Brian Anderson: Welcome back to 10 Blocks. This is Brian Anderson, the editor of City Journal. This week’s special episode features Manhattan Institute senior fellow and City Journal contributing editor James Meigs and journalist Richard Davies interviewing financial historian Edward Chancellor. They discuss the history of money lending and the dangers of manipulating interest rates. Edward Chancellor is the recipient of this year’s Hayek Prize. We hope you enjoy.
Jim Meigs: Our guest today is financial analyst and historian Edward Chancellor. He specializes in understanding financial crises, whether you call them bubbles or crashes or my favorite word, panics. In the late 1990s, his book, Devil Take The Hindmost anticipated the big dot-com crash.
Richard Davies: And now Edward Chancellor’s latest book is called The Price of Time: The Real Story of Interest, and it looks at how our system of charging interest on loans developed a very long time ago.
Jim Meigs: Edward joins us in New York. We’re recording this podcast in the offices of the Manhattan Institute, where I’m a senior fellow, and we are pleased that this conversation will also be released as part of City Journal’s 10 Blocks podcast series. Welcome to How Do We Fix It?
Edward Chancellor: Well, thanks for having me.
Jim Meigs: The core of your book is looking at the sometimes-underappreciated importance of time. In economic affairs, Benjamin Franklin famously said that “Time is money.” Explain.
Edward Chancellor: Every economic activity, every financial activity, takes place across time. We have a tendency to assume time away, to forget about the importance of time in our economic activities. And I think that’s particularly pronounced by modern economics that assumes equilibrium and doesn’t really dwell upon the issue of time. Now, the invention of interest has been described by the Yale economic historian William N. Goetzmann as “The most important invention in the history of finance.” Because it allows for transactions to take place over time. Interest is the difference in value of something over a period of time. You could say it was the exchange rate between the present and the future, and if you don’t have that exchange rate for pricing activities across time, then you really don’t have any guide or direction to your economic or financial activities.
Richard Davies: I find it fascinating, your suggestion about the importance of time when it comes to interest. That you are not just paying for the loan, but you’re also paying for the time that it takes to pay the person back.
Edward Chancellor: Yeah. So in valuation we talk about the time value of money, and we use a discount rate in our spreadsheets for making valuation estimates. Time is money, and the more efficiently we use our time, the greater our productivity and our output will be.
But there’s another factor of time that we have to consider, which is that humans are mortal and that we place a greater value on our current pleasures than on our future pleasures. The great American economist of the first half of the century, Irving Fisher, talked about interest as “crystallized impatience.” Time brings with it uncertainty. So if you have something now, it’s not just more valuable to you, but it has a certainty. Whereas if you have something or if you promise something in the future, you are not going to be 100 percent certain that that promise is going to be realized. And I think when you look at these ancient critiques of interest, and I cite Aristotle, and Aristotle says that “Interest is unjust because the lender is demanding back more than he’s supplied.” And what I say is that would be true if the lender was lending and demanding back the money with interest simultaneously. But that’s not the case with a loan. And Aristotle is ignoring this dimension of time, which is why I call the book The Price of Time.
Jim Meigs: So this idea that it’s not right to demand interest on a loan goes through practically every culture and thousands of years of commentary and law. Why do you think that’s such a powerful sense, that it’s essentially immoral for one person to loan money to another and charge interest for it? And you still see that today. People are complaining about things like payday loans and other forms of lending.
Edward Chancellor: So first of all, I’d say think about it, your loans within the family or loans to friends, they tend not to charge interest. If your sister asks you for money, you don’t say, “I want 10 percent back.” You just say, “Here’s the money.”
Jim Meigs: Oh, I think my sister would.
Edward Chancellor: Anyhow, within kinship groups, it’s been traditionally considered wrong to charge interest. And in fact, if you look at the ancient Israelite injunctions against the charging of interest, they were within the tribe, not outside of the tribe. But there’s another element to this which is very important. In a primitive agricultural society, high rates of interest that exceed the productivity of an economy can actually lead to compound interest, people getting into debt, and then from getting into debt, it’s a small step to debt bondage and slavery. And that was the case in the ancient world. We can see it in ancient Mesopotamia, and that is the case in places in the modern world today. So I think there is a well-founded prejudice against interest in, if you will, a traditional rural society. However, the mistake as far as I see it, is to then take that prejudice and apply it to a sort of capitalist world where loans are productive and the person who’s borrowing the money can actually profit.
Richard Davies: Explain why loans are productive.
