The Price was Wrong, Ben! A Conversation on Interest Rate History

Chapters

 

00:00:00 Intro

00:00:35 Episode overview

00:02:31 Ed’s prescient publication timing

00:04:23 The correlation between low interest rates and speculation

00:09:14 The origin of interest rates

00:10:56 The shift to anti-interest sentiment

00:16:25 Defining the natural rate of interest

00:22:21 What the Fed has gotten right (and wrong) with their recent monetary policies

00:28:50 How to break the cycle of lowering interest rates

00:31:03 The merits of a central bank crypto currency (a digital Chicago plan)

00:36:17 Lightning round

 

Greg Dowling (00:06):
Welcome to the FEG Insight Bridge. This is Greg Dowling, head of research and CIO at FEG, an institutional investment consultant and OCIO firm serving nonprofits across the U.S. This show spans global markets and institutional investments through conversations with some of the world's leading investment, economic, and philanthropic minds to provide insights on how institutional investors can survive and even thrive in the world of markets and finance.

Greg Dowling (00:35):
The FEG Insight Bridge is delighted to host best-selling author and renowned financial historian Edward Chancellor. Ed will share his thoughts from his latest book, The Price of Time: The Real Story of Interest Rates, which made the Financial Times' Shortlist for Business Book of the Year. He is also known for his best-selling book, Devil Take The Hindmost, and before becoming a full-time author, Ed was a member of GMO's asset allocation team and started his career in merging banking at Lazard Brothers. On today's podcast, Ed will take us on an epic journey through time. We'll hear about the evolving philosophy, debate, and controversy surrounding interest rates--from the time of the Babylonians to the current unconventional central bank policies of today--to better understand the role interest rates played in the tulip bubble to the Silicon Valley Bank collapse. Time is money, so spend it wisely by listening to this podcast.

Greg Dowling (01:36):
Edward, welcome to the FEG Insight Bridge.

Edward Chancellor (01:39):
Well, thanks for having me.

Greg Dowling (01:41):
Well, before we get started, would you mind briefly introducing yourself?

Edward Chancellor (01:45):
Okay. I'm a financial historian, financial journalist, investment strategist, former investment professional with GMO in Boston, and the author of three books--and two books that I've edited, so I suppose five in all.

Greg Dowling (02:01):
Well that's great. A big shout-out to GMO, because one of your former colleagues was able to connect us, so I do appreciate that. We're going to talk a lot about your books and probably spend the most time on your recent book, The Price of Time. Speaking of time and timing, the time that you write your books, the timing of which you have, is sort of prescient. You wrote Devil Take The Hindmost and the Price of Time right before different bubbles here in the globe--and especially in the U.S.--popped. How do you come up with your ideas for your books?

Edward Chancellor (02:33):
First of all, I'd say about timing, it's largely fortuitous. I have a naturally bearish nature and as you probably know, they say that the bull market doesn't end until the last bear has capitulated. So the bears tend to be very, very early. But the advantage--if you're writing a book instead of shorting a stock--is actually the process of writing a book and then getting it published is quite a long time, particularly as I research my books very heavily. The first book I wrote, Devil Take The Hindmost: A History of Financial Speculation, I think I started on that in '94 and a friend of mine who was a fund manager said, "Hey you've got to get this out now, you've got to get this out now. There's a bubble, it's about to burst," and that was until '95. And I said, "Well it may burst, but I've got--" I've just hadn't progressed far enough.

Edward Chancellor (03:20):
So I then carried on working away for the next few years, finished it in, I suppose in '98, and then it took publishers just under a year to publish. So that book came out just as the dot-com bubble was reaching its peak, but I started on the book six years earlier. If I'd been a bit speedier, I would've been far too early. The same is true of this recent book I've just finished. I started that book in 2015. It was about--and we'll talk about it--it was about the problems caused by the ultra-low interest rates and in particular the sort of "everything bubble" that was fueled by the low rates. Again, that just took a long time to come out. It's hard to believe it now, but when I handed that book into the publishers, the final draft, at the beginning of last year, 2022, the Fed funds rate was still at zero and the Fed was still conducting its quantitative easing strategy. I handed it to the publishers and I said, "You've got to market this as the first book of the next crisis." They didn't really know what I was talking about. But fast-forward nine months since the publication of the book, the world looks a different place.

Greg Dowling (04:23):
Taking your two books together, do low interest rates and speculation go hand in hand?

