The transcript from this week’s, MiB: Edward Chancellor on the Real Story of Interest, is below.
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ANNOUNCER: This is Masters in Business with Barry Ritholtz on Bloomberg Radio.
BARRY RITHOLTZ, HOST, MASTERS IN BUSINESS: This week on the podcast, I have another extra special guest. Edward Chancellor is a legend amongst financial journalists and historians. His book on the history of speculation and manias and bubbles, “Devil Take the Hindmost” is just legendary. It is the full history of financial speculation.
His latest book could not be more timely, “The Price of Time: The Real Story of Interest,” it’s all about the history of interest rates, money lending, investing speculation, funded by banks and loans and credit. According to Chancellor, interest is the single most important feature of finance, both ancient and modern. And it’s how we allow transactions to take place across time. I found this conversation to be fascinating, informative. He is one of a kind, and I’m confident you will find this to be fascinating also.
With no further ado, my conversation with Edward Chancellor.
Let’s start with your background in academia. So you study history at Trinity College. What is a Master of Philosophy in Enlightenment and History from Oxford? Am I mangling that in the American —
EDWARD CHANCELLOR, AUTHOR, FINANCIAL HISTORIAN & INVESTMENT STRATEGIST: Well, we call it MPhil. It’s the shorter version of a doctorate or DPhil. I read a research paper and had exams at the same time, and it was originally created as a sort of academic teaching degree, but then got somewhat usurped by the PhD.
RITHOLTZ: And that was where I was going to go, it looks like you’re setting yourself up for a career as an academic.
CHANCELLOR: I thought about it. And then I was invited with the other graduate students to my History professor’s house on the outskirts of Cambridge. And I thought, well, if this is where — this is where — the guy who’s got to the top at Oxford list, I’m going to go and get a job in the city of London. So that’s what I did. And I sort of didn’t — my thinking on leaving academia is that if I need to earn a living, I might as well make money from money, which is what Aristotle disapproved per se. It was the sort of an anti-Aristotelean act of going into the city.
RITHOLTZ: That’s really interesting. So you go into the city of London, and is that where you began at Lazard Brothers or how did your career start?
CHANCELLOR: Yes, I started at Lazard’s.
RITHOLTZ: No relationship to the U.S. Lazard?
CHANCELLOR: Yes. They’re all — they call it Lazard Brothers in London, Lazard Freres in Paris, and Lazard probably here. So they’ve now all been drawn together. Though, when I was there, there were sort of interconnected shareholdings that were joining the different branches together. I went into what’s called corporate finance, what people would see now as sort of M&A department.
RITHOLTZ: In the 1990s in London, that had to be pretty busy time.
CHANCELLOR: Well, I was actually in a sort of subgroup there, which was called corporate strategy. We were sort of doing our job. Our job was basically to give sort of strategic advice to Lazard clients, which would generate capital-raising mergers and debt financing. First, these companies, they were sort of self-interested advice. But I didn’t last very long there because I thought I didn’t like corporate finance. I sort of — I felt they were sort of ruthless, cynical, always looking for a deal.
I remember once, one of my colleagues says that a friend, one of the French Lazard Frerers partners was asked by a sort of junior, “How much should we tell our client to bid?” And the French partner said, “The price is right which hurts our client.” There’s sort of cynicism in corporate finance. I didn’t find it intellectually interesting. You had all those deal books you can imagine and — but it was —
RITHOLTZ: Tedious, not thrilling.
CHANCELLOR: Yes. And I was sort of grunt level.
CHANCELLOR: And I came to the point where I thought, well, I’d sooner be driving a bus if I continue this work.
RITHOLTZ: Right. So how did you transition from Lazard to GMO.
CHANCELLOR: So it wasn’t a straight path. When I was at Lazard, you can’t work in finance without people talking about the great speculative bubbles of the past. So people would mention this British Railway Mania in the 1840s and Tulip Mania and so forth. And I left with no more money than I had when I came in, and I decided I would write a history of financial speculation of my own bat. I’ve read the other stuff, Kindleberger got rate [ph] and that sort of stuff. And I still felt there was room to write a new book.
RITHOLTZ: The space had not been mined through exhaustion.
CHANCELLOR: I think Kindleberger is very good. If you’re me, he’s writing a sort of taxonomy of the bubble. And then as an historian, I wanted to write the narrative of the bubble. Now, you’re probably aware of Charles Mackay’s “Extraordinary Popular Delusions.”
CHANCELLOR: I mean, that’s your 1840s narrative and it’s highly inaccurate and —
CHANCELLOR: Yes. It is full of sort of legend. He talks about the black tulip and stories that people bite — people biting — with the tulip bulb, he talked about a sailor coming along and mistaking a tulip bulb for an onion and eating it, and it turning out to be a rare tulip bulb worth the value —
RITHOLTZ: Hundreds of thousands of dollars.
CHANCELLOR: — of an Amsterdam townhouse. And (inaudible) from a sort of investment perspective, you don’t really get a proper picture of what’s going on. So in some ways, I was sort of right. And then, obviously, Mackay writing, he only covered tulip mania, South Sea bubble and Mississippi bubble. So I thought I want to write the sort of arch of financial speculation up to the current day. And then in the course of writing it, the dot-com bubble started to form. So that made it more pressing, and in a way, more interesting, because you could —
RITHOLTZ: You’d see it in real time.
CHANCELLOR: Exactly. But also, you could see these parallels. So I was writing about the British Railway Mania of the 1840s. Railways were this revolutionary technology that was going to change the world, going to change civilization, the speed with which people — roughly at the same time, remember Mary Meeker of Morgan Stanley —
CHANCELLOR: — in light with the Internet report that was being sold at Barnes & Noble in ‘96. And I wrote the book, but also journalism in ’96 and the FT saying, “Hey, this Internet stuff looks a lot like the railway mania of the 1840s,” and ‘96 hadn’t really started getting and going for —
RITHOLTZ: As a reminder, Alan Greenspan’s infamous irrational exuberance speech was late in ‘96.
