The Price of Time: The Real Story of Interest

It is a good habit to hold some skepticism with regards to expertise in monetary policy. Its tools operate within a social science and cause and effect are far less clear than often maintained. The post internet bubble period have witnessed to greater and greater degree abnormal monetary policy in the context of human history and Edward Chancellor in the Price of Time argues it has been part of the problem and in no way has it been a framework providing a solution. It is a deep book with a lot of reference material that is worthy of consideration, it is certainly not obvious what the right policies should be to deal with the current challenges in economics but the ideas in this book are rarely if ever considered by monetary authorities outside the BIS and that is likely a blind spot.It is hard to summarize this book as it says a lot and often quickly, but there are some core ideas that are worth highlighting. The primary idea is that focusing on using interest rates to target inflation is a bad one. Productivity improvements cause deflation (obvious in technology, but true for all manufacturing) and so the idea that we should bias interest rates lowers to overall counteract that is dangerous. Inflation is a dynamical process that is determined by numerous factors and changing the cost of capital to target it can have massive unintended consequences. Associated with this is that interest rates have a much more direct impact on the credit cycle. Interest rates are not neutral and policy makers setting rates inescapably set the rate for which capital can be borrowed and low rates mean they support businesses with low efficiency and this act leads to zombification of the economy and also difficulties in new entrants to cause creative destruction as incumbents are supported despite being uneconomical to a reasonable rate of growth or return. The author also focuses on the savings patterns that come from low rates, one is that with lower rates, saving for retirement will take longer dampening consumption and increasing savings which is counterintuitive. He also highlights that economies which have more market investments benefit from asset appreciation thus giving the illusion of wealth and lead to higher consumption due to false asset appreciation. Though this is not explicitly stated this supports a growth in global imbalances based on where savings are parked, namely the market or deposit rate related savings. The author also discusses inequality in these terms and takes an interesting and opposite view to Picketty which is that actually it is when r < g that inequality grows. In particular they discuss opposite things, Picketty describes the rate of growth of assets while Chancellor focuses on the rate of growth of money in a savings account both relative to growth. Both would likely see the same phenomenon that, if r < g than the rate of return on assets will be greater than g as that is the intended mechanism for some potential trickle down effect to take place. Ultimately the utility of low rates in being the preferred environment to escape the low growth world is questionable. It has certainly not worked as intended, negative rates has hurt the banking system and prevented transmission, 0 rates largely were taken advantage of by huge companies rather than midsized ones and created a wedge in pricing between actors and capital formation has not been higher due to the low rates as investment has been more in intangibles. How much of this is due to interest rate policy vs the changing nature of the economy is questionable. The Price of Time makes valuable points, especially with regards to the credit cycle's association with rates but it provides no alternative regime other than one which has higher rates and its not clear what that would deliver either. There is an inescapable shock to the economy if it were to go from low real rates to higher real rates, even with high rates now, they are still low/negative in real terms. So we seem stuck in a system which is hard to break because it is very path dependent and we have gone down this path for a long time now.The Price of Time is a very worthwhile read on the asymmetry of monetary policy in the Greenspan era and beyond and the long-term detriment that has caused. It questions the logic and philosophical principles behind modern monetary policy and heavily quotes the BIS to discuss a logical alternative. There is a lot of history in the book showing how low rates drive speculation, whether it be John Law or the recent period and pretending that low rates actually solve problems is questioned. The key idea that monetary policy doesn't just operate as some means to affect inflation (which is seriously doubted) but rather it means to adjust the cost of capital is an important one as it adjusts the creative destruction properties of a vibrant capitalism. It does feel as though the author has a preference for manufacturing capitalism and so the new tech software and service dominance seems to be less relevant to this whole analysis which might make some of the perspective a bit anachronistic, but this book really should be read more broadly as it makes many important points that should be considered quite deeply.

For me, someone without a finance/economics background who is trying to change careers, this book was excellent, without any equations explained what are the interest rates and their role in OUR capitalist system.Also there are a plenty of references to great articles and books.Recommended 10/10Rodrigo G.