Edward Chancellor (04:28):
Yeah, I think so. I mean, the first book dealt with speculative bubbles in a very general way. For instance, I looked at how new technologies fuel speculative bubbles, and I have a chat on the diving bell mania--of these little submarines that we used for salvaging--of the 1690s, which is the first tech bubble. And we have the great arc of technology bubbles through to the dot-com bubble and then recently into these tragic SPACs, which are sort of continuing to implode. So that's one aspect. Then you have the irrationality of the bubble--the investor irrationality that's sort of underpinned by... I suppose I called the book Devil Take the Hindmost, was the idea that this was a greater fool game. If you could buy a stock or speculate into something, hand it on to someone, it didn't really matter that that stock was overvalued in a bubble.

Edward Chancellor (05:21):
And then, as those of us who have been in investment know, there's also this agency problem. The fund managers will continue going over the cliff like lemmings, but they daren't get out of a bubble too early. It's what my old boss Jeremy Grantham calls "career risk." Jeremy thinks the markets are largely driven by career risk. And there are other factors, changes in communications and so forth. These things are dealt with in Devil Take the Hindmost in a very sort of generalized approach. But when I started out thinking about this new book, I wanted to leave those other factors aside--technology, psychology, if you will, principal agent issues--and just focus on the question of monetary policy. Not monetary policy, interest rates and bubbles. And the easiest way to really explain that is, as we all know, those of us in investment, is to calculate current value by using a discount rates.

Edward Chancellor (06:12):
So if you take the discount rate down to a very low level, you're going to get a very high current value. Warren Buffet puts it quite well when he says that, "Interest rate is to valuation what gravity is to matter." If you remember, you know, there are various different ways of valuing the stock market, cyclically adjusted price, earnings ratio, that sort of thing, Tobin's Q. But the model that a lot of asset allocators use, and that the Federal Reserve actually encourages, is something called the "Fed model," which is just looking at the earnings yield on the stock market relative to the bond yield. So if the bond yield is brought down to a very low level, then you are going to get a high market valuation--or at least in the short run. Our view at GMO was always that the Fed model was not a reliable long-term indicator of value and that asset prices, stock markets mean reverted over periods of time, so that interest-based model for value in the market was not reliable in the long run.

Edward Chancellor (07:11):
But you can see how at various times it fueled bubbles. And in this current book, in one chapter--well, in a couple of chapters really, or perhaps more--I look at the various historical bubbles and show that they did tend to coincide with periods of abnormally low interest rates for that day. And you go back even to--I hadn't known this before I did this book, although I had a chapter on the tulip mania of Holland of the 1630s in my first book, when I was looking at this again, it just turns out that actually the 1630s in Holland were a time where interest rates appeared to have come down pretty sharply. It was shortly after, two decades after the establishment of the Wisselbank, the first central bank, European central bank.

Edward Chancellor (07:56):
Now, unlike the sort of modern central banks, the Dutch central bank actually only issued notes backed by gold. But apparently it was so popular with foreigners, the Wisselbank, it's paper notes were so popular, there was a huge inflow of foreign capital into Holland in the 1620s and in particularly in the early 1630s. So you can sort of see, you can't see very clearly, but you can sense that there was a monetary impulse to even the tulip mania, what we often consider to be the first-ever mania. Then in the rest of the book, I just, in a way, described that over and over again in different places. And then you end up, of course, with the lowest interest rates in history over the last decade, which gives you the "everything bubble," which Buffet's partner, Charlie Munger, says is the most extreme financial event in all of history. And as I say in the book, I think Munger was right. Those of us who've lived through... Look, we've lived through… I don't know when you started, but I've lived through from the dot-com bubble to the current day, and these really are the craziest financial markets, as far as I can see in my reading of history, that have ever been witnessed.

Greg Dowling (09:02):
I started right before the tech bubble, so I've seen a few. But it's funny that you say that. We talk about TINA, "there is no alternative," and it appears that acronym goes back in time. You could use that and apply that to a lot of different times. I wanted to ask, as you were doing your research, when was the first time in history that there is a recording of interest being charged?

Edward Chancellor (09:22):
Well, as I mentioned in my book--and your listeners, if they're interested, they should get ahold of a copy of Sidney Homer and Dick Sylla's History of Interest Rates. But in that book, in the History of Interest Rates, that records the earliest interest rates in ancient Near East in Mesopotamia going back to the third millennium BC. But they also point out, one finds it in other writings that the earliest words for interest in these ancient languages almost invariably is linked to words relating to the offspring of cattle, sheep, or goats. What that suggests is that early pastoral farmers, the ones who took over from the hunter gatherers, were lending each other livestock and probably grain too, and were charging some interest on their loans. So I would say this would seem to be long before definitely [laughs] millennia before the invention of coinage. I say that Babylonians were lending an interest before they'd discovered the wheel and that sort of thing. So it's very, very old, interest. And as you know, it's not just serving an economic function, but it appears to be ingrained into human psychology that because the future's uncertain, because we're mortal, because there's a risk associated in getting something in the future, because we're naturally impatient, we will always put a lower price on something in the future than we can have today. So you might say that interest is hardwired into us in the same way that language is hardwired into us.

