Book Review: The Price of Time by Edward Chancellor

What Is the Ideal Interest Rate?

I hope everyone had a wonderful Christmas. I’m taking a break from my normal work, which means time to write a few more pieces for the email list:

One of my favorite book genres is that of the magisterial, century-sweeping economic history, preferably by a British academic. I find Brits to be more plain-spoken than Americans, perhaps because of their more rigid class system. A British academic from an aristocratic background doesn’t feel the need to impress readers with bureaucratic, complicated language that usually reflects unclear thinking. Edward Chancellor certainly fits this type:

Chancellor was born in Richmond, England to barrister John Paget Chancellor (the editor of Knowledge), the eldest son of Sir Christopher Chancellor and Mary Jolliffe, who was the daughter of Lord Hylton. The Chancellor family were Scottish gentry who owned land at Quothquan since 1432.[5]

As I’ve gotten older, I’ve tried to apply this in my own writing. If you can’t explain something to a ten-year-old, you probably don’t really understand it.

The Price of Time was an easy and pleasant read. Because I am already familiar with its subject and largely agree with his views, I found its review of economic history most interesting. In the first part of the book he defends the concept of interest from classical and early Christian attacks on usury. These attacks make sense at a first approximation, which is why they held sway for so long. Aristotle argued that, unlike animals, plants, or people, money is sterile and cannot naturally reproduce. Therefore, allowing people to earn money on their money through interest is inherently immoral and any arrangement that allows someone to do so is simply a drain, a parasite, on the productive economy. Islam today still forbids the taking of interest by similar reasoning.

Chancellor demonstrates the error of this thinking. Perhaps the simplest is the economic concept of consumption versus capital goods. Money is indeed sterile, but it represents a current claim on consumption goods. If you have money in your pocket, you can go to Wal-Mart and buy any number of consumer goods. The more people spend their money, the more consumer goods that must be made, and the workers and materials necessary to make them. The more this happens, the less can be invested in capital goods, or those things that make us better, faster, and cheaper at making consumer goods. When people choose not to spend their money, they can invest it in buying the things that make consumer goods more available in the future. Things like highways, manufacturing facilities, warehouses, etc. Since all people would naturally prefer a reward now to later, there must be an incentive to induce people to save, forgo consumption, and invest. That incentive is interest. People aren’t being paid because they have money, they are paid because they delay spending their money. That isn’t sterile at all, as it’s the difference between the consumer who pays a rancher to kill a cow for meat today versus an investor who provides the capital to breed more cows for next season.

Some would argue, as Islamic scholars do, that while investing is permitted because a risk is being taken, taking interest is not because the lender has an absolute right to be repaid regardless of the success of the business venture. The flip side of this, however, is that a lender has limited upside. No matter how well the business venture performs, the lender gets paid no more than promised in the note. Lenders also take risk in that they aren’t always paid back, and typically have no protection from unexpected inflation.

Interest then is, like an investment, simply a share of profits for someone who produced value in the past (they earned money) and agrees to further delay collecting that value (by not spending the money they earned) into the future to enable the production of more goods for everyone else. What’s a fair split? Chancellor cites Adam Smith who believed fairness was about one-third for the lender and two-thirds for the working entrepreneur. This strikes me as a natural split, and it’s interesting that it seems to hold approximately outside the world of finance and in the natural economy of land. Both mineral and farming activities give landowners (capital) about 1/4-1/3 of the production depending on the tenants’ labor intensity.

After justifying the legitimacy of interest, Chancellor proceeds to demonstrate the effects of different interest rates throughout economic history. In general, lower interest rates indicate a more advanced, stable economy. However, once interest rates go below about 3%, investors get antsy about their income. No one wants to bleed down their principal, and no one, and certainly not most rich people who derive social status from their wealth, wants to endure even a temporary lifestyle downgrade from less income. One is reminded of Machiavelli’s dictum that a man will hate you less for killing his father than the humiliation of losing his fortune.

So when interest rates go below 3% and especially as they approach 2%, investors become desperate for higher yields. This creates an environment where speculative bubbles become attractive, which become self-reinforcing as they grow. These bubbles conveniently always come packaged with a plausible narrative that explains why the speculative asset is not a bubble but rather a world-changing economic innovation. Sometimes these narratives happened to be true, such as the economic revolutions associated with railroads and automobiles, but bubbles arose when way more capital entered an “obvious” opportunity than could possibly make a decent return on investment, while sometimes they are mostly cons like John Law’s Mississippi scheme, Holland’s tulip bubble, or cryptocurrency. Those who remain in safe assets get to feel dumb and poor while everyone else makes a mint, for a time. When your buddy doubled his money last year in crypto, it's easy to feel like a loser sitting on bonds yielding 2%.