Edward Chancellor, a financial journalist, has written an interesting, wide-ranging and lucid account of interest rates and why they’re so crucial to a modern, capitalist economy. Essentially, the book is in two parts: (1) the history of interest and its condemnation as usurious throughout much of human history, and (2) a severe criticism of expansionary monetary policy by the world’s central banks in much of this century and a corresponding criticism of the “ultra-low’ interest rates such policy has effected. It would seem that much of Chancellor’s perspective is from the vantage point of a bond or fixed-income investor, and that as his “confirming” sources, he relies heavily on the BIS, James Grant and Friedrich Hayek, which should give you a good idea of his economic and political orientation.With regard to interest as usury, I’m reminded of a friend’s wife who when notified that they would be paying more in interest than in principal over the life of their 30-year mortgage was both outraged and dumbfounded. Isn’t this usurious…why do we have to pay this interest? This kind of attitude was ingrained in the world’s religions for most of human history. The title of this book gives us a basic rationale for interest, i.e., the price of time. But the author nicely acquaints us with other, albeit closely related, explanations for the economic and social validity of interest: the cost of renting capital, the wage of abstinence, or stated another way, an individual’s time preference can be seen as a kind of personal rate of interest. Keynes defined interest as the reward for parting with liquidity for a specified period. One explanation I particularly liked in Chancellor’s book was that interest is the “toll” levied on borrowers for bringing forward consumption and the fee paid to savers for moving consumption into the future. Each of these explanations is more insightful than the one in the textbook from which I used to teach, i.e., interest is the marginal rate of substitution between current and future consumption! But in addition, interest has a key role in pricing risk; interest and risk are interconnected. Future cash flows are discounted at a rate that reflects their riskiness in materializing.Accordingly, financial intermediation (via financial institutions or financial markets) links “savings surplus” economic units (lenders) with “savings deficit” units (borrowers), so that those who possess savings can channel it, and earn legitimate interest, to those who have insufficient savings to meet their economic needs. When we get to his account of the adverse impact of low interest rates from expansionary monetary policy, we hear about the effects on low-income people and not bond investors. But I can imagine savings deficit units as, say, a young family needing a mortgage or a small business needing to replenish its seasonal inventory, and savings surplus units as a retired couple with accumulated wealth or a large corporation with substantial cash flow (doesn’t Microsoft have over $200 B in marketable securities from its cash flow?). Hasn’t economic history shown that borrowers seem to favor inflation and lenders seem to favor deflation? In any event, I would like to see more empirical evidence on the redistributive aspects of low interest rates vs. high interest rates.And now we can transition to the more controversial part of his book, the adverse impact of low interest rates stemming from expansionary monetary policies from the world’s central banks. Much of his analysis comes from the policy response of the Federal Reserve, the Bank of England and the ECB to the worldwide financial crisis of 2007-2009 which did indeed lead to very low interbank borrowing rates, and even some negative rates for some European bonds. The author suggests that “zero interest rates discourage savings and investment and impair economic growth” and that “ultra-low rates kept zombie companies on life support.” Kudos to Mr. Chancellor for resurrecting this quote from airline executive Frank Borman: “capitalism without bankruptcy is like Christianity without hell.” Other adverse effects of low rates were the encouragement of merger consolidation and enhancement of private equity activities (I’m all “in” with him when he asserts that private equity is more about “wealth extraction” than “wealth creation”) and the stimulation of share buybacks (which he grossly misinterprets).I concur with him that many of these effects can be viewed as indeed adverse effects of sustained low interest rates. However, low rates should encourage more investment as more investment opportunities will exceed the lower hurdle rate (cost of capital) but there’s a risk of a misallocation of capital as marginal projects get funded. He places much emphasis on the Fed Funds rate which is an overnight lending rate to member banks. It was indeed near the zero-bound line but it should be stressed that the Federal Reserve directly affects only ST rates, LT rates are largely affected by inflation expectations (I should acknowledge that the QE programs did provide some channels for affecting LT rates). Moreover, risk-adjusted rates were considerably higher than these overnight rates he’s fixated on, but nonetheless, the period from 2008 to 2016 exhibited very low interest rates.But we have to set these costs against an economy where private demand was shrinking rapidly at the beginning of this period and badly needed expansionary fiscal and monetary policies. Too little was done during the Great Depression and only WW II rescued the US from a decade long economic slump. So while Chancellor on page after page moans about the poor returns that savers are getting, he barely covers, if at all, the labor market during this period. Unemployment was 10% in 2009 and didn’t get below 5% until 2016. In addition, the capacity utilization rate was in the 60s (!) for much of this time, suggesting that labor and capital employment were far below their full employment levels. I would submit that the sustained expansionary policy helped the economy in more broad terms than it hurt it.On a related issue which he mentions from time to time but criticizes estimates of it, the “natural rate of interest,” the unobserved rate at which the economy is at full employment and stable inflation, the rate at which monetary policy is neither contractionary nor expansionary, has been below 2.5% since 2008. We don’t hear a whole lot about the natural rate in the book because estimates of it are based on so-called real factors such as technology, demographics and preference shifts for safe and liquid assets, and the author denigrates the influence of real factors and favors an exclusive focus on central banks and their expansionary policies. A comparison between the unobserved but estimated natural rate and prevailing market rates would appear to be in order. I know I’m nowhere smart enough to separate the influence of say the Fed from real factors in evaluating the current level of interest rates. I do know this, however, and that is that the author would be more satisfied with the current level of rates as of this review (3/2024): mortgage rate of 7%, T-Bond rate of 5%, prime rate of 8.5%, and Fed Funds rate of 5.5% as the Fed has been pursuing a “contractionary” policy to combat the recent spike in inflation, a policy apparently more to his liking.To conclude, I can’t let the author get away with that naive example of the price gains from a share buyback (p. 165) where seemingly an accounting model of a firm is emphasized over an economic model. His hypothetical example shows a firm buying back 50% of its shares by borrowing approximately 50% of its market capitalization with a 50% increase in EPS. “But since investors appreciate EPS growth,” the P/E grows (grows!) from 15.0 to 17.0. Any securities analyst would tell you that the substantial increase in leverage would increase the cost of equity through the additional financial risk premium added to the firm’s operating risk. Such an increase in the cost of equity would LOWER the P/E. And allow me to say a positive thing about share buybacks. They represent a “recycling of capital” as maturing firms distribute excess cash to their shareholders for reinvestment in, say, IPOs or venture capital. Do you want to see a maturing firm engage in “empire building” or pursue an uneconomic conglomerate strategy, or do you want to see the firm’s shareholders pursue greater growth opportunities? Also, share buybacks are more flexible; a firm can do them when it’s cash position exceeds its profitable investment opportunities whereas a dividend or dividend increase locks you in.

Além do ótimo conteúdo, é excelente para atualizar o inglês.

Very informative book!

Muy recomendable libro sobre historia económica y muy focalizado en los tipos bajos de los últimos años y su impacto en la economía

A deep analysis on interest rates from an austrian perspective. Great read!I'd suggest it to anyone with a good knowledge of the monetary and financial system as it offers a great dive on a single factor and its direct and secondary effects.The amount of information included and quotes is also quite impressive. Chancellor put a lot of work on this, and i'm thankful for it.

An important book. It provides a brutal and convincing critique of the appalling dangers of ultra low interest rates.