CHANCELLOR: Yes, December.
RITHOLTZ: Yes. And we were really just ramping up for the next couple of years.
RITHOLTZ: So the book comes out, I think, June 1999, is that right?
CHANCELLOR: Yes, correct.
RITHOLTZ: That’s fairly auspicious timing.
CHANCELLOR: So it came out with Farrar Straus. I’m sure you’re aware. And I said to Jonathan Glass [ph], the editor, “You’ve got to get this out quickly. And FSG, to their credit, reduced publication time from their normal one year to six months.
RITHOLTZ: You still had 15 months so — well, let’s see, June, you had nine months before things really topped out.
CHANCELLOR: Yes. As you know bearish messages oftentimes — I’d say even — was it better to have left the publication date later? I don’t know. I mean, you remember a bit later, Robert Shiller’s “Irrational Exuberance” came out.
RITHOLTZ: 2000, right?
CHANCELLOR: Yes. So I was probably a sort of eight, nine months before Shiller.
RITHOLTZ: But it’s a book. It’s not — you’re not picking the top or bottom. A book is multi-year process and it’s — it could have been “Dow 36,000” which came out around the same time. So —
CHANCELLOR: Well, yes. No, I — the first thing I spoke at was a Goldman Sachs Asset Management conference, strange enough in a place called Carefree, Arizona. And the “Dow 36,000” people were there. And I was saying there’s a great bubble, which is about — this would have been in late ‘99. And I said, “We’re here in Carefree, Arizona, but around the corner is a place called truth or consequences. And perhaps we should really be meeting there.”
You can imagine, you give a bearish message at a bullish investment conference, and no one listens to you. Not a single one of the partners or anyone like that thanked me or —
CHANCELLOR: — for the talk. It was completely — I felt completely blank. But actually, I’m later met, one of the “Dow 36,000” people, Kevin Hassett. I met him there. He’s actually a very nice fella. And he did — when I met him, let’s say in 2010, he acknowledged that they’ve got things wrong.
RITHOLTZ: James Glassman, and Kevin —
CHANCELLOR: Kevin Hassett.
RITHOLTZ: –Hassett. Now, not too long ago, just before the pre-pandemic period, like late 2010s, they kind of came out when Dow first crossed 36,000. Maybe it was ‘21. They kind of came out and said, “See, we told you.” And it’s like if you write a book Dow 100,000, well, I guess you just got to come back in 60 years to say, “I told you so.” But 23 years later, you don’t get credit for saying you could buy stocks right here, right before they collapse.
CHANCELLOR: Yes. But the other point is that when people say, “Oh, well,” and I think Wall Street Journal had an editorial opinion about “Dow 36,000.”
RITHOLTZ: That’s how you know it’s going to be low?
CHANCELLOR: And look — yeah, but then if you look at the valuation of the market at that time, the market was — the U.S. market at the end of last year, so probably we’re on what we call the Shiller P/E ratio, the cyclically adjusted price-to-earnings ratio, which is the sort of most reliable long-term valuation, where it was at its highest level at the end of last year than at any point apart from the last stages of dot-com bubble that’s higher than in 1929 and higher during the 1950s when the market is very expensive.
And what we will also know, those of us who work in investment, is that your future returns are inversely related to the valuation. So perhaps every time we get to Dow 36,000, you can expect a long period of decline. I mean, in the end, inflation will — and accrued earnings will mean that we’ll get to 36,000 one day on a sustained basis.
CHANCELLOR: But just probably not the next decade or so.
RITHOLTZ: That’s interesting. So you write the book, gets published to great acclaim. How did you go from that and other writings to GMO?
CHANCELLOR: So ’99, the quant shops, Jeremy Grantham in GMO; Rob Arnott’s First Quadrant, now Research Affiliates; Cliff Asness —
CHANCELLOR: — AQR. They were in trouble. They were not buying into the TMT bubble. They were buying their beloved value stocks. And everyone was just saying they were idiotic quants and that that approach would no longer work. So then they found that — they saw this book came out, saying, “Look, the —
RITHOLTZ: You’d be right eventually?
CHANCELLOR: And then they looked through the dot-com bubble, it looks a lot like these historical bubbles. So all of them, independently, Jeremy, Rob, Cliff read the book and got in touch with me. And Jeremy became more of a friend, but I didn’t go straight to GMO. I then was doing journalism for Breakingviews, which was the sort of dot-com startup, FX FT people known by Reuters, and started doing some — and then I did some research for Crispin Odey, London hedge fund guy.
And so, Crispin and I were having lunch in late 2003. Crispin said — we were talking about what was going on in the markets and in world. And Crispin said, “It’s really all about credit.” And I said, “Yes, I agree.” And he said, “Well, why don’t I just pay you to write a report and to analyze what’s going on?” So I spent next sort of nine months looking at what was going on in the U.S. and the U.K. in the credit boom, in real estate boom, and development of securitized lending and subprime, so forth.
And then I put that out as I — I did that for Crispin, but I also sold it as a report, but not for wide distribution, sort of $1,000 a shot. And that went to sort of a few people. I gave a copy to Jeremy as a present. And then I was having lunch with Jeremy in Boston. I was working for Breakingviews in New York, and we were returning to England after a couple of years. I was having lunch with Jeremy in the summer of 2007, just after the Bear Stearns hedge fund started blowing up. And Jeremy said, “Well, at least there’s enough structural redundancy in the banking system.” And I said, “What the hell makes you think that?”
RITHOLTZ: And what was his response?