Edward Chancellor: Very simply, you could have a loan to buy, and the person would use it to buy a house, and the person could then rent out that house and receive the rent, and at the end of the loan, sell the house and give the money back. Then obviously you have a business that is moderately profitable, will need money for working capital, for development, for investments, and there will be profits generated from that. And in fact, the word interest in its Latin origins, it actually means a loss of profit, the opportunity cost. For instance, I could lend you some money, you could go and buy some shares and hold those shares for 20 years, and I would’ve not had that opportunity to invest in the stock market to make the profits, whereas you would’ve done. So that loan would’ve been an opportunity cost to the profits I could have made with the capital.
Jim Meigs: So during the Renaissance, there were bankers and entrepreneurs that were developing much more sophisticated ways of thinking about credit and building businesses on credit. What did they do, and how did that effectively change the world?
Edward Chancellor: Well, the Italians developed banking in the 13th, 14th century, and they developed it at a time when charging interest was officially forbidden by the Catholic Church. And they found ways, needless to say, of getting round the ban on usury, for instance, by using these bills of exchange. And a bill of exchange is when a merchant takes another merchant’s paper and pays them a certain amount of money and is repaid some money later. And you could with these bills of exchange, have an embedded interest or they sometimes charge interest as a gift. The Italians called it discrezione. Anyhow, they had myriad ways, even the church themselves, the Cardinals were lending out church funds at interest. And in the end, the church gave up. The forces of commercialism of these Italian bankers and merchants trading across Europe at these fares across Europe and this proto-capitalism became so strong that the church couldn’t stand up against it any longer.
Richard Davies: You mentioned the term usury. There’s a lot of confusion about that because in historical texts, sometimes usury is the same as an interest rate, whereas in modern times we think of usury as unfairly high interest rates.
Edward Chancellor: Yes. So I mean, the word usury comes from use, has the same origin of the word use. So it is just use of money. But in the modern world, usury is seen as exploitative.
Jim Meigs: But in the modern world, after the 2008 financial crisis, central banks all around the world decided that the only way to bring the economy back from that crisis was to keep interest rates as low as possible. Can you explain the mechanisms they used to do that?
Edward Chancellor: Well, one obvious mechanism is that central banks set the policy rates, the rates at which they will lend to the banks in their own monetary systems. In the U.S., the Fed funds rate was taken close to zero. Then in Europe, some of the Scandinavian banks and the European Central Bank and Swiss National Bank actually took their policy rates negative. They also told the market with what was called forward guidance, that they weren’t going to raise interest rates for a prolonged period. You remember Fed Chairman Jay Powell in 2020 said he was not even thinking about thinking about raising interest rates. That’s the sort of extreme position of forward guidance. The central banks also went and bought a whole load of bonds. In the developed market, the central banks now own government bonds given to 70 percent of GDP. That’s roughly, I’d say, five times greater than the historic average. So by going in and buying the bonds, creating a demand for bonds, they brought bond yields down. So those were the sort of main ways in which they kept interest rates low.
Richard Davies: When you have a recession or when you have a financial crisis or the pandemic, what’s wrong with cutting interest rates and trying to stimulate the economy that would presumably save a lot of jobs and ease a great deal of suffering?
Edward Chancellor: Yeah, I mean it’s everything in moderation. I think there are two problems with the post-crisis monetary response. First of all, where did the global financial crisis originate? From my perspective, what got the credit boom going in the first place was these very low interest rates instituted by the Federal Reserve after the internet bubble burst in 2000. So by 2002, Fed funds rate was at 1 percent, which was the lowest level up till then in the post-war period. Then we got this great U.S. real estate bubble, and we got all this money flowing into these rather complicated subprime mortgage securitizations. One of the reasons those subprime mortgage securitizations were attractive to investors is they had higher yield in a world that was quite yield starved.
Anyhow, then we got the crisis, there was no official recognition that the very low interest rates had played a part in the crisis. But what it turns out is that by 2021, set interest rates in the U.S. were still at 0. And in the previous year, the central bank had acquired, Fed, had acquired as many treasuries as it had done in all the previous 12 years. So we became addicted to the low interest rates and we became addicted to the quantitative easing. We really became addicted to money being free, and it’s a sort of financial doping.
Richard Davies: Edward Chancellor is our guest. This is How do We Fix It? I’m Richard Davies.
Jim Meigs: And I’m Jim Meigs.
Richard Davies: And it’s very nice, Jim, to be recording together in person.
Jim Meigs: Isn’t it great?
Richard Davies: Yeah, it’s been too long. Now, back to our interview. At first glance, it really does seem like a good idea to allow people to borrow money for a car or get a mortgage at a low interest rate. So why can this have unintended consequences?
Edward Chancellor: If you reduce the cost of borrowing, you will increase the amount of debt. I mean, one of the definitions of interest is the price of leverage. So is it socially just to get a large number of people into debt, into debts that they can’t pay, to get them to buy cars that they can’t afford?
Richard Davies: Or houses, in the case of the subprime mortgage crisis.