Greg Dowling (10:56):
In your book you talk about the early origins of interest and being agrarian in nature, but then you go more to some of the--gosh, I think of some of the philosophers, the Ancient Greek and Romans, through early Christendom where interest is this bad thing. You talk about Aristotle saying that, "Money is barren, money shouldn't create money." Even in literature, Shakespeare, you think about Merchant of Venice, Shylock. They're painting it with this horrible brush. So how did we get into this?

Edward Chancellor (11:25):
If you remember, I say that some of the greatest figures in history, you know, [inaudible], Thomas Aquinas, Saint Augustine, or the great philosophers, Aristotle, have all been against interest, but so was Hitler.

Greg Dowling (11:38):
[laughs]

Edward Chancellor (11:38):
You can take your pick.

Greg Dowling (11:39):
Fair enough. All right, fair enough.

Edward Chancellor (11:41):
And Marx. It's sort of good and bad to be anti-interest, let's say you're in mixed company. I think the problem with interest in an early agrarian economy that is not growing, in other words it has no compounding of economic growth, is that it's very easy for interest charges to run out of control. The Babylonians had a word for compound interest, "mash-mash," a mash being a kid goat. It was a sort of kid goat on a kid goat. And they even, as I say in the book, they even actually calculated compound interest. But what we can see in the Babylonian period that the first laws, Hammurabi’s laws, were actually restricting the amount of interest that could be charged and giving certain periods for letting people off their interest. For instance, if there was a flood or a rainstorm, then the farmers didn't have to pay interest on their loans.

Edward Chancellor (12:33):
So there is always--and I think it's legitimate that one should have concerns about excessive charging of interest in an agrarian society. That led, in the ancient world, to people falling into debt and slavery. And we get debt bondage today in parts of the world where the interest charge is very high lent to peasant farmers and so on. So that's a legitimate concern, and you find these prescriptions against interest in the Bible and in Islam. However I take issue with Aristotle where he says, as you mentioned, that money was not created to make money from money but to be used in exchange, because that's not really an accurate description of what we do when we make a loan. Because when we make a loan we are transferring some purchasing power over a period of time.

Edward Chancellor (13:30):
The person you make a loan to can use that money, that purchasing power, to do something that's beneficial to them. They could, for instance, buy a house and rent the house out, or they could use the money to finance a commercial venture. And there is this period of time that takes place. So Aristotle ignores the dimension of time on a loan. If you were to make me a loan and to simultaneously demand back more than you'd given me, that would seem to be an unfair or an oppressive transaction. But if you were to make me a loan and to say, "Can I have the money back in five years' time with a certain percentage interest?" Well that would seem probably more reasonable, because I could do something with your money in the interim.

Greg Dowling (14:12):
So we have that, and then it seems like when we go into more of a mercantile society that there's still stigma against interest rates, but everybody's getting around it by shaving coins and doing funny things. So even in the Middle Ages there's still some issue regarding the charging of interest.

Edward Chancellor (14:30):
The Catholic Church ban on usury continues into the 16th century into the Reformation period. But it breaks down, because from what the 13th century onwards, the Italian merchants are trading abroad, funding these trips abroad trading right across Europe. They're using credit and bills of exchange to finance themselves, and in those bills of exchange is embedded and hidden an interest charge. In the Medieval world, they were wonderfully smart at getting around the ban on interest. Sometimes it was a gift and sometimes the interest was embedded in a currency transaction, and so forth. I think even probably in the Babylonian period where there were restrictions on interest, there was also ways of evading the interest rules. One of the things I take away from that, which is sort of relevant to the current day is that what we call "regulatory arbitrage," getting around financial restrictions, is almost as long-established a practice as interest itself, and there is no way you can regulate and ban the charging of interest in sort of medieval societies or theocracies.