CHANCELLOR: Well, he sort of — yeah, he thought about it. And then I went home, I went — we have a house in Cape Cod and I went out. Jeremy called and said, “Would you like to join the asset allocation team?” And —
RITHOLTZ: That’s a hard thing to say no to.
CHANCELLOR: Well, I said no initially. And then went back to England, then he called again. And because these investors sometimes say, like, throw job offers around then never serious.
CHANCELLOR: And then he called a couple of months later, and then I decided, yes, I would take it. And Jeremy wanted a — obviously I’ve done a lot of work on the credit boom. But he also wanted sort of — I said to Jeremy, “I’m not a quant.” And look, GMO is, so to speak, a quant shop.
RITHOLTZ: It’s filled with quants. Right.
CHANCELLOR: Filled with quants. Yes. And Jeremy said, “I’m not a quant, either.” So he wanted a sort of non-quanty view input into the asset allocation process.
RITHOLTZ: And I assume that worked out pretty well.
CHANCELLOR: Yes and no.
RITHOLTZ: They did well during the financial crisis.
RITHOLTZ: It’s relatively —
CHANCELLOR: They were well positioned.
RITHOLTZ: Positioned already. Yes.
CHANCELLOR: They had the equity allocation. I mean, I didn’t want to blow my own trumpet up too much because most of the positions were in place, the quality funds, which more defensive and less leveraged, and low allocation to — a relatively low allocation to equities, and then the hedge funds sort of long/short positions that benefited in the financial crisis.
My only real contribution that year was right at the beginning, when I hit the first week I joined GMO, I’ve written a piece in an FT column I had at the time saying, “Don’t believe the story that emerging markets can decouple from the rest of the world.” And GMO was still sitting on a massive emerging market position in the asset allocation team. And I tried to sort of chip away at that with Jeremy, and not having much success. And then the CLSA Asian economists called Jim Walker. I don’t know if you ever came to know.
CHANCELLOR: He’s sort of Scotsman with sort of voice like a Presbyterian minister. He was also on the sort of anti-decoupling story and he was bearish on EM. I dragged Jeremy to Jim Walker. And he said that this Scotsman with his gloomy voice is more effective and persuasive than I with my language, English drawl. And then Jeremy went out and sold all the emerging position.
RITHOLTZ: Wow. Really?
CHANCELLOR: Several billion dollars. And within, I don’t know, two months, he bought them back at half the price.
RITHOLTZ: So you earn your keep then?
CHANCELLOR: Yeah, only by — I think it was Jim Walker who did the thing, but at least I got Jeremy —
RITHOLTZ: You got him in front of him. That’s what I’ll say.
CHANCELLOR: Yes. And that sort of — I suppose I used to tell that sort of paid my way while I was there.
RITHOLTZ: Absolutely fascinating. So let’s talk about what’s with this quote that I like from a 19th century trader, James Keene, “All life is speculation. The spirit of speculation is born with men.” Tell us about that?
CHANCELLOR: Well, I mean, the act of speculation is to look out into the future. The word speculator is Latin and was a Roman military guard whose job was to look out and see whether the —
RITHOLTZ: Speculate on danger.
CHANCELLOR: — the gulfs [ph]were (inaudible) over the hills. In particular, when you get into what — financial market’s capitalist world, you’re always trying to anticipate what’s going on. In that sense, even people who describe themselves as investors are also necessarily speculators. But when we talk about speculation, we often talk about sort of unfounded, or irrational, or dangerous gambling- type tendencies.
RITHOLTZ: So that leads me to the question, what is the actual difference between speculation and investing? Clearly, they’re both a gamble on the future. Is it about the amount of risk taken and the psychology of the person involved? Or is it something a little more quantitative?
CHANCELLOR: You read threads where all the customers (inaudible). And you remember there he says, “The difference between speculation and investment is that speculation is an attempt, normally unsuccessful to turn a little amount of money into a lot. Whereas an investment is an attempt, normally successful to make sure a lot of money —
RITHOLTZ: Doesn’t turn —
CHANCELLOR: — doesn’t become a little.”
RITHOLTZ: Fred Schwed, right? Is that who wrote the —
CHANCELLOR: Fred Schwed. Yes, that’s right. So embedded in that is the idea — is the speculator is going to be taking more risk.
RITHOLTZ: And not concerned with preservation of capital, the way an investor might be, is that what’s embedded in that?
CHANCELLOR: I’d say the speculator now called in the book, “Devil Take the Hindmost.” And that is really a reflection of what they call the greater fool theory of investment is via a Shiba Inu coin or an NFT, and sell it to you, Barry. Well, then I buy because I think Barry is a bigger sucker than I am., and that he’ll take it off me from a bigger price. That’s a sort of Ponzi scheme or pyramid chain letter dynamic to a speculative bubble.
And the other aspect of the speculator is he often gets lured into envisioning how the world will be and gets drawn into these new technologies, whether it’s radios or cars in the 1920s, or Internet stocks in the 1990s, and various types of — well, think of all those specs and electric vehicles the last couple of years. And the speculator — the trouble is that they look into the future and they draw — they imagine the future is actually much closer than it turns out to be. And so you could say that they’re operating with a sort of hyperbolically discounting the future, or just say they have too low discount rates. So they’re drawing everything forward.
And even with the Internet, which we know, established and changing one’s life within a very short period of time. Even then, it didn’t stop the NASDAQ coming down by more than 75%.
CHANCELLOR: A lot of these dot-com businesses flaming out.
RITHOLTZ: By the way, everybody talks about the Internet happening so quickly. It began in the 1980s as a way to survive a nuclear attack and be able to launch the retaliatory codes through DARPA.
RITHOLTZ: So it took decades to be commercialized and more decades to become more broadly adopted. So if you are an Internet investor in the late ‘80s, early ‘90s, most of those companies didn’t do well.
