Malinvestment

I picked up Edward Chancellor’s The Price of Time thinking it would be a history of interest. Granted, it does start that way, with a discussion of the treatment and thinking of debt in ancient societies, through to the Christian era. What I wasn’t expecting was for it to then change tack, to become a polemical analysis of recent monetary policy, particularly in the lead up to, and following the last two long term debt cycles (peaking in 1929 and 2008), but I enjoyed it all the more for it.

Chancellor’s argument is that interest is a critical piece of the economic fabric because it puts a price on the act of bringing money from the future into the present (lending). As in any market, incorrect pricing can have serious negative side-effects, so a correct price for time is needed to prevent accumulated imbalances cripling the underlying system. Because interest permeates the entire economy, the importance of this price being set correctly is fundamental. Get it wrong, and you’re risking the whole house.

Chancellor then attempts to show that defective monetary policy in the lead up to and following the Great Recession (GR) (2007-2009), not only precipitated the triggering crisis, but has led to the slow recovery since. The main precipitating policy for the GR was repeated Fed puts from Black Monday in 1987, through the dot-com bubble and into the early 2000s. Chancellor does not ignore the other consensus causes of the GR, but rather outlines how the artifically low interest rates created by this monetary easing presaged all other causes. Low rates created a drive for return that caused capital to flow to riskier assets; banks sought returns in issuance of subprime mortgages, which unreliable borrowers could take out because of low rates. The suppression in the price of time created a feeling that there was little to no cost in leveraging now by bringing money from the future. Eventually, the pile buckled under its own weight as the bad investments banks made to risky borrowers soured, and the mesh of leveraged capital unwound.

In the ensuing years, interest rates were held even lower than before the crisis. New ground was broken with negative rates and ZIRPs. For more than ten years, central banks held rates near zero to stimulate economies, yet the expected effects were not seen. Instead, Chancellor details a host of side-effects from the loose policies in the 2010s. Among these are zombie companies, social unrest (inequality, Brexit, Trump), and continued speculative mania (crypto). The poor recovery, according to Chancellor, was because of, not in spite of, the artifically low rates set by central banks.

Core to this argument is the idea that low rates cause malinvestment, which is the misallocation of capital into poor investments. The end result of which is not only the buildup of bad debt, but also slower economic growth as less money is put to good use. Chancellor gives the counter example of Iceland, where a forced hand produced contrarian monetary policy that raised interest rates in the years following 2008, and the country has seen an outperforming recovery since.

The argument is no doubt convincing. It is evident to me that interest rates are a fundamental part of economies, I also agree that they are important as a limiter on the bringing forward of future money, and that too much credit brought forth creates imbalances and malinvestments. I think the correct allocation of capital is an important component for economic performance, and I think that low rates lead to low returns, which drives capital into riskier ventures. But do I agree with Chancellor entirely? Well, sort of.

Arguments like these are always enticing, but a single cause for such a complex plethora of events is too good to be true. Granted, I think Chancellor would agree with me here: I think he is intelligent enough to realise that easy monetary policy is not the only cause of the issues he outlines. GDP has more components than effective investment, and monetary policy is only one input to determining where capital flows in an economy. These other factors cannot be ignored, but I feel they are in the book, to the detriment of his argument. That said, Chancellor provides a service in bringing to light a factor that is often overlooked by mainstream narratives. You hear investment is poor regularly, but the argument that low borrowing costs are driving this is rarely made.

In his polemical style, Chancellor also sidesteps addressing the question of what alternative there was to the policies pursued post-2008. What central bank governor was going to raise interest rates in response to the largest financial cataclysm for 80 years? Interest rates were already too low, but the consensus view was and is that cutting rates alleviates markets. Central bank heads are not immune to being ousted for poor performance, and indeed they are expected not to rock boats. One can imagine a hawkish Ben Bernanke simply being replaced by a dovish successor who would toe the line. In a way, the response was baked in by actions and consenses viewpoints that were thirty years in the making by the time of Lehman’s collapse in September 2008.

Lastly, Chancellor also misses the “revolver of history”. An idea I first encountered through Nassim Taleb, that history is like Russian roulette; we see only the events that occur; we are blind to what is in the other barrels of the revolver. In the nearly two decades and a half since 2008, the world has faced increased challenges, in many ways it has not moved on. I think there are valid sharp criticisms to be made about the response, more so about the lead-up, but it is worth acknowledging that the global financial system remains intact, that unemployment did not soar to the levels of the Great Depression and indeed returned to normal relatively quickly. The crisis was so bad that concerns about societal collapse at the time were not unfounded, but they were avoided. There are alternatives left in the barrel that we did not experience, but we know they were probably there. I think the decision makers of the time deserve acknowledgement of that, alongside the heavy criticism Chancellor brings to bear.