Edward Chancellor (15:35):
In a modern world, and this is the point I make towards the end of the book, there's no way... However many financial regulations you create, those regulations will not be robust when the rate of interest is extraordinarily low and there are profits to be had from taking certain types of risk. Frankly, what we've seen in the last nine months, the blowup of the UK pension fund, a blowup of the crypto world and subsequent recovery, and the collapse of the regional banks, Silicon Valley Bank--regulation can't restrain interest, and regulation can't restrain risky practices induced by extraordinarily low rates.

Greg Dowling (16:13):
Well if you think about it--think about the Bank of Medici, right? The Medici basically built an empire on regulatory arbitrage and they also financed a lot of great paintings. So there's some benefits to wealth and wealth creation. So we go past this period of time in your book where there's this argument about whether there should be interest and we move on, and then it's about what is the appropriate level of interest, and you talk about John Locke and others. What is the natural rate of interest? I guess in today's time we would call it like r-star, but what is that?

Edward Chancellor (16:44):
I didn't put it in the book, but I was talking to a friend of mine, a German economist called Thomas Mayer who used to be the chief economist at Deutsche Bank. He says there was something called the Salamanca School of Economists in the 16th century, where one of their leaders said, "The real rate of interest is known only to God." So it is problematic what the natural rate of interest is. I've really come down to sort of two views on the matter. One is, I think this in a way is a simple one, is: "What would the rate of interest be in a world in which the supply of money was somehow constrained?" In other words, you didn't have banks just creating money out of thin air through their loans, or we didn't have central banks expanding their balance sheets and creating money that way. But in a world in which money was constrained, then the rate of interest would really be the, as I call the book, the price of time, the price people were charging for time.

Edward Chancellor (17:34):
And that would depend on the supply of loanable funds and the demand for those funds. The supply would be linked by the amount of savings, and the amount being charged would be linked to people's impatience, or what you call "time preference." The amount paid would probably link to the return on capital, the marginal return on capital or productivity of capital. And I think when I start discussing arguments for lowering interest in the 17th century in England, the problem then was that the English still retained usury laws that allowed lending but capped the maximum charge, and there were... In the 17th century... There is nothing new under the sun. In the 17th century, big business and large landowners, aristocrats, they always wanted lower interest. The aristocrats because they'd mortgaged their lands and the business people because they were conducting their business activities with lending and they're also using loans to buy back shares and so forth, just like they're doing today, so they wanted lower rates.

Edward Chancellor (18:35):
The great English philosopher John Locke made an argument in this pamphlet that I came across written in the 1690s called On the Consequences of the Lowering of Interest in which he argued that the rate--that interest shouldn't really be legislated against, that it should be a natural price. And a natural price in 17th century language is one which is found, so to speak, in the market. So that is, to my mind, what the natural rate is. But what you were alluding to earlier, r-star, is the economist’s theoretical natural rate of interest in a state of equilibrium. And that may or may not exist. It slightly depends on whether you actually believe in the concept of the economy as an equilibrium. One of the problems, as far as I understand, with the notion of equilibrium is it doesn't have a time dimension, and if you don't have a time dimension you can't really have interest.

Edward Chancellor (19:25):
So that's the theoretical aspect, the modern theoretical aspect of the natural rate of interest. Now, you can either sort of take that or leave it. I say you're never going to know what the natural rate of interest is, and as you know, I argue in the book you can't really just discover it by whether the fact prices are rising or falling. But there are a number of things you can look to. As I say, if you see asset prices far above their normal level, if you see rates of leverage far above their normal level, if you see people taking large amounts of financial risk, and even actually if you see inequality increasing very rapidly, these are all signs that the rate of interest is probably below where it ought to be [laughs]. People say, do I believe in the natural rate of interest? I say it's like Goldilocks and the three bears, you don't want it too hot--everyone knows that--where you're too high, but you don't want it too cold either. You just want it somewhere in the middle.

Greg Dowling (20:18):
It's funny how we have all of these PhDs out there that are trying to get very precise, and when you get too precise, you're precisely wrong [laughs]. It's really hard to control this.

Edward Chancellor (20:28):
Yeah, but one of the reasons I wrote the book was not just that they were being precise about interest, but academic economists, monetary policymakers, central banks had concluded that you could discover the natural rate of interest simply by the presence or absence of inflation or deflation, so as long as you were hitting your interest rate target of 2%, then you'd come across the right rate of interest. I didn't think they had any real view or deeper insight into the nature of interest than that. And if you look at history and look at the history of economic thought, you realize, actually, that there's a huge amount of literature on the question of interest, and you quickly realize, and I outlined them in the book, that interest as a lever to control inflation is probably one of 7 or 8, possibly 10 different functions of interest, and possibly one of the least important [laughs].

