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ALTIF transcripts: Putting the Right Price on Time (Edward Chancellor)

It’s arguably the most important number in world history, and one that drives almost all our main economic decisions. But how is the interest rate set, and (more importantly) have we been setting it wrong in recent years, to the detriment of our economies? We discuss interest rates from Babylon to QE with economic historian and author Edward Chancellor.

Presented by Jonathan Ford and Neil Collins.

With Edward Chancellor.

Produced and edited by Nick Hilton for Podot.

Neil Collins 00:05

Hello and welcome to a long time in finance with Jonathan Ford and Neil Collins in partnership with briefcase dot news service that brings intelligent curation and analysis to your media monitoring.

Jonathan Ford 00:22
Time is money as we like to say on this podcast.

Neil Collins 00:24
Definitely yes, and brevity is wit.

Jonathan Ford 00:28

And our guest this week is someone who not only knows a great deal about the price of time, but also has an impressive sense of timing. Edward Chancellor’s first book ‘devil take the hindmost’ on financial speculation was published just before the bursting of the .com bubble in 2000. Now he’s published the price of time, a history of interest rates. Just as monetary policy around the world is tightening and threatening to tip many countries, including our own, into recession. Along with taking an entertaining tour through the highways and byways of compound interest from the time of the Babylonians, the book issues a stern warning about the dangers of loose monetary policy or setting interest rates too low. Eddie, welcome back to a long time in finance, good to have you back.

Edward Chancellor 01:16

Nice to see you.

Jonathan Ford 01:17

I just wanted to start in your book, you basically argue that many of the problems we have; low productivity, impossibly expensive houses, a bloated financial sector, all stem from our decision to keep interest rates too low. Perhaps you can explain how you believe you can tell they’ve been too low and how you attach all these ills to them.

Edward Chancellor 01:38

When I embarked on this book, it was really because I was concerned about the state of the financial system and the economy. And I thought that you could really only understand what was going on by having a picture of what these very low-interest rates for the last decade, were actually doing. In the book, I try and look at interest across a number of different dimensions. Conventionally, the central bankers only think about the interest rate movements relative to inflation or deflation. But I argue that there are a number of other things that interest influences to start with, it affects how capital is allocated, the movement of resources, from low return investments or businesses to higher returns. But as I also pointed out with very low-interest rates, you get an incentive to invest in projects with very long-dated returns. I would argue that we’re doing that with the unicorns of Silicon Valley, many of which are just specious speculations, they are a zombie company. So there’s this misallocation of capital. But then, Jonathan, as you and I know, as particularly those of us who worked in corporate finance, at the beginning of our careers is, you know, the discount rate that one uses for valuing streams of future income has a huge impact on your current value, on what we call the net present value. So it seems to be no coincidence that the US stock market has exhibited some of the highest valuations in history, with the only exception of the peak of the .com bubble in ’99-2000.

Neil Collins 03:31

Can I just pick you up on the point that you made about low interest rates encourage speculative businesses, but surely, low-interest rates are a great incentive for taking a longer view? And that presumably, you would agree is a good thing rather than a bad thing?

Edward Chancellor 03:52

Now, I mean, Neil – it’s good point. You can take too short a view, and you can take too long a view. Too long a view is investing in in a business whose returns lie too far out in the distant future, and perhaps don’t even exist at all.

Jonathan Ford 04:10

So the point really, the point you’re making is not that these businesses are not necessarily terrible investment opportunities. We just don’t know whether they are or not. It’s more that the stock market or the private investment market is misvaluing them or encouraging people to pour money into ventures far more than a rational world would devote to these activities, whether building fraudulent electric vehicles, or Uber, or whatever it might be. 

Edward Chancellor 04:38

No, yeah. So as you know, when writing about that, when I’m talking about the misallocation of capital in tech ventures, I cite some venture capitalists writing in 2014, 2015, telling the economists that this was the best time to be financed since you know the ancient Egyptians. And then if you read the books by you know, silicon valleys insiders? They’re not really building, building businesses. And I should say here, Johnson and I were involved in a .com startup back in 2000.

Neil Collins 05:12

I think we might might extinguish that from the record.

Jonathan Ford 05:15

No, no, no, no, no, that was a rare case of a valuable one. I think.