Chancellor demonstrates that the gold standard is no protection against bubbles, as interest rates in advanced economies under the gold standard would often go below 2%. But hard money being what it is, inelastic beyond the gold supply at least in the long-term, these bubbles would always end with spectacular crashes. The fools would be parted from their money and capital transferred to more prudent hands. It was possible for some portion of the investing public to remember the last crash, avoid the bubble, and be rewarded for their patience. This created an old-money elite* with conservative values and social skepticism towards potential con artist strivers with ephemeral wealth from speculative ventures.

(*Paul Fussell’s entertaining book Class describes the residue of this elite as of the early 1990s, an upper class content to buy nice things, preferably once, and own them for a long time rather than engage in conspicuous consumption. In Fussell’s telling, this true upper class, now almost extinct, doesn’t care what the public thinks and is known by wearing 30-year-old threadbare, frequently repaired tailored suits and driving a 20-year-old meticulously maintained Volvo or Mercedes rather than the latest Louis Vuitton or leased luxury car.)

When bubbles collapsed historically, interest rates would usually rise in response. So much capital had been wasted in the bubble that the price of utilizing the remaining, prudent capital rose. These rising interest rates helped hasten the collapse of the bubble and redirect labor and capital to productive, needed enterprises.

The end of the gold standard in the 20th century, however, changed the game entirely. Whatever the frequent hazards of bubbles in the past, central banks were now free to suppress interest rates and keep bubbles going indefinitely. We now live in a world where virtually no one alive remembers a real panic and collapse, and those who fear one are seen as cranks who have been almost entirely eliminated in their assets under management by market ecology, as described by CBS:

The investors whose styles produce the best results are selected in favor of those whose styles produces inferior results. As Wolfgang Sterrer put it, "an organism represents a hypothesis of its environment, continually tested by selection for its predictive value and modified by adaptation for a better fit."

The problem with investing is that this is measured on the wrong timescale. The different parts of economic cycles occur so infrequently that the intervals between them exceed the working lifespans of investors.

We have had such a long experience now with artificially low real interest rates and easy money that many business biographies today can be summarized as “sociopath took insane risk, got lucky.” As this ecology continued to develop, we saw the insane valuations of money-losing tech businesses through 2021. This is not only destructive to capital, but also to functioning markets. Once two or more firms in a market are no longer constrained by the need to earn a profit, it becomes impossible to invest responsibly in important sectors. Especially in those sectors most pursued by bubble companies, from online commerce to self-driving vehicles, the market will struggle to find equilibrium and economically meet consumer’s needs until the excess capital is consumed. This sets back legitimate technological and economic progress, as everyone involved is flying blind without price or profit signals.

For example, something like Walmart+ makes a lot more economic sense than Amazon Prime. Walmart ships things from a limited number of vetted, efficient suppliers in big, efficiently-packed container-size trucks to their stores and performs last mile delivery from each store without the need for extensive and labor-intensive packaging. Amazon, by contrast, ships everything in tiny boxes on tiny trucks to consumers many miles away from their distribution centers. Yet as long as Amazon can put off making a sustainable profit and pay their top talent with their overvalued shares, Walmart will struggle to reap the benefits of its superior distribution system.

These artificial, investor-funded price supports in everything from food delivery to streaming media service to personal transportation has been aptly called the “Millennial Lifestyle Subsidy.” There’s at least a poetry to the arrangement, if Boomer investors eventually sustain massive losses after impoverishing their children with money printing and borrowing. Millennials may not have an inheritance after Boomer parents die broke, but for a few years there they enjoyed ridiculously cheap Uber rides.

Chancellor is adamant, however, that the bubble cannot go on forever. Fake money has allowed it to go longer than any before, but there is always a price to pay for misallocated capital. In a few years, it may become apparent that we have wasted a generation of talent on unsustainable business models, including our most gifted mathematical geniuses many of whom work for hedge funds picking up pennies in front of steamrollers, while facing a shortage of skills in fields critical to human flourishing like petroleum and nuclear engineering. As the hard costs of aging infrastructure pile up, and the self-reinforcing cycle of capital gains from bubble investments peter out, there will be a price to pay for wasting capital and labor on money-losing enterprises.

