The interest rate crisis has only just begun - financial historian Edward Chancellor
Big picture stuff
Edward Chancellor recently released a book, the Price of Time, which is all about interest.
For all of recorded history there’s been a record of interest.
He argues that the story of interest is the most important story in finance.
After 2008, interest rates went close to zero, and in some places negative. This had never happened before and we’re yet to see the effects.
The problem with low or negative interest rates is they discourage savings, and encourage spending today (because you can’t get a decent return on holding your money).
After 2008 we saw the lowest productivity growth in the UK since the Industrial Revolution.
Interest rates are effectively the price of time. They allow you to borrow money that you can use into the future, like your mortgage for 30 years. If you didn’t have interest rates you couldn’t do that.
He argues that the reduction of interest rates post 2008, temporarily stemmed the flow of the consequences of the financial crisis. But now that we’re in a new interest rate environment (a much more normal one) we’ll start to see the 'biblical response' that got staved off.
How interest affects the world
You can think of interest rates a bit like a force which holds many financial instruments and institutions in orbit - like gravity and planets.
For example, the housing crisis in this country is at least part fueled by interest rates (rather than just supply) because people could afford to borrow more in the last 15 years, so they paid more, so prices went up.
Mortgage debt relative to income is 2.5x higher today compared to the 1980s and 90s.
Interest rates are to valuation of companies what gravity is to matter (said Warren Buffett).
When interest rates are low it helps bad businesses stay in business because they can remain propped up by borrowing - also known as zombie firms.
And of course central banks can use interest rates to try to control inflation.
But, since Sterling moved off gold in the last 90 years, it’s lost more than 99% of its value versus gold - so Edward argues that controlling inflation has been a disaster.
He also explained that the relationship between interest rates and inflation isn’t clear or linear. It’s not like a switch that central banks can flick. It’s very crude - and often they can create a virtuous circle where they feed each other rather than cancel each other out.
Interest rates are a blunt tool to control inflation. He thinks higher rates actually control inflation by smashing an economy - rather than a direct link.
Interest and the rich and poor
When interest rates are low, people who have assets grow wealth because it fuels borrowing on assets (like homes) which inflates the prices of those assets (as we’ve seen in the UK property market).
Plus, richer people can borrow at low rates and invest it - compounding growth.
By contrast, poorer people, who don’t have the assets - and keep more of their money in cash as a percentage of their wealth - get low interest rates on their cash savings so don’t benefit from growth.
Plus low interest rates drive pay day loans, also hurting the poor.
Edward has a view on 'good' inequality - basically, if you do something that adds value to society, it’s not just fair that you should get a share of that but also important so people innovate.
By contrast, 'bad' inequality comes about when you’re not creating real value, like monopoly power, or just benefiting from asset growth in a low interest rate environment without anything genuinely additive happening.