Edward Chancellor 05:19

One of the tech insiders whose book I read said that the businesses were sold for the, for the IPO, it’s about selling for capitalization.

Neil Collins 05:32

That’s not necessarily something which is confined to bubbles or whatever you care to call them. It’s happening all the time. You look at the IPOs, recently in London, and some of them have collapsed within a year of coming to market. This is just part of the warp and weft of markets. I don’t really think that’s got anything to do with interest rates anyway.

Edward Chancellor 05:57

So, but what I’m arguing in the book is that you can set aside your behavioral finance aspect of the bubble. And you can also set aside the sort of abuse of conflicts of interest that investment bankers and others engage in when they’re during bubbles. I’m trying to draw attention to the relationship between the bubble or spectre of euphoria and the monetary underpinnings.

Jonathan Ford 06:24

So I want to pull the lens back and explore a bit. What do you think the Fed should have done? And your assessment of why it didn’t do what it should have done?

Edward Chancellor 06:36

Yeah, the slightly evasive answer is one shouldn’t really have been starting from that position. In that the global financial crisis in my reading was engendered by the Feds initial response to the .com bust that led the Fed to take the Fed funds rate down to 1% in 2002 engendering the global credit boom. Okay, but leaving that aside, there is an argument for the central bank to act as lender of last resort during a crisis which I discussed in the book, the so-called Badgett doctrine that a central bank should lend against high-quality collateral.

Neil Collins 07:18

At high interest rates. That’s the point. That’s classic. Badgett. Yes.

Edward Chancellor 07:21

And what I argue is that the Badgett doctrine, it was confined to the crisis period. And what we saw is the Fed expanded this Badgett doctrine to lending against low-quality collateral at low rates of interest, which was made certain few insiders a great deal of money when the markets recovered in 2009. But they also continued these policies. So, you know, up until this year, we were still getting quantitive easing.

Neil Collins 07:56

That brings us to Jonathan’s question, why do you think they continued with it at a time when the crisis was passed?

Edward Chancellor 08:03

I think that you know, that the financial markets were sort of hooked on it. And that whenever there was any question of withdrawing the liquidity and normalising monetary conditions…

Jonathan Ford 08:15

So if you want to go back to my original question, how to avoid having the hangover in the first place? And basically, you’ve not sort of wholly addressed the question of, is there a way in which we can identify the right level of interest at any particular juncture? And is it, therefore, perverse of central banks that they have for a long period, ignored this clear signal and proceeded with a policy of keeping interest rates at a rock bottom level and storing up all the problems you’ve just described?

Edward Chancellor 08:47

Yeah, I think there is. I’m critical in the book at the policy of setting an inflation target, which most central banks nowadays set at around 2%. As you know, I argue that they massively exaggerate and misunderstand the risks of deflation and the nature of deflation. There is such a thing as a good deflation, just like there is such a thing as good cholesterol, and good deflation comes from productivity improvements and falling prices. The man on the street doesn’t complain about a good deflation. In fact, no one really complains about a good deflation, except for the central bankers who use it as an excuse to take interest rates down. And I would say there’s no there’s no particular level below which interest rates should fall. But it seems to me and again, going back to Walter Badgett, again, problems inevitably start to come when interest rates fall below 2%.

Neil Collins 09:49

The attraction of course of an inflation target is something that ordinary mortals can understand. A lot of the things which you claim are more important indicators are really beyond the understanding of many people, if not most people. And I think that you’re in danger of advocating something which will be lost in complexity and misunderstanding when the bank has to raise interest rates.

Edward Chancellor 10:18

We live in a complex world. If you try and put a simple and misleading target in a complex world. And when you’re dealing with a phenomenon, interest, which I argue is, you know, the universal price, the single most important price in the capitalist system. If for the sake of simplicity, which sounds to me, rather patronising notion that if for the sake of simplicity you impose a target, you are going to have all sorts of problems. And that’s what we’ve seen.

Neil Collins 10:50

Well, I would push back on that and say that I don’t accept that. And I think that the banks’ problems in the last two or three years, has been that they failed to see what was going to happen to inflation, they failed to see the result of what they were doing, which is why they kept interest rates far too low for far too long.