CHANCELLOR: What I didn’t say the “Devil Take the Hindmost” was some research from a guy. I think he was at Bell Labs at that time, called Andrew Odlyzko. He’s now at University of Minnesota. And he and a colleague worked out in ’98, ‘99 that the projections for Internet traffic growth that the likes of WorldCom and big telecoms company was saying that Internet traffic growth was doubling every couple of months. And Odlyzko found out that actually the rate of growth was slower than that. Still doubling, but I think once every six months or so.
And the result was getting — in the mania, people get overfixated on growth. They have growth projections –overoptimistic growth projections, then you get the overinvestment, you get speculative companies raising money over investment. And then if you remember after the dot-com, bust, you had these miles and miles of so-called dark fiber because you had excess capacity in fiber optic cable, which is, I mean, so commonly cited about, some 95% excess capacity. And that ran for several years, a bit like the sort of — if you think about it, the excess U.S. homebuilding during the real estate bubble which took —
RITHOLTZ: A couple years to work out.
CHANCELLOR: When they’re more than — I think it really took from 2006 to 2012. Before that, access build had really just worked its way out the system.
RITHOLTZ: And then the hangover from that is we were under building houses for the rest of the decade because once bitten, twice shy. And then when suddenly there was demand for houses, there’s no inventory. There’s a shortage.
CHANCELLOR: Yes, that’s it. I mean, given now, we’re going to get right into later. Now, first year mortgage rates have doubled. I think the Americans going to be grateful that they didn’t do that much building in the last few years because otherwise, we would really have a replay of 2007 and ’08.
RITHOLTZ: That’s really quite fascinating. So I mentioned earlier, the book comes out in June ’99, pretty auspicious timing. But it raises the question with the publication of your new book, how often does history repeat itself? Are all of these bubbles and manias and collapses, is it pretty much the same playbook that just substitute Internet for railroads, substitute houses for telegrams? Do all these things just follow the same sort of cycle just forward in history?
CHANCELLOR: Well, Jim Grant has a comment there. He says, “We’re always stepping on the same rake.” And I have a — a friend of mine, a financial strategist, lives in Edinburgh called Russell Napier runs a — has a —
RITHOLTZ: Oh, I know the name. He wrote a book on —
CHANCELLOR: He wrote a book called the “Anatomy of the Bear.”
RITHOLTZ: Of the bear, that’s right.
CHANCELLOR: An excellent book. He has a financial library in Edinburgh called the Library of Mistakes. And the idea is that you can learn everything you need to know in finance and for an investment career by actually working out the mistakes people have made. And that does seem to be, yes, as sort of similar pattern. Although, I should add that certainly it doesn’t help you on the short side, betting against speculative bubbles.
When I was at GMO, we — a colleague and I ran a sort of quantitative analysis of speculative bubbles and we crunched, produced my system date 10,000 years of data of various commodity markets, and real estate markets, and stock markets around the world. And what we found is that bubbles are indeterminate in length. And they’re also indeterminate as to how high they can go. So if you don’t know how long the bubble is going to last and how high it’s going to rise, then you might be able to identify a bubble. And I don’t think that’s, frankly, that hard. And I think that’s useful if you’re just a long-only investor, you can stay out of the bubble market.
RITHOLTZ: Right. But the timing on the downside is really difficult.
CHANCELLOR: Yes. And I think what we’ve been — look, the last decade, we had — people were talking about dot-com 2.0 back in sort of 2012.
CHANCELLOR: And I actually — one of my last projects at GMO was to do a sort of — to look at what was going on from economic sentiment perspective, looking at various different measures in a bull bear ratio, amount of margin loans in system. I can’t quite remember what they were. But anyway, I put them all together and it looked — that speculative sentiment was very inflated in 2013. And actually, I presented this to (inaudible) and Jeremy got up afterwards and said, “I think the bull market has looked good to run.” And the other day, he was sort of tweaking my notes by saying — reminding me that I had been bearish and that he’d been relatively bullish. But clearly, there was another seven years to go and it got pretty — what happened in 2020 was nothing like — it was–
RITHOLTZ: That’s a one-off. Yes, for sure.
CHANCELLOR: Yes. I mean —
RITHOLTZ: By the way, I have a — my partner Michael Batnick wrote a book that your colleague Russell Napier would really appreciate, called “Big Mistakes: The Best Investor and Their Worst Investments.” And he went through the history of George Soros and Warren Buffett, and all these legendary investors, and their giant mistakes and what they learned from them. I’ll send you guys a copy, you’ll appreciate it.
CHANCELLOR: Yes. And that definitely belongs to the Library of Mistakes.
RITHOLTZ: Yes, for sure. It’s literally exactly what he was discussing. So again, we see auspicious timing on your part to put out a book on interest rates in the middle of 2022, the most rapid increase in inflation since the 1980s, the fastest rising set of rates from central banks. I think you could say they ever from zero to 3.5% on the way to 4%, 4.5%. Your timing is quite auspicious. When did you first start thinking about, hmm, maybe it’s time to write a book about interest rates?
CHANCELLOR: Well, quite a long time ago. I think I got interested in those subjects about a decade ago. And when I did this work on the credit boom, before the financial crisis, I belong to the school that thought that when the Greenspan Fed took U.S. Fed funds rate down to 1%, after the dot-com bust, that ignited, in my mind, the real estate bubble.
RITHOLTZ: Obviously, a giant factor, has anyone actually made a case to say, “No, no, keeping rates under 2% for three years and under 1% for a year had no impact on real estate?” I mean, it’s not the only factor. But it’s pretty hard to say, “Oh, no, not relevant.”
CHANCELLOR: Whether the Fed under Nobel laureate Bernanke —
RITHOLTZ: Yes. Saving squad, we all know that’s nonsense.