Edward Chancellor (21:18):
The other ones, we've already discussed this question of valuing assets, discount rate, interest obviously affects the allocation of capital, your payback rate for investments, and it affects the amount you save. It affects, as we've already mentioned, your risk preferences or the amount of risks you are likely to take. It has all these other different functions, and I think that that was really lost in modern academic thinking of interest. Those of us who work in the investment world are obviously much more aware of it. I've noticed since my books published--the investment community, my book speaks to their understanding of what interest is and the harms done by the very low interests. Whereas, I think the academic world just says, "Hey what's this? Just some screaming polemic," [laughs] and don't bother to open the book. So as you know, we live in a different world from the academics. Jeremy Grantham was saying to me the other day that when he used to hire economics PhDs at GMO, he said it would take him two years to un-brainwash them.

Greg Dowling (22:17):
[laughs]

Edward Chancellor (22:17):
So that they'd start seeing the world as the rest of us see it.

Greg Dowling (22:21):
So let's fast-forward to modern times and talk a little bit about the Great Financial Crisis. At the helm of the Federal Reserve was Ben Bernanke, who studied the Great Depression and all of the monetary tools that were used and not used. From that point on, we kind of passed the baton to Yellen and now to Jay Powell. During this period of time, in your opinion, what did they get right and what did they get wrong with their unconventional monetary policy?

Edward Chancellor (22:50):
I mean, we could take this argument back a bit further to how we got onto this series of bubbles.

Greg Dowling (22:55):
You could almost start at Greenspan, right?

Edward Chancellor (22:57):
People will debate when Greenspan started inflating the bubbles, but I think everyone who thinks about it would definitely agree that the Fed's intervention with the collapse of the long-term capital management in September '98 when the Fed cut the Fed funds rate, I think it also supplied some liquidity to the market. And then you've got the sort of final run-up in dot-com boom. Anyone who was short tech stocks in late '98-99 got completely hammered. And then you had your dot-com bust. And then after the dot-com bust, Bernanke had just arrived at the Fed, 2001. He was an arch anti-deflationist. He said, "We think that deflation is around the corner.” That argument was used to take Fed funds rate down to 1%. Now, with the Fed funds rate at 1%, you see the U.S. house prices start to take off, and in a rather complicated way. With the Fed funds rate very low, a lot of dollars actually went out to places where higher yields and returns were on offer in other parts of the world.

Edward Chancellor (23:53):
China for instance. And because the dollar's standard was sort of being manipulated, these dollars actually came back, they boomeranged back to the U.S. But that sort of brought down long-term U.S. rates. So you had low short-term rates and then low long-term rates, and you've got this great housing bubble. Then the housing bubble burst and then it took roughly two years between the downturn and the housing bubble and the blow-up of Lehman Brothers. Then we were in a bad place. If you remember, those of us in the investment business were wondering whether our brokers were going to go bust or our prime brokers were going to go bust. So it was sort of harried times. Unemployment was rising pretty rapidly, got up I think to around 10% in the U.S. And what we can say is that the interventions that central banks supported by fiscal policy served to prevent a debt deflation from emerging, a debt deflation spiral.

Edward Chancellor (24:47):
The stock market, if you remember, sort of bottomed in February '09 and came back pretty sharply. Unemployment lingered relatively high but gradually came down. So the main argument--you're going to say, "What did they do right?"--is that they prevented another Great Depression. That's the argument of those who still support the Fed's policy. A month or so ago I had a debate with the chief economist at the Financial Times, Martin Wolf, who's a big supporter of Bernanke and doesn't really like my book. His argument is that I ignore that, which I don't think I do. He seems to think that I want, or people like me who are critical of the ultra-low rates wanted very high levels of unemployment. But what my book is focused on is: what were the consequences of these ultra-low rates?

Edward Chancellor (25:34):
And, as I say, when you've got the asset levels, buildup of debt, the risk-taking, the pensions crises, I argue that low productivity from the misallocation of capital in zombie companies is linked to the ultra-low rates. I argue that the growth of inequality is actually, to a large extent, linked to the very low interest rates. Those of us who've worked in finance know that in the end, your year-end bonus is a sort of derivative or two from the level of the stock market, which, however hard you've worked, you haven't really done that much [laughs] to determine. And that's likewise true of senior executives who are paid in stock options or equity-based compensation. So I argue that you've got this inequality, and out of the inequality you actually then have populism and discontent. In particular, intergenerational discontent, because the older people who own their houses and have assets and who already saved for their pensions do well.