Such a reckoning may have welcome moral effects for those of a conservative mindset. While the start of our moral decline predates the low interest rate era, it certainly could have effects that accelerated it. If Rene Girard is right that most people do not know what they actually want, but rather simply copy what they think others find desirable, it would follow that different economic environments create different kinds of elites with downstream moral influence on the masses. Perhaps the ugliness of our culture is partially an artifact of an environment rewarding the most brazen risk-takers and sociopaths with unspeakable wealth. Such individuals are not likely to offer moral examples consistent with conservative values. Morality can be seen as a properly calibrated level of time preference that seeks long-term over short-term pleasure; a keystone of Reformed theology is that God only commands us to do things that are normally for our collective and individual good, temporal and eternal.

There’s an argument that much of our decay is part of an “Everything Bubble” where all sorts of unnatural behaviors have emerged in a passing, artificial environment contrary to the normal state of nature, economic and otherwise. Perhaps a new post-Bubble elite with more durable values can accelerate a renaissance of natural law. Time, and its price, will tell.

Chancellor smartly stays away from discussion of moral issues, but does devote significant parts of his book to documenting how unnaturally low interest rates work paradoxically to increase inequality and thus social instability. Many thinkers assume that lower interest rates benefit the poor, who often pay interest to buy the necessaries of life. Whatever benefits accrue to the poor, however, are dwarfed by benefits to the rich. Since rich people are the only ones who have sufficient collateral to borrow massive amounts of cheap money, their first access to the money printer allows them to buy and bid up assets in a virtuous cycle. Borrowing begets bidding which begets price appreciation which begets more collateral for borrowing.

The wealth effect of capital gains starts to price out the poor and middle class from the best neighborhoods, vacation spots, restaurants, spectator events, and other basic pleasures of life, even if consumer goods remain reasonably priced. It’s the reason a Disney family vacation, once a realistic middle class aspiration, now requires a five-figure budget. This type of inequality, amplified by the FOMO of social media, is particularly grating to people who cannot afford the luxuries they see others consuming. Trust in institutions (rightly) plummets, and the country can pull apart, much as it is doing now, as more people (again, rightly) believe the system is rigged against them.

Chancellor’s thesis is that central banks should leave the market alone and let it settle on what he calls the natural interest rate to be determined by supply and demand for capital. But one implication of his work demonstrating the harms of low interest rates is that perhaps a central bank should set a minimum interest rate, in the range of 3% plus inflation, to restrain the con artists and speculators who inevitably destroy capital during bubbles. This would not restrain capital focused on legitimate economic opportunities, for the internal returns most companies demand for large projects is on the order of 20% or more annually.

That said, I have not thought through the idea fully, and there are almost certainly side effects to such a policy that would be unpredictable. The government does something like this already with the I-series bonds, which guarantee a small real interest rate above inflation, but purchases are limited to $10,000 per year per individual and they can only be resold back to the government. An expansion of this program with richer rates, perhaps with an integrated 401k-type payroll savings option, would allow the general public to save for retirement without being fee-fleeced by Wall Street or having their retirement ruined by the inopportune collapse of a bubble.

A return to a natural interest rate and/or hard money is very unlikely. The Federal Reserve will attempt to land the plane without crashing it, and most likely that means higher inflation for a time to provide a soft default on debt obligations*. Demographic trends towards smaller populations likely means less economic specialization and growth, unless truly groundbreaking technology improves productivity. Understanding this sea change will be key to successful investing over the next several decades. I am now reading The Great Reversal, which integrates these two recent themes in my economic reading: declining population and unsustainable debt. Look for a review in the next couple of months.

*(One of my biggest questions on how this plays out is that many debt-like obligations, such as Social Security, government salaries, etc, are linked to CPI measures of inflation. However, most people’s wages are not keeping up with inflation due to overall lower output and workforce participation, which means those outside the productive economy will continue to receive a larger share of purchasing power. Do wages eventually catch up, or will everyone in the bottom 40% of income not working for the government or on SSI/disability feel like a schmuck? Does the government find a way to depress reported CPI? If not, I would expect many more cases of “long Covid” or other psychosomatic disability diagnoses for working people responding to obvious incentives.)