CHANCELLOR: Yes. I mean, I used to write about that in this new book where money flows off to the emerging markets when dollar rates are low. And then it comes back because these guys, they’re not saving. They’re actually just buying long dollars, treasuries.
RITHOLTZ: And then investing. Right.
CHANCELLOR: They’re buying them to manipulate the currency of China, most of all. But then I suppose difference between Bernanke and me is that Bernanke has a sort of abstract view of economics, whilst I try and look at what’s going on in the real financial world.
RITHOLTZ: Although, to be fair, for an academic, he actually got to put his theories into practice as Fed chair.
CHANCELLOR: Yes. And that’s problematic. I mean, do you remember, it was in ‘99 Milton Friedman’s 90th birthday.
CHANCELLOR: When they passed 2002, Friedman’s 90th birthday party in the Fed, Bernanke says facetiously to Friedman, “Apologizing for the Great Depression on behalf of the Federal Reserve, and ensuring that it won’t happen again.” And then five years later, we get meltdown. Bernanke and the Fed had — in particular, Bernanke had no inkling of what was about to happen. And then we didn’t get a Great Depression. But we then got into this era of extremely low interest rates and of quantitative easing, and that was associated with a period of what they call secular stagnation or extremely low growth. And we never really got out of that. We —
RITHOLTZ: Until the pandemic.
CHANCELLOR: Well, we didn’t get out — I mean, the pandemic was just the last gasp when they went back to quantitative easing. And they really came — the House of Lords, which the House of Lords wrote a report on quantitative easing last year which they called a dangerous addiction. And as Ben Bernanke introduced this financial dope, and I went off to work for hedge funds, or whatever he does, that is.
RITHOLTZ: He’s a consultant.
CHANCELLOR: He’s consultant.
RITHOLTZ: Right. They consult. So let’s bring this back to the book, which is really quite fascinating. You start in Babylon with the origins of interest, and you go straight through the most recent boom and bust. How did the concept of paying interest on money begin?
CHANCELLOR: Well, what we know is that interest is a very old phenomenon, five millennia, at least.
RITHOLTZ: Before Babylon? I mean —
CHANCELLOR: Well, if you look at the words in the ancient languages, including Assyrian, and Greek, and Latin, Egyptian, all the words for interest are linked to calves and lambs and kid goats. So there is this sense that interest must have existed in prehistoric societies. And the idea was I’ll lend you my cow. But a year later, I want the cow and a calf back, and you can keep if it has male. You can keep the male. Now, you can keep the extra cow. And as I cite in the book, the Americans were still — in the beginning of the 20th century, they’re out in the Midwest or whatever, people were still lending livestock and demanding interest payments in the offspring of the livestock. That I think is the origin.
And then as I say, in ancient Mesopotamia, which had large cities and trading quite in a way, quite capitalistic, and you can see that interest was used on loans. It contains a sort of risk factor that people were using, borrowing and paying interest to finance, shipping ventures to finance local businesses and trade crafts, and also for financing the purchase of houses. So, you’ll see that in this sort of what you might call a proto capitalistic society, interest is serving a number of different important functions.
And my reason for getting back to that point is to try and underline how important the function of interest is. That the Yale historian, William Goetzmann says that the invention of interest is the most important invention in the history of finance because it allows people to transact across time. And my thought, when I was doing this work, is we’re at a moment of zero interest and of negative interest in many countries, and that the zero negative interest was the sort of second most important development in the history of finance, and possibly the most, to my mind, worrying development.
RITHOLTZ: We’re going to talk more about negative interest rates in a moment. But I have to reference the title of the book, “The Price of Time,” interest and interest rates are all about being able to engage in commercial transactions over time. Essentially, that’s what interest rates allow.
CHANCELLOR: Yes. So time, as Ben Franklin says, is money. Time is valuable. Time is our most precious possession. And we must use time well. All our economic actions are taking place across time. And we need to sort of coordinate those actions. How much are we going to save? How much are we going to invest? What type of investments we’re going to make? What valuations will we place upon the house that we’re purchasing? Whether — should we invest in this country? How much risk should we take? All these factors have an interest rate embedded in them.
And the American economist, Irving Fisher says that interest is an omnipresent phenomenon. And really what I’m trying to do with this book is to take this oldest of financial institutions, this omnipresent phenomenon, that to my mind, had been neglected by modern economists who really just see interest as a lever to control inflation and ignore these other functions. And thrust to the argument, the second half of the book is that the — when the central banks focused only on using the interest to prevent the price level from falling after the global financial crisis. They neglected the impact the saving has on valuations, on the allocation of capital, on savings and pensions, on the amount of risk-taking, and on capital flows, and the direction of capital flows.
And in each of these other areas, we see a chronicle in the book, problems building up. And so if you take, for instance, valuation and we just discussed earlier how valuation of the U.S. stock market was very high last year, but aggregate household wealth that the Fed actually gathers —
RITHOLTZ: Record highs.
CHANCELLOR: Six times GDP against an average of 3.5 times GDP. And what you can see if you chart and I showed a chart in the book, is I showed the household wealth with the Fed funds rate. And each time the Fed funds rate goes down, the household wealth sort of pushes higher and higher and higher. So that’s obviously a source of instability because then when you raise rates, hey, presto, the markets come down in tandem with the bond stocks. Everything bubble gives way to the everything bust.
RITHOLTZ: So clearly, the cover of the book has an hourglass showing time slowly seeping away. How important is time to those of us working in finance and engaging in transactions, where capital is put at risk?
CHANCELLOR: Well, I mean, it’s likely. But, first of all, I’d say time is important to all human beings. And what’s called time preference, people’s tendency to prefer the present to the future to what we call discount the future, it appears to be a universal phenomenon. Some people are — another way to talk about is impatience. Some people are more impatient than others. So everyone has their own internal interest or discount rate.