Edward Chancellor (26:29):
If you're starting out in life and house prices are way more expensive relative to your income than they were in the past and asset prices are so high and bond yields are so low that it's going to take you a much, much longer period to build up a retirement nest egg--if you can do it at all--then it's not surprising that there is a bit of resentment and the end sort of feeds through into a sort of anti-capitalism. It's difficult to tally. I argued to Martin Wolf that, yes, unemployment was restricted, let's say in 2009, 2010, but do we know that it hasn't just been pushed off to some time in the future? Because now inflation is in the system, and historically, getting that inflation out of the system is associated with a large number of bankruptcies and a large amount of unemployment. And the inflation, although the central bankers deny it until they're blue in the face, everyone else on the planet knows that the inflation is primarily caused by the combination of the low rates and the quantitative easing.

Edward Chancellor (27:29):
So have they just not deferred the unemployment from those who might have gone unemployed in 2009, 2010 for some later date? And is that a useful thing? I'm not saying that the Great Depression was a bed of roses, it was actually the short, sharp shock. Yes, you've got 25% unemployment, nearly 90% of the stock market and thousands of banks bust. But again, you've got a recovery, so that by--I'm saying 10, 11 years after the '29 crash--U.S. GDP growth was back on its pre-crisis trend. The Great Depression was really a bad memory, but it didn't permanently alter the wealth of the United States, the wealth and incomes of the United States. Whereas, as you know, since 2009, our productivity growth has actually dipped and continued to go down. I don't know how it stands like for like, but certainly the 10-, 15-year GDP growth of the U.S. from '29 to say '44 will have been better than what we've just been through. Although what we've been experiencing... At some level, has the current outcome been not as optically bad, but in some ways worse for the economic and financial system as a whole?

Greg Dowling (28:43):
You know, it reminds me of Schumpeter and creative destruction. You kind of need that for capitalism, otherwise you have moral hazard. I worry--and I was going to ask you this question--is that every response to every crisis is just lower rates, and so therefore we just stumble from one bubble to the next. How do we get out of this?

Edward Chancellor (29:02):
Well, in the book I have a chart that shows U.S. household net worth with data provided by the Federal Reserve. If you look at, say... They have the data going back to 1952, and you can see that in the last 30 years we've had these series of bubbles as evidenced by trend growth and household net worth, little mountain peaks. But the most recent bubble, the so-called "everything bubble," is a much, much bigger wealth bubble than the U.S. real estate bubble. Pretty frothy markets at time, but nothing like we saw recently. And then it's a much, much bigger bubble in aggregate than the dot-com bubble. I show that chart with the Fed funds rate over the course of the cycle, each time going lower and lower. So I think the bubble bursts--it may already have burst. A bubble bursts when the authorities lose control of inflation and no longer have these monetary tools---i.e., lower interest rates or QE or various other tricks that they have in their bag to manipulate the markets onward, higher.

Edward Chancellor (30:05):
We're definitely not completely there yet because you see central bank interventions in the last year, last eight, nine months being relatively successful. The Bank of England came and intervened in the gilts market when the UK pension funds were going bust, and that brought gilt yields down. More recently, the Fed has put a safety net under the U.S. banking system and the FDIC has insured all deposits. But you know, inflation's not completely under control, it could easily be quite volatile going forward. So the question is that at some stage the central banks may find that their capacity to ensure the system has worn thin, that they've lost their credibility. I think that is probably where we're heading because, as you say, we know that they will--if given the opportunity--underwrite risk. And as you say, the underwriting of risk leads to moral hazard that leads to more risks being taken. You do escalate these things until you get to a point where they're a bit too big to control.

Greg Dowling (31:03):
In your book, sort of at the end, you talk a little bit about digital currencies. It seems a bit optimistic, so I wanted to talk to you a little bit about that. I can see your point, but I also can see the point of manipulation and control.

Edward Chancellor (31:15):
You mean the central bank digital currencies?

Greg Dowling (31:18):
Yes.

Edward Chancellor (31:18):
Well actually, I've got a piece out on that today. I've written a piece for my Reuters column which came out earlier today which is elaborating actually the last paragraph of the postscript of the book. This friend of mine who I mentioned earlier, Thomas Mayer, the former chief economist of Deutsche who now runs a German economic think tank, he came up with this idea a few years ago that a central bank digital currency could be arranged upon the same lines as the so-called Chicago plan of the 1930s. And what that means is that with the Chicago plan, which was devised by several Chicago economists, Frank Knight and--I don't remember who the other ones are--George Stigler, and also by Irving Fisher at Yale, the idea of the Chicago plan is that banks are engaged in fundamentally risky activity.