Edward Chancellor: Well, exactly. I mean, that was, if you remember, one of the criticisms of the government policy and of the Fannie Mae and Freddie Mac is that they had been so gung-ho on the sort of social justice element of providing mortgage finance that they ... Too many subprime loans made to people who couldn’t afford it, and that then can create a crisis, and then who suffers worse in the crisis, but the poorest and most vulnerable people. But there’s another thing to it is that, stay with housing, if you lower the cost of mortgages, you will raise the cost of buying a house. So who benefits from that? Well, actually people like you and me who own their houses, when we’ve done nothing virtuous. And who suffers from that? Well, who suffers is younger people who haven’t yet managed to buy a house and who find that they can’t get on the housing ladder. So where’s the social justice in that?
Jim Meigs: After the 2008 crisis, there’s been this long-running campaign to keep interest rates as low as possible to pour money into the economy. A lot of people at the time, conservative economists especially warned that that might eventually feed inflation, but for a long time didn’t. Why did it take so long for problems to emerge?
Edward Chancellor: I mean, well, that’s a good question. There was some particular reasons why these low interest rates and the central banks buying bonds didn’t lead immediately to inflation. First of all, we talk about the central banks buying these bonds as printing money, but in fact, actually what happened is that money remained trapped within the financial system creating huge amount of asset price inflation. The U.S. stock market performance from February, March, 2009 through to the end of 2021 was really one of the great bull markets of all time. And if you look at U.S. household wealth, it rose to higher level than at any time in his history.
Richard Davies: So the “haves” did very well.
Edward Chancellor: The “haves” did very well, but also we had a huge amount of inflation.
Richard Davies: Asset inflation.
Edward Chancellor: We had asset inflation.
Jim Meigs: It wasn’t at the grocery store.
Edward Chancellor: And actually, to some extent, I think what happened in 2020, ‘21 is that central banks again went on a sort of splurge, much bigger and in a much narrower period of time. And that money really in both Europe and in the U.S., was really matched by governments borrowing and lending to households. So you had a much more direct expansion of the money supply, and also an expansion of household incomes. And I’d say “savings” in quotation marks because the money was just given to them by the government.
Richard Davies: So once the economy recovered from the initial crisis in 2008, and once the economy recovered from the worst of the COVID pandemic, you are saying that instead of 0 or near-0 interest rates, that if we had, say, the Fed funds rate closer to like 3 or 4 percent, that instead of asset bubbles, this would give more opportunity for say, businesses that are producing stuff to invest rather than the money to go in financial instruments.
Edward Chancellor: I think on paper, it would’ve been nice to have to get rid of these really extreme monetary policies very soon after the crisis. But there was always an excuse to delay, always an excuse to go back.
Jim Meigs: And what about today? What should we do going forward?
Edward Chancellor: I mean that’s a difficult question because some people read my book and they say, “Oh, Chancellor wants higher interest rates.” So again, I say, “I want them on paper.” But we also have a reality of the system that is extremely sensitive to raising interest rates. And we’ve seen that over the last year. Last year the bond markets and stock markets crashed. We’ve had these U.K. pension funds almost went bust because they had exposure to long-dated U.K. government bonds that had negative yields, and those bonds collapsed. We’ve seen the crypto winter, which the SEC seems to be intent on keeping going. We still have a lot of problems built up in the system of loans made on the assumption and investments and speculations made on the assumptions that interest rates would remain low, more or less indefinitely.
And I wonder, and perhaps I’ll be wrong, but I wonder whether the system can survive at these current rates of interest. People have been quite complacent and they think we’re having a month or two where nothing happens, everyone thinks it’s fine, and then you get a banking crisis, a crypto crisis, or whatever. So my view, and I say just a hunch really, is that we are not in your eighth or ninth innings, but we’re sort of perhaps closer to the midpoint or even earlier, heaven forbid.
Jim Meigs: Are we talking baseball or cricket?
Edward Chancellor: Yeah.
Richard Davies: There are no ninth innings in cricket. You should know that.
Jim Meigs: I’m an American.
Edward Chancellor: It’s two innings aside, one game. So baseball, and we’re probably not halfway through.
Richard Davies: Central to your argument, then, I think is because this runs counter to the thinking of a lot of central bankers and economists that very low interest rates are not the natural order of things, that we shouldn’t go back to a time when we had very, very low interest rates for years.
Edward Chancellor: No, I mean, go back to what I was saying earlier, human beings are naturally impatient, and interest is our crystallized impatience, your price of time. Now, in recent years, as I mentioned, we’ve had negative interest rates, so that’s putting a negative value on time. Now that is almost sending the clock ticking backwards, and that’s not healthy, because going back to where we started, if all activity takes place across time, that activity must be coordinated in some way. Otherwise, everything’s going to end up in the wrong place. You’re not going to save enough for your retirement, you’re not going to be able to afford a house, you’re going to make crazy investments that won’t deliver returns.
