (US govt does no better). When losses don’t show up in financial institutions balance sheets, they do so via slowing growth and deflation (and China exports deflation by dumping its goods onto the world)

• As long as yield on govt bonds was held below level of inflation, over time national debt could be inflated away (Financial repression is how war debts were inflated away post WW2)

• Central planning doesn’t work (its essentially communist than capitalist). Yet, capitalist economies rely on central banks to set rates (Hayek). An economy in which risk is socialised is no longer Capitalist

• Inequality can be good (grows the pie and incentivises those that improve their lot) or bad (rent-seeking and causes stagnation). What we have is the latter

• Low-rate thinking has percolated into everything from investor thinking, market forecasts, inflation expectations, valuation models, leverage ratios, debt ratings, affordability metrics, housing prices and corp. behavior. Truncated downside volatility, forestalling business failures has given wrong impression of risk having gone into hibernation (Seth Klarman)

• Interest rates are to value of assets what gravity is to matter (Buffett)

• When inflation returned after the war, treasury yields rose for next 3.5 decades. If globalisation reverses and China’s workforce declines, same thing could happen now

Interest and capitalism are inseparable. Interest rates are required to direct the allocation of capital and without it, we cannot value investments. We are in a crucial juncture where there could be a paradigm shift and we must understand the open possibilities and implications well – for even if the probabilities of such possibilities occurring are low, the implications are so huge that it threatens the world as know it. This is a very well researched and well written book and deserves a read if finance and economics is your thing. 10/10