Edward Chancellor 11:13

If we wanted to come to an agreement, we could just change the timeframe. You were earlier mooting, that it would be nice to work with a long time frame, I’d be perfectly happy to work with a long time frame and try to think of delivering price stability over the long term. And you deliver price stability over the long term, by avoiding asset price bubbles and credit booms that end in deflation and require a lot of monetary priming to get out of, and that monetary priming sooner or later feeds through to an inflation. I think the failure of the central banks in recent years, directly follows from their inflation targeting.

Jonathan Ford 11:54

Is there an error in which central banks, in your view, broadly followed the right policy with regard to the setting of interest rates? And is therefore the kind of error into which they have fallen the result of inflation targeting? Or do you think there’s something more fundamental, which is; central bankers just think that they’ll be terribly unpopular if they keep rates high for a long time, and therefore they shy away from this horrible kind of medicine?

Edward Chancellor 12:21

It is so… well, first of all, I think of the history of sterling over the last century, which has lost what sort of 99.5% of its value, clearly, and that hasn’t all happened in the last year. So clearly, something has gone wrong, if one cares about price stability. But there is a price to pay for price stability. Namely, in the 19th century, when the central bankers didn’t really have an active monetary policy, all it did was seek to maintain the convertibility of its banknotes, of sterling banknotes, into gold. And that required it to raise interest rates whenever the Bank of England stock of gold was low. So that’s a pretty harsh system, but it delivered price stability, but with a lot of financial crashes. You either have harsh crashes and price stability, or you have these attempts to avoid the financial downturns and the loss of monetary stability. And for all this talk of inflation targeting, it should be clear to everyone now that the central banks have failed in the remit to deliver price stability.

Neil Collins 13:36

I mean, it’s self evidently true with inflation in double figures in the UK.

Edward Chancellor 13:41

Yes. And it’d be, as Jonathan says, a sort of slightly political bias that the people who are hurt by low-interest rates are the so to speak, the forgotten man or woman, whereas the people who benefit, the people who work or who own houses or stocks or who work in the city, the beneficiaries are stronger and more coherent advocates of low interest than the people who suffer in silence.

Neil Collins 14:07

So do you think that the, what I would shorthand called the Bernanke policy of allegedly trying to support employment and prevent recession, is effectively a tax on the lower paid part of the workforce?

Edward Chancellor 14:26

Yes, and as I argue, although the central banker strenuously deny it, the ultra-low interest rate policies have contributed in large measure to the rise in inequality in recent years. Something which the central banks take no responsibility for.

Neil Collins 14:44

I have to say, I feel we may agree on this.

Edward Chancellor 14:47

Yes, it’s fine. I didn’t mind agreeing.

Neil Collins 14:51

Can I ask you, do you believe that is such a thing as a natural rate of interest?

Edward Chancellor 14:57

Yeah, that’s a moot point. I’d like to say it depends on what one means by … I’m being like Clinton now.

Neil Collins 15:07

Yes, yes, yes.

Edward Chancellor 15:09

In the 17th century, you know, I cite John Locke, the philosopher who was also, as you probably know, responsible for determining the gold content of sterling. John Locke talks about letting – I’m not sure if he uses a natural rate – but allowing the sort of forces of nature to determine what the interest rate should be rather than legislative Fiat. From 17th century perspective, the natural rate is simply the rate at which money is changing hands in the market between winning buyers and sellers. But you have to bear in mind that Locke is talking about a world of gold-backed currency. And before the creation of fractional reserve banks that changed the story. There is this notion, this sort of academic notion, which is that an economy is in equilibrium -and this is the rate, the sort of implied return, societies implied return of on capital. And Bill White, who’s former chief economist at the Bank for International Settlements, has been having correspondence by this, Jonathan, with the great Andrew Smithers. White’s argument is there’s no real natural rate because the system itself is a dynamic evolutionary system. So there isn’t a sort of fixed natural rates supposedly. What I use in the book as a sort of proxy for this unknowable rate is, you know, your trailing average nominal GDP growth, that gives you a sense of society’s return on capital.

Jonathan Ford 16:45

Your trailing economic growth rate. So just looking over a number of years up to the present day.