In finance, all finance is about transacting across times, lending, investing and so forth. It’s absolutely essential. There’s no activity in finance that doesn’t involve an interest rate. I mean, I cite a description of the failure of the Soviet economy. Even if you have a Soviet planned economy, you need to allocate resources across time. And if you’re not guided by the interest rates, as which the Soviets weren’t, you’re going to have these misallocations of capital that eventually clog up the system.
RITHOLTZ: So let’s talk about that. I love this quote, “Interest rates are the most important signal in a market-based economy and the universal price affecting all others.” You’re suggesting, because that signal was missing from the Soviet economy, it eventually crashed and burned?
CHANCELLOR: Yes. I mean, among other reasons. What I’m saying is that every — because it’s innate to human, because all humans are constrained by their mortality. All actions take place. Economic actions take place across time. But even if you didn’t have a capitalist or market economy, suddenly would need to rational to direct your resources or direct your behavior across that. In a way, it’s more explicit in a capitalist economy because you’re paying a certain rate of interest on your loan, or you have a certain required hurdle rate on your investment, or you’re applying a certain discount in the valuation of an asset. So in that sense, the time value of money is sort of first thing one learns in finance.
RITHOLTZ: So prior to the financial crisis, I never thought about zero interest rates and I certainly never thought about negative interest rates. The decade that followed that seem to have created all of these negative rates. How do they affect economies? How do they affect trade? And how do they affect the consumer?
CHANCELLOR: So the zero rate leads to these buildups of financial instability, and at the same time contributes to a misallocation of capital.
RITHOLTZ: You’re not getting any yield on fixed income, so you tend to go to more speculative —
RITHOLTZ: The whole TINA, there is no alternative.
CHANCELLOR: Exactly. Yes. I say the English 19th century finance writer Walter Bagehot, where he says, “John Bull, the eponymous Englishman, John Bull can stand many things, but he cannot stand 2%.” And when people — we talk about yield chasing or carry trading when rates are very low. With the negative rates, you remember the argument negative rates was that they were going to turbocharge the economy. This was a phrase used by Ken Rogoff, the Harvard economist who wrote a book called “The Curse of Cash” in I think 2016, where he argued that you need to get rid of cash so that we could have properly negative rates.
Well, the way I see negative rate is it’s a tax on capital, which is instituted by an unelected —
RITHOLTZ: Central bank.
CHANCELLOR: — central bank, or policymaker, without any one voting for it. He said these people who wanted us all to have accounts with the central bank, with the central bank having an authority, just takes much of our capital weight, seem to undermine property rights. But leaving aside that, while we see you in a place like Japan and Europe, there was no turbocharging of the economies. In fact, as you know, banks can’t make money at negative rates, and they are reluctant to lend.
This is a point the Bill Gross, PIMCO’s former sort of Bond King, was making very early on in the era of zero rates. He says it’s sort of created — it was like sort of leukemia in the financial system, the negative rates, that destroyed the vitality of the banking system. But he said — he says that you need positive carry for the financial system to carry on making loans. Now, negative rates may seem a lot worse. I mean, what you saw when the Japanese went over to negative rates in 2016, articles in the newspaper about Japanese buying safes to store their money. And one of the large German banks also announced that it was going to be storing cash.
And then you get these absurdities. So to note, I think it’s the impetus to credit growth, but you had these absurdities like Danish homebuyers actually receiving payments on their mortgages. So you’re having a transfer of wealth from savers to borrowers. And then they —
RITHOLTZ: Which makes no sense.
CHANCELLOR: No. I mean, we’ve been living in Alice in Wonderland world. I mean, I think it’s just the Lewis Carroll world. But I mentioned some of the long-dated Japanese bonds at negative yields, that some Japanese life insurance guy who I cited said, “Yields state matter.” And people were buying long-dated bonds at negative yields in anticipation —
RITHOLTZ: Of them going lower?
CHANCELLOR: — of yields going lower. And therefore, you could get capital gains from bonds with negative yields. And if you wanted income, you had to buy equities.
RITHOLTZ: How is that any different than the people buying some of the coins you mentioned or the NFTs? You’re buying a negative yielding instrument. I’ll give you $100 for a century, and in 100 years, give me back $98. How is that any different than buying an NFT?
CHANCELLOR: Well, I mean, you’re right. It’s —
RITHOLTZ: Other than you get your $98.
CHANCELLOR: Yes. I mean, well, credit of the government. But look what happened in the gilts market.
RITHOLTZ: Recently or —
CHANCELLOR: In the U.K. quite recently. So you had these long-dated index-linked gilts. The one I say is a 2073 linker,
RITHOLTZ: So equivalent of a 50-year bond here in the U.S.?
CHANCELLOR: Yes. But actually trading on a negative yield last year, 2.5%, been trading down for a long time. This year, that bond has lost 85% of its value at the trough before the Bank of England intervened to try and sort of stop the gilts market completely blowing apart. It was yielding to redemption 1.1%. So you blew 85% of capital to end up with an asset, with an expected real return held to redemption of just over 1%.
RITHOLTZ: It doesn’t sound like a great trade to make.
CHANCELLOR: It was A trade that, as you know, the U.K. pension funds engaged in to the tune of hundreds of billions of pounds. And to make things more interesting, they use leverage too. So there is sort of really a story for our times of pension funds induced too, because of the low interest rates and because that may have affected the present value of their liabilities as your discount rate. Again, they’re forced to go in and do sort of Walter Bagehot-type stupid things of leveraging up these long-dated bonds, while at the same time owning stuff that would have had a higher return, but then getting into a mess.
RITHOLTZ: So let’s talk about what’s been going on around the world. And here in the United States, we have inflation at its highest level in 40 years. How much blame do you assign to central banks for the current circumstances? How significant were those quantitative easing and zero interest rate policies to the current state of inflation?