Edward Chancellor (32:06):
They create money through their acts of lending, they borrow short and lend long, and they're highly leveraged. When the banks get into trouble, then not only do they go bust, but that has a contagious effect on the rest of the banking system, and then the money supply starts to contract and you get this downward deflationary spiral. The solution put forward by Frank Knight and his colleagues, one was called Henry Simons, was that the cash deposits in the banking system should be backed entirely by short-term government debt, non-interest bearing, and that the banks shouldn't be allowed to lend out their deposits, since what would be left for banks would be much closer to what we'd see as a sort of credit fund. A bit like what Apollo does, for instance. Anyhow, so Thomas' insight was, "Hey these central banks are planning a central bank digital currency and you could actually have the central bank digital currency as the backing for all deposits in the banking system."

Edward Chancellor (33:03):
It would be the only form of cash, so to speak. You can still have printed bank notes. The advantages of that are severalfold. First of all, you end Silicon Valley-style bank runs. You're not going to have a bank run. Who's going to have a run on a bank when it's just a custodian of your state money? The state money itself then would increase by a certain amount each year. That would then bring inflation under control, because it would be like a sort of better version, if you will, of the gold standard. You could build in a certain growth and control inflation. And one of the advantages, if you flipped from our current system to the system advised by Thomas, what I call the sort of “digital Chicago plan,” is you could actually convert a lot of the government bonds into the backing for this new state money.

Edward Chancellor (33:46):
And that would actually in effect roughly halve the national debts. It doesn't halve it on a balance sheet basis, but the actual debt interest payments would decline. Now, as you know, central banks, governments have ratcheted up their debt, in part because interest rates are too low. Needless to say that politicians took advantage of that by spending money like water. So now they're left with too much debt and the interest payments on that debt's rising very rapidly. At the same time, central banks are sitting on all these bonds that are losing money and the banks are sitting with reserves with the central banks, and no one knows how to deal with this. They've got themselves into a really deep problem. I do think that Thomas' central bank digital currency plan, or say the updated Chicago plan, would get you out of it.

Edward Chancellor (34:31):
I don't think they'll do it, because there are a lot of vested interests. There is one particular aspect of this idea which I like. It goes back to what we were saying earlier. If under this new plan, under sort of a digital Chicago plan where you have a restricted money supply that is a liability of the government and it only increases by a small amount every year, then the rate of interest being charged on a loan is actually the difference between the supply and demand for loanable funds. It would discover the rate of interest. So we wouldn't--the central bank would no longer be in charge of setting the interest. I wouldn't want a job at the FOMC. I mean, would you? Does anyone know what rate of interest to charge? The rate of interest, as I say in the book, is the universal charge. It's an omnipresent phenomenon. And as I was saying earlier, only God--

Greg Dowling (35:18):
[laughs]

Edward Chancellor (35:19):
--knows the rate of interest. So you see my idea that if this were to be realized--and it's just, I admit it's not going to go ahead because we know our policymakers prefer to patch up a system that is failing rather than address its underlying flaws. But you can see that if it were done just as sort of a thought experiment, you would then discover what the rate of interest was. Irving Fisher, he said, “You wouldn't have inflation or deflation, you would have individual failures but they wouldn't be contagious and the oscillations of the business cycle would probably be less severe.” So look, Keynes says somewhere, "The difficulty is not having ideas, but persuading other people of their benefit." I started writing about finance 30 years ago, and initially I thought, "I've got this idea, I'll put it out, perhaps someone will take it up." I was quickly disabused of the notion that anyone would actually pay any attention to anything one said, or certainly weren't going to act on it. But still, one therefore has to have ideas just for their own self-satisfaction.

Greg Dowling (36:17):
A couple last questions for you. So one--maybe so I can short this--any topics for your next book?

Edward Chancellor (36:22):
Well I'm helping my old boss Jeremy Grantham write his memoirs. That's already taking up some of my plan. The stuff I've just been talking about, about the digital Chicago plan. I was talking to Thomas Mayer, I do think it's worth putting into a short book or pamphlet. Because one of the criticisms of my book, which I--you know, not valid [laughs]. But one of the criticisms in my book was a sniffy review said, "Chancellor spends hundreds of pages writing about the evils of the outlay rates but devotes no time whatsoever to what the solution might be.” But you were a sharp enough reader to see that actually, there was a little sort of glimmer of light in the last paragraph. So I think it might be worth my while to elaborate that little glimmer of light into a short book as a sort of postscript, if you will, to this current book.