So the system, a market-based system needs market-based signals that actually coordinate activity. And the interest rate is, as Jim Grant, my friend, the financial journalist and historian says, “It is the universal price.” So if you take the universal price out of a capital system, reduce it to zero or turn it negative, then I think you can be guaranteed that the system will start to fail. And I think that’s where we have been heading in recent years. Whatever happens, we are probably going to be surprised by what happens to interest rates going forward.
Richard Davies: Thank you, Edward Chancellor, and thank you also to the Manhattan Institute for housing us and lending us their studio for this podcast. Coming up next, our recommendation followed by a very brief conversation. Jim, your recommendation? You’re up this week.
Jim Meigs: Yes. Well, since we are here in the offices of the Manhattan Institute, I thought it’d be appropriate to pick one of the podcasts in the MI family that I listen to regularly. It’s from Brown University economist Glenn Loury, and it’s called The Glenn Show. And it’s just a fascinating, easygoing, ongoing conversation with lots of interesting people from across a political spectrum. Glenn brings a distinctive perspective as an economist who takes a free-market, somewhat conservative worldview on things. And as an African-American, he sees issues from a really interesting angle. He has on his good friend John McWhorter, the famous linguist, now also a columnist for the New York Times. So to hear these two esteemed scholars kick around the issues of the day and often look at a lot of mainstream ideas, especially about race from a different perspective, it’s just really rewarding. And to me, it’s what podcasts are so good at is a kind of intimate, up-close conversation.
Richard Davies: And they have a nice chemistry, these two guys. I mean, they’re clearly friends. So yeah, I agree with your recommendation, a good one, The Glenn Show. Now, our conversation about Edward Chancellor, and I’m sure because you suggested this, you’re a fan.
Jim Meigs: Well, I just think the book is really important, and I think it challenged both of us when we were talking about it beforehand, and I kind of mentioned the central thesis that interest rates can be too low and there there’s a risk to it. You immediately came back, “But isn’t it good for people? Isn’t it good for the economy to have low interest rates?” And I sort of thought that way, too. And the book really convinced me that the benefits for low interest rates on one side are balanced out by all kinds of hazards and problems that maybe don’t get appreciated as much.
Richard Davies: Edward moved me somewhat toward the idea that that zero interest rates are an aberration and that there should be some kind of charge for interest because after all, as he points out, time is money. That’s fair. And that also, if you have zero interest rates for a long time, then you can have unfortunate distortions in the economy where very wealthy people often come out much, much better than people on the lower end of the economic spectrum. Where I don’t agree with him, where I am a bit more of a skeptic, is I think that he doesn’t believe that the Federal Reserve or global banks should really lunge in and help out when there is a crisis like COVID or the 2008 financial crisis. I mean, I think there is a strong case for keeping interest rates very low during a recession in order to avoid suffering. But where I do think I move toward him is the idea that we shouldn’t have zero interest rates for very long.
Jim Meigs: Well, I think the book has a more nuanced discussion of that that we didn’t get fully into. And in fact, part of it that’s really interesting is something of a critique of the monetarist economics that I’m a big fan of, partly thanks to the fact that my dad was a monetarist economist in the school of Milton Friedman. What he would argue is that the central bankers shouldn’t just look at prices and preventing inflation or deflation as their central standard on controlling the money supply. They should also be looking at what’s going on with credit and watching out for asset bubbles, watching out for investments that are getting overinflated. I think he makes a good case for that.
And when it comes to who benefits from policies that are meant to have kind of a positive social impact, it’s a classic lesson of a free market or libertarian perspective that the very things that we do that we think are going to help the poor, like encouraging banks to lower their standards, to lend money to poor people so they could buy houses, often hurt the very people we claim to want to help. And then when it all collapses, those people are out of their houses, but what happens to the rich bankers? Sometimes, not much. The risk got offloaded onto other people. So I think the book is a really worthwhile corrective to a lot of shallow economic thinking. And the fact that he explains the evolution, these ideas over centuries to me was really fascinating. It’s kind of an intellectual history as well as a look at the financial system.
Richard Davies: And one of the things I really liked about what Edward says, and he said it at the end of the interview, is interest rates always surprise you. You never know what’s coming next, and we don’t know what’s coming next. We haven’t booked our next guest, so we may be as surprised as you are by our future shows. It’s How Do We Fix It? I’m Richard Davies.
Jim Meigs: And I’m Jim Meigs.
Richard Davies: Our producer is Miranda Shafer. How Do We Fix It? is made for Davies Content. We make podcasts for companies and nonprofits, especially in the bridging space where we try and bring different sides of the political aisle together, at least for a brief 30 minutes or so. Thanks for joining us.