CHANCELLOR: What do you think? I mean, pretty significant.
RITHOLTZ: I think it’s one of many things, but obviously a very big one.
CHANCELLOR: Yes. I mean, the inflation is complex phenomenon.
RITHOLTZ: Right. But we had massive fiscal stimulus in U.S.
RITHOLTZ: And then the closing and reopening. But within the long-standing environment of zero for a decade.
CHANCELLOR: Yes. So I think I mentioned quantitative easing becoming a dangerous addiction. Initially, that quantitative easing after the financial crisis, was a time where the sort of financial system was deleveraging. The money wasn’t really making its way to Main Street, besides Main Street was high unemployment, and so on and so forth. It’s different when by 2020, with the lock downs, and not just U.S., Britain and —
RITHOLTZ: Around the world.
CHANCELLOR: — around the world. You had I think $8 trillion of central bank QE or balance sheet expansion, and roughly, dollar-for-dollar increase in government spending. And then, obviously, people were just staying at home with their stimulus checks.
CHANCELLOR: And they were going out and buy meme stocks, having looked up on Wall Street bets, which stocks to be targeting, and borrowing at 2% from Robinhood. And —
RITHOLTZ: So here’s the question, if artificially low rates helped get us into this mess, will raising rates help get us out of this mess?
CHANCELLOR: No. I’ll tell you why. I mean, the thrust of the book is that you’ve got yourself into a perilous position, too much debt, too much risk-taking, overinflated valuations, too little real savings, too much financial engineering, and too little real investment. And once you’re in that position, it’s very difficult to get out of it. Do you remember after the financial crisis that was commonly used this phrase “kicking the can.” And really for the last — you could say for the last 25 years or so, we’ve been kicking the can. And now, we’ve reached the point where we have inflation, as we say, and it’s more difficult for the central banks to come in and kick the can any further because they’re in danger of losing credibility.
RITHOLTZ: The can is kicking back.
CHANCELLOR: The can got bigger. It’s like sort of quantum. Every time you kick it, it gets bigger and bigger, and bigger. So we’re now sort of sitting under a massive can.
RITHOLTZ: So I want to roll back to the financial crisis because I suspect I’m reading between the lines a little bit or maybe not so much. When we rescued a lot of the banks and then kept rates very low for the next seven, eight years, we ignored some of the things we had learned previously, when we go back to Walter Bagehot. Shouldn’t we have taken these banks and allowed them to go to that lovely building with the columns downtown, the bankruptcy court, and allow all these banks to wipe out the equity holders, give the bondholders a haircut, and clean up their balance sheets and send them back into the world revitalized? Like, the zombie banks we kept on life support of low rates, wasn’t fixing one problem, eventually setting us up for the next problem.
RITHOLTZ: Yes. I think so. Well, the policymakers said — and central banks, they say there was no alternative. And if you criticize that, you were wishing another Great Depression. But, in fact, actually, I cite right towards the end of the book, the case of Iceland as a counterfactual. Because what happened in Iceland, Iceland went completely crazy.
CHANCELLOR: Their debt, foreign debt was 10 times GDP. The current guide deficit was 25% of GDP. They’ve completely given up fishing. They’ve all turned into bankers.
CHANCELLOR: And then it blew. But Iceland was not part of the EU, so no one was really coming to their rescue. The Fed didn’t offer either credit lines, dollar swaps to the Iceland central bank. And so poor Iceland was just left on its own. And what’s interesting is they sort of followed that course that you described. The big banks went bust. They were put into receivership. Domestic depositors were protected. The mortgage borrowers who — interest rates went up, but mortgage borrowers were protected by giving taxation relief on their interest payments. And the foreign debt was defaulted on. And currency declined with capital controls. But after a few years, capital controls were taken off.
And this is what’s most interesting is that the Icelandic economy transformed away from finance towards tourism, and technology as well. So you had this Schumpeterian creative destruction. The government debt relative to GDP came down. The economy, within six or seven years, Iceland was growing, had recovered all its losses, and was growing faster than any other European country. So making the creditors take a haircut, forcing them take that, goes back to these ancient Mesopotamian practices of debt jubilee, such they originated the debt jubilee, the giving up the writing off of debt, which also the Egyptians and the Israelites did. So — and that’s seen as a sort of left-wing idea, but I don’t think it necessarily has to be. If you’ve made loans that have bad loans, then it’s right that the creditor should take a haircut.
RITHOLTZ: Right. And hence, bankruptcy courts exist for a reason, right? They shouldn’t — they are not just there to show off the architecture of those columns.
CHANCELLOR: I’ve never been — as I mentioned in the book, insolvency rates was sort of absurdly low. We talked about the Great Depression. The new headlines were “Oh, another worst financial — the worst crisis since the Great Depression, it was called the Great Recession.” And then, actually, if you look at insolvencies, they were lower than the insolvencies after the dot-com bust —
CHANCELLOR: — or the insolvencies after the savings and loan crisis of the early 1990s. So you didn’t get your bankruptcy, you said you get the zombies. And the zombies are sort of living dead, which is sort of death to a capitalist economy because they —
CHANCELLOR: — they don’t — they discourage entrepreneurs. They discourage investment. They discourage productivity growth.
RITHOLTZ: No doubt about that. And there are ramifications and unanticipated consequences that we’re still living with till this day, whether it’s a very low growth rate that begot the rise of authoritarianism, both here and abroad. You can trace that back to not allowing the banks to go through that process.
CHANCELLOR: Yes. Well, I do — I mean, my chapter — the book ends with a — called The New Road to Serfdom, and the argument —
RITHOLTZ: Channeling Hayek.