Edward Chancellor 16:51

What I notice is, you know, what one notices is that it’s when the policy rates are taken way below the nominal GDP growth rate that some of the sorts of bubbles and credit booms and so forth appear to take place. And, and that’s not just true of US and Britain and Europe, but as I mentioned, in the book – of China in recent years,

Jonathan Ford 17:14

Given that so much of this is unknowable, as you explain, what is the purpose of central banks in setting interest rates? Do we even need them? Should we go back to 19th century America, and basically just have banks basically, operating on their own – the confidence they enjoy from their depositors with no backstop,

Edward Chancellor 17:36

Jonathan, as you know, there’s no point wasting one’s time suggestions. As journalists, we always knew that no one pays attention. But it’s interesting to know what they are. My friend, Thomas Meyer, former chief economist of Deutsche Bank, argues that you don’t need to go back to a gold standard. You could have a central bank, digital currency CBDC, backed by government debt, and that could be the monetary unit, that the interest rate would then be set by borrowing and lending of a restricted number of these CBDCs or of digital currencies. The problem with this suggestion is you’d have to get rid of the conventional banking system, the banking system will no longer be able to just take money.

Jonathan Ford 18:28

Do his employers at Deutsche Bank know what he’s suggesting?

Edward Chancellor 18:36

Instead of the banks creating money through the act of lending, they would have to take the money that already exists. And then that, and they could leverage up if they wanted to. So in a way you’ll be shifting from these sort of great behemoths of financial institutions, too big to fail, to a more, you know, system dominated by what; FinTech, private equity, hedge funds, ETFs and so on. It’s feasible. I think you’d probably need to more or less bankrupt the banking system in order to make…

Jonathan Ford 19:12

Doesn’t sound as if you’re going to achieve much de-financialization here.

Neil Collins 19:17

I must say it sounds to me as though the cure could be worse than the disease, especially if it involves nearly bankrupting major banks, who might take exception to this line of attack. You’re a fan of Hayek and you’re very critical of Bernanke, understandably, given what’s happened recently. What is the most important history lessons we can learn from your overview of the importance of time value of money?

Jonathan Ford 19:46

Are there any great Babylonian economists you want to do a shout-out to?

Edward Chancellor 19:54

The world was a better piece for the appearance of economists and no doubt, I think, we would all be much more prosperous if the business of economics was outlawed. Now, as I mentioned, the for instance (inaudible) Mississippi bubble in 1720 seems to me a perfect case study in the dangers of fiat money and manipulation of interest rates and how that feeds through to asset price bubbles, and followed by inflation, and financial crisis. John Law is really the most fabulous figure in the history of finance; a gambler, a duelist, a murderer, brilliant mathematician.

Neil Collins 20:39

And that’s just with the currency…

Edward Chancellor 20:43

An economic theorist of the first order, who arrives in France and persuades the regent  to France after the death of Louis 14, in 1715, that he can bring prosperity to France by establishing a central bank, getting rid of the gold currency, printing money and bring down the rate of interest. He does briefly achieve all three, everything he promised, and in the process becomes the richest man who ever lived because he was not only the central banker, but he also ran the Mississippi Company, which was the largest corporation in history, and he had a large, very big stake in this Mississippi company whose shares went up 20 fold during the bubble.

Jonathan Ford 21:29

That was part of the scheme, right? You would transfer the debt you were owed by the king and his government to shares in a very faraway place, of which you knew very little, but you were told was fantastic.

Edward Chancellor 21:42

He is this great theorist, and in a way idealist, but he’s also a promoter. His fatal mistake, a quality he shares in common with Boris Johnson is, is he had no attention to detail. He is failure to pay attention to detail, and I think I would say some flaws in his theory (inaudible) and what’s so fascinating, unbelievable, is that the central bankers ( insofar as they know any financial history which is probably limited) they actually deliberately imitate Law… it’s bizarre.

Neil Collins 22:28
And it’s obviously a more interesting character than Hayek, who is your hero?

Edward Chancellor 22:32

I love Law. I mean, I think he’s the most that…I mean, if one had to meet one person from the past, I probably would choose John Law rather than Friedrich Hayek.

Neil Collins 22:47

There’d be more jokes, anyway. That was a long time in finance with Jonathan Ford and Neil Collins, editing and production spine, Nick Hilton, and our sponsorship partner is briefcase dot news. Join us again next week.


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