A new book argues that central bankers’ attempts to keep down the cost of borrowing are feeding a global financial wildfire
In 1905, the US Forest Service was created, to protect America’s magnificent forest reserves. Unfortunately, woodland ecologies are complex systems, where top-down management risks a cascade of unintended consequences. When the Forest Service decided to protect trees by stopping them from being burnt down, the results were disastrous. Modest, intermittent forest fires, it turns out, are part of the natural process that maintains the landscape. They prevent larger fires from burning out of control, destroying everything in their path. By suppressing a natural balancing mechanism, the technocrats of trees caused far worse, and more lasting, damage.
Now imagine treating interest rates the same way. America’s central bank, the Federal Reserve, was created less than a decade after the Forest Service, and for Edward Chancellor the parallel is irresistible. In his terrific new book, The Price of Time, he argues that well-meaning attempts by central bankers to manage interest rates have also brought disaster — not just for America this time, but all round the world. The book opens with a graph showing the rise and fall of interest rates over the past 5,000 years. It nicely illustrates how unprecedented our own times really are. The European Central Bank plans to raise its base rate next month, for the first time, but it will remain at a historic near-zero low. The more you read of this engrossing book, the more terrifying that simple fact becomes.
It is no mean task to turn such a dry topic into a lively read, but Chancellor pulls it off. This is not just a worthy successor to his history of financial speculation, Devil Take the Hindmost, but an urgently needed warning.
Rock-bottom interest rates were imposed in the wake of the 2008 financial crisis and have now lasted so long that they have started to seem almost tolerable. To read this book is to be reacquainted with the bizarre, Alice-in-Wonderland condition of modern finance. It is an absurd world, where savers lose their shirts and zombie companies stumble uselessly forward, kept alive by easy money.
Central bankers slashed the price of borrowing over time to protect us from short-term disaster. There were fears of a deflationary spiral or runaway price inflation and a second Great Depression. But has forcing rates below their natural level in the name of price stability done more harm than good? Chancellor says it has taken us to the brink of a new financial precipice.
With inflation now surging, savers crushed, house prices unaffordable and asset bubbles and speculative manias popping up on every side, it is getting harder by the day to brush such worries aside. Anyone who wants a fresh perspective on today’s problems needs this book on their summer reading list.
The Price of Time begins as history. We learn of the ancient roots of interest payments, which far pre-date coined money: the Mesopotamians were apparently charging interest on loans before they put wheels on carts. Even the dangerous miracle of compound interest was known from the earliest of times. Around 2400 BC, a compounding debt that became unpayable caused a war between the city-states of Lagash and Umma. We also learn about the ancient tradition, common to many cultures, of debt jubilees, where debts are cleared to prevent interest accumulation driving debtors into slavery.
For centuries, interest payments were anathema to the Western tradition and condemned as usury. But when modern commerce emerged in Europe, it brought a fair price for credit. Interest rates in northern Italy had been 20pc in 1200; by the late 1300s in Genoa, that was down to 7pc. Elizabeth I legalised lending at interest in England in 1571, with rates capped at 10pc. Anything greater than that was usury, a ban on which was only lifted in 1854.
The Price of Time’s later sections shift from history to interpreting recent events. Interest is presented as a master co-ordinator — the ringmaster at the centre of our financial circus. The interest rate’s “universal price” helps prioritise the allocation of capital, set savings levels, measure risk, regulate international capital flows and more. When you artificially set that price close to zero, chaos and unforeseen consequences inevitably follow, just like those out-of-control wildfires in America.
For example, recent cryptocurrency price bubbles may simply be the inevitable yield-searching that consumers pursue whenever interest rates fall below 2pc. Even the Arab Spring, Chancellor argues, can be traced back to a commodity price bubble inflated by low interest rates. Iceland, by contrast, recovered strongly after the financial crisis without crushing the life out of interest rates. Instead, it seems to have offered a modern version of the ancient debt jubilee.
The Price of Time’s conclusion, titled “The New Road to Serfdom”, turns to the Nobel-winning economist Friedrich Hayek, who showed that market prices co-ordinate the economy in ways that central planners can never beat. For Chancellor, fixing the economy’s “universal price” — the rate of interest — is a less obvious but equally doomed effort at central planning, 21st-century style. Today’s omnipresent mix of government over-reach and failure is the unsurprising result.
Economics: The Price of Time by Edward Chancellor
Allen Lane, 432 pages, hardcover €31.50; e-book £12.99
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