CHANCELLOR: Yes. Friedrich Hayek, the Austrian economist, philosopher, and he wrote a book in the Second World War, thinking that the advance of the state during the war into the economy and into people’s lives was not going to retreat. And it wasn’t really right. There was sort of retreat. But my argument, drawing on Hayek, is that if you take away the universal price, the price of interest that guides the capitalist system, then the system will fail. And the more system fails, the more the authorities have to come in to prop things up until you get to a position where you no longer, in a way, have a capitalist society.
And I suppose that’s the juncture we are today. Are we going to sort of go through the problems of adjusting from the low rates to normal rates, whatever that takes, or are we going to just shift into a sort of a different type of paradigm in which the state allocates capital and controls over that? I’m not saying that we’re going down that route. I’m just raising the question that I talked about people sort of stumbling, progressing without really — no real intention, blind progression. And one sense is that this has sort of been a blind progression. And no one, I mean, it’s absolute clear to me that no one in any position of authority considered the actual ramifications of monetary policy of these low rates.
RITHOLTZ: Quite fascinating. I only have you for a few more minutes before we have to send you off to the airport. So let’s blow through these five questions in a few minutes, starting with, tell us what kept you entertained during the pandemic. What were you listening to or watching?
CHANCELLOR: Well, we watched “Succession.”
CHANCELLOR: And we watched then the other HBO, the —
RITHOLTZ: “White Lotus?”
CHANCELLOR: I watched “White Lotus.” I watched the TV — the series, “A Game of Thrones.”
RITHOLTZ: Oh, okay.
CHANCELLOR: I watch a lot of “Game of Thrones.”
RITHOLTZ: Right. Tell us about some of your mentors who helped to shape your career.
CHANCELLOR: Well, when I was writing “Devil Take the Hindmost,’ I went see Charles Kindleberger outside Cambridge, Massachusetts. Crispin Odey, who I mentioned, commissioned me to do that work on credit, which been very useful to me. Another investment from Marathon Asset Management, a friend called Charles Carter. I edited a couple of books for them called “Capital Cycle Theory of Investment,” which has been sort of quite important to me. And then Jeremy Grantham at GMO has been my mentor, I’d say.
RITHOLTZ: That’s an impressive list. Let’s talk about other books in addition to what you’ve written. What are some of your favorites, and what are you reading now?
CHANCELLOR: My wife and I get into Indie quite a lot. And my favorite novelist is R.K. Narayan, who Graham Greene said was the best writer in the English language. And I actually — I start that book with an epigraph from Narayan’s “The Financial Expert.’ On sort of Indian theme, I’ve been reading these colonial thrillers set in 1920s Calcutta by an Indian-Scottish writer called Mukherjee. I can’t quite remember his first name. They’re pretty good. And Vaclav Smil, Doctor Smil is the Canadian scientist who writes about energy and civilization, and has written — and last year, I read a book called “The Great Transition.” And this year, he’s written a book about — called “How the World Really Works.” And Smil’s argument is to look at how mankind has moved from one energy source to another.
RITHOLTZ: I’ll definitely — I’ll definitely look at that.
CHANCELLOR: Yes. And Bill Gates says he’s his favorite. I don’t know if that’s a recommendation.
RITHOLTZ: Really interesting. Our last two questions, what sort of advice would you give to a recent college graduate who is interested in a career in either history, journalism or finance?
CHANCELLOR: Sort of almost think again. I mean, I don’t think academia is a place to go into now. Journalism is much less — and my grandfather worked at Reuters. He was Shanghai Bureau Chief in the 1930s. And in those days, you could earn a decent living and have a decent career in — it’s harder, where in
Bloomberg, the guys here are paid reasonable. Financial journalism pays, most other journalism doesn’t pay. So I’d probably say if you’re going to go into journalism, do financial journalism.
And in finance, again, in my view, I went into finance, as I say, almost cynically. It actually then became a calling for me because I actually turned out to be genuinely interested in finance and finance history. People are drawn into finance because people are paid better. And we’ve had the financial sector growing and the markets rising. If we’ve reached a cusp, and the market is going to be not raising in the future, then actually that sort of (inaudible) that you earn from finance is perhaps not going to be there.
And I suppose if I was sort of recommending, so when I said they want to get into investment finance, I would say, are you sure your talents can’t be used more beneficially elsewhere? Because if you think you’re just going to enter into this sector because you’re going to be paid 5 to 10 times more than anyone else, than the average, then I wouldn’t be sure that that’s going to be the case going forward.
RITHOLTZ: And our final question, what do you know about the world of speculation, bubbles, interest rates today you wish you knew 30 or 40 years or so ago when you were first starting out?
CHANCELLOR: Like, I didn’t know any. I mean, I didn’t know anything then. I mean, it’s — look, we’ve been living through the most extraordinary period. I used to think the dot-com bubble was amazing.
RITHOLTZ: It was until we supersized.
CHANCELLOR: No. And then I thought why wasn’t the security, subprime securities? That was extraordinary. And then we had the pandemic, everything, bubble. And we have lived through the most extraordinary period in the history of finance. I had no idea that that was going to be the case when I started my career.
RITHOLTZ: Absolutely fascinating. Thank you, Edward, for being so generous with your time. We have been speaking with Edward Chancellor, author of “Devil Take the Hindmost” and “The Price of Time: The Real Story of Interest.” If you enjoy this conversation, well, be sure to check out any of the 450 or so conversations we’ve had previously. You can find those at Spotify, iTunes, Bloomberg, YouTube, wherever you feed your podcast fix.
We’d love your comments, feedback and suggestions. Write to us at email@example.com. Sign up for my daily reading list @ritholtz.com. Follow me on Twitter @ritholtz. I would be remiss if I did not thank the crack team that helps us put these conversations together each week. Sarah Livesey is my audio engineer. Atika Valbrun is my project manager. Sean Russo runs our Research. Paris Wald is my producer.
I’m Barry Ritholtz. You’ve been listening to Masters in Business on Bloomberg Radio.