Edward Chancellor, Author of 'The Price Of Time', discusses the functions of interest rates, misallocation of capital, heroes and dogmatism in finance, consequences of low interest rates such as rise of corporate monopolies, and the future of the market rate of interest and financial repression.
Interest rates serve multiple functions beyond controlling inflation, acting as an inducement to lend and preventing hoarding, while also being used to value financial assets.
The distortion of interest rates as manipulation tools by central banks has consequences for the allocation of investments, capital, and resources, leading to asset price bubbles, credit booms, and a need to review inflation targets and the functional role of central banks.
Deep dives
The multifunctionality of interest rates
Interest rates serve multiple functions, beyond controlling inflation. They act as an inducement to lend, preventing hoarding, and are used to value financial assets. Low interest rates discourage lending and create financial absurdities, as seen in the spikes of speculative assets. Central banks have been distorting asset prices and misallocating capital, as admitted by central bankers themselves, leading to risky financial engineering.
The need to reconsider central banking
Central bankers' actions, driven by narrow mandates and narrow-minded dogmatism, have led to asset price bubbles and credit booms. The distortion of interest rates as manipulation tools by central banks has consequences for the allocation of investments, capital, and resources. There is a growing need to review inflation targets and the functional role of central banks. The responsibility lies not just with central banks, but also with politicians and society at large to hold them accountable.
China's misallocation of capital
China's history of financial repression and rigid control of interest rates has contributed to massive misallocation of capital. The import of easy money and low interest rates led to a boom in investments, real estate, and credit, resulting in a misallocation of resources on an unprecedented scale. Market-imposed interest rates reflect trust and lending confidence, with property rights playing a crucial role in determining interest rates. Any undermining of property rights can lead to a lack of trust and reluctance to lend, resulting in higher interest rates.
The link between interest rates and human behavior
Interest rates play a role in influencing human behavior and have consequences beyond inflating asset price bubbles. Low interest rates stimulate speculative behavior and encourage reckless investments, creating opportunities for fraudulent activities and market manipulations. Higher interest rates discourage speculative markets and incentivize more cautious, long-term investments. Interest rates also have moral implications, shaping the quality of human behavior and trust in financial systems.
All economic and financial activities take place across time – and interest coordinates those activities. The story of capitalism is thus the story of interest: the price that individuals, companies and nations pay to borrow money. Edward Chancellor could barely have chosen a more topical moment to publish a book about the history of interest rates (The Price Of Time), and host Russell Napier opens this fascinating interview by asking him if one of the problems that economies face is that interest rates are expected to perform too many functions.
(Note to listeners: Edward's first answer is accompanied by some effusive birdsong and traffic noise, but the quality improves thereafter.)
For more information on the Advanced Valuation in Financial Markets course mentioned by Russell, please see www.didaskoeducation.org.
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