Edward Chancellor (37:12):
I've been doing a lot of work on inflation. One of the things that strikes me is for the last 25 years, the economists didn't understand anything about bubbles, so we had the great dot-com bubble; they didn't understand anything about credit, so we had the Global Financial Crisis; they didn't understand anything about interest rates, so the whole world went [inaudible]; and then finally, we can see that they don't really understand anything about inflation either, which is extraordinary. Normally, as I said to you earlier, I normally start on a book long before the question is flagged. However, over the years I have done a lot of inflation work, so it's conceivable. And there are some quite good books on inflation, but nothing that I find completely a100% satisfying, which for me is why you want to write a book. You obviously want to write a book as someone who has got there first. So perhaps I've sort of got inflation on the back burner too.

Greg Dowling (38:02):
There are books on interest rates, but many of them are written almost like a textbook. Yours is much more readable. It's more of a history book. And boy there are some amazing characters. We didn't have time to talk about it, but one of my favorite historical characters and bubbles is in France, the Mississippi Land Company. I mean, unbelievable. It's worth buying the book just for reading that. And then there also are books dedicated to that. But lots of great stories in there. Other than buying your book, which should be available on Amazon and all the normal places, where else can they get more Edward Chancellor, where else do you post?

Edward Chancellor (38:36):
Well, I'm not really a poster. I mean I don't do social media. But I write a column for the Reuters Breaking News, which is on the Reuters website. Also on Breakingviews, which is a commentary service, and I do podcasts [laughs].

Greg Dowling (38:50):
[laughs]

Edward Chancellor (38:50):
And I write here and there. I write for odd places. I've just written a long piece for the New York Review of Books and another piece for the Times, so I suppose look around. But it's Reuters where I was a sort of founding member of the team at Breakingviews in 2000, which was a financial commentary site. I've been writing for it ever since.

Greg Dowling (39:09):
I'm going to ask you a very, very difficult question, and you've got to just answer with one. What is your favorite non-Edward Chancellor book?

Edward Chancellor (39:17):
In finance?

Greg Dowling (39:18):
It can be finance. If you want to do one in finance or one that's outside of finance, that's okay. But one.

Edward Chancellor (39:22):
When I started out writing the history of finance economics, I met Kindleberger, who was then in retirement living outside Boston. I do think his Manias, Panics, and Crashes is very good. I have to warn your readers, it's been rewritten by a fellow called Aliber and it just has none of the actual intellectual incisiveness, wit, and dryness of the original. I do think if you go back and get an early edition of Kindleberger, that's pretty good. The other person who I am a disciple of is James Grant. I first read his stuff roughly 30 years ago, and I knew that I was intellectually hardwired in exactly the same way as Jim. And you know, Jim's written lots of great books. His first book, Money of the Mind, which is sort of a history of credit in the U.S. 19th and into the 20th century.

Greg Dowling (40:09):
You seem like you would be kindred spirits in that you're both really good at rediscovering or reintroducing a lot of financial history and why it's relevant today [laughs]. With Jim Grant, you'll hear about the Coinage Act of 1962 or 1774. It's great.

Edward Chancellor (40:26):
I once said to my wife, "Why does Jim Grant write more amusingly--

Greg Dowling (40:31):
[laughs]

Edward Chancellor (40:31):
--finance than I do?" And she said, "Perhaps he understands the subject better." [laughs]

Greg Dowling (40:36):
[laughs] That's great.

Edward Chancellor (40:37):
Only a wife would tell that to you.

Greg Dowling (40:39):
Only--or your kids, that's another source of brutal honesty. Edward, thank you so much for this. Anybody who's listening and wants more, go buy the book. It's very readable. And I know I will buy Grantham's memoirs written by you. He's one of my favorites.

Edward Chancellor (40:54):
Co-written.

Greg Dowling (40:56):
[laughs] Co-written. Thank you so much for this. We appreciate it.

Edward Chancellor (40:59):
Greg, thanks a lot.

Greg Dowling (41:01):
If you are interested in more information on FEG, check out our website at www.feg.com, and don't forget to subscribe to our communications so you don't miss the next episode. Please keep in mind that this information is intended to be general education that needs to be framed within the unique risk and return objectives of each client. Therefore, nobody should consider these to be FEG recommendations. This podcast was prepared by FEG; neither the information nor any opinion expressed in this podcast constitutes an offer or an invitation to make an offer to buy or sell any securities. The views and opinions expressed by guest speakers are solely their own and do not necessarily represent the views or opinions of their firm or of FEG.