# The Price of Time  ## Metadata - Author: [[Edward Chancellor]] - Full Title: The Price of Time - Category: #books ## Highlights - Bastiat was having none of this. Interest wasn’t theft, he maintained, but a fair reward for a mutual exchange of services. The lender provides the use of capital for a period of time, and time has value. Bastiat cites the famous lines from Benjamin Franklin’s Advice to a Young Tradesman (1748): ‘Time is precious. Time is money – Time is the stuff of which life is made.’ ([Location 408](https://readwise.io/to_kindle?action=open&asin=B09NS1CZ7W&location=408)) - Tags: [[blue]] - Bastiat foresaw disaster if Proudhon’s plans were put into practice. If lending were not rewarded, there would be no lending. To restrict payments on capital would be to abolish capital.11 ([Location 415](https://readwise.io/to_kindle?action=open&asin=B09NS1CZ7W&location=415)) - Tags: [[blue]] - In the sphere of economics, a habit, an institution, or a law engenders not just one effect but a series of effects. Of these effects only the first is immediate; it is revealed simultaneously with its cause; it is seen. The others merely occur successively; they are not seen; we are lucky if we foresee them. The entire difference between a bad and a good Economist is apparent here. A bad one relies on the visible effect, while the good one takes account of both the effect one can see and of those one must foresee.16 The bad economist, says Bastiat, pursues a small current benefit that is followed by a large disadvantage in the future, while the good economist pursues a large benefit in the future at the risk of suffering a small disadvantage in the near term. ([Location 445](https://readwise.io/to_kindle?action=open&asin=B09NS1CZ7W&location=445)) - Tags: [[blue]] - He attacked what he called the ‘fetish’ of full employment. Schumpeter’s idea of ‘creative destruction’ must be allowed to operate unhindered, Hazlitt wrote, as it was as important for the health of an economy that dying industries be allowed to die as it was for growing industries to be allowed to grow.19 Hazlitt compared the price system in a competitive economy to the automatic regulator on a steam engine. Any attempt to prevent prices from falling would only keep inefficient producers in business. ([Location 460](https://readwise.io/to_kindle?action=open&asin=B09NS1CZ7W&location=460)) - Tags: [[blue]] - After the Lehman Brothers bankruptcy in September 2008, neoliberal economists implemented the anarchist Proudhon’s revolutionary scheme. Central bankers pushed interest rates to their lowest level in five millennia. In Europe and Japan, rates turned negative – an unprecedented development. The results were not as Proudhon anticipated, however. Rather, Bastiat’s grim forebodings about free credit appear closer to the truth. ([Location 476](https://readwise.io/to_kindle?action=open&asin=B09NS1CZ7W&location=476)) - Tags: [[blue]] - White suggested that the sharp decline in interest rates had encouraged households to spend more and save less. The downside of bringing forward consumption from the future, White suggested, was that people must in fact save more for any predetermined goal; ([Location 483](https://readwise.io/to_kindle?action=open&asin=B09NS1CZ7W&location=483)) - Tags: [[blue]] - The authorities believed that low rates would boost corporate investment. But White suggested firms were actually investing less. Furthermore, ultra-easy money was responsible for the misallocation of capital. Creative destruction was thwarted. ([Location 486](https://readwise.io/to_kindle?action=open&asin=B09NS1CZ7W&location=486)) - Tags: [[blue]] - Note: This is precisely the money burning that was going in tech - the industry that had the easiest time raising capital in an already low interest rate environment - By lowering the cost of borrowing, ultra-easy money provided an incentive for investors to take undue risks. ([Location 489](https://readwise.io/to_kindle?action=open&asin=B09NS1CZ7W&location=489)) - Tags: [[blue]] - This book is about the role of interest in a modern economy. It was inspired by a Bastiat-like conviction that ultra-low interest rates were contributing to many of our current woes, whether the collapse of productivity growth, unaffordable housing, rising inequality, the loss of market competition or financial fragility. Ultra-low rates also seemed to play some role in the resurgence of populism as Sumner’s Forgotten Man started to lose patience. ([Location 504](https://readwise.io/to_kindle?action=open&asin=B09NS1CZ7W&location=504)) - Tags: [[blue]] - The most encompassing view of interest is contained in the notion of interest as the ‘time value of money’ or, simply, as the price of time. ([Location 540](https://readwise.io/to_kindle?action=open&asin=B09NS1CZ7W&location=540)) - Tags: [[blue]] - if the rate of interest is linked to profitability, as most economists have believed since the time of Adam Smith, then interest rates and the pace of economic growth (i.e. the rate of return for the whole economy) must also be connected. ([Location 558](https://readwise.io/to_kindle?action=open&asin=B09NS1CZ7W&location=558)) - Tags: [[blue]] - The most important question addressed in this book is whether a capitalist economy can function properly without market-determined interest. ([Location 567](https://readwise.io/to_kindle?action=open&asin=B09NS1CZ7W&location=567)) - Tags: [[blue]] - The argument of this book is that interest is required to direct the allocation of capital, and that without interest it becomes impossible to value investments. As a ‘reward for abstinence’ interest incentivizes saving. Interest is also the cost of leverage and the price of risk. When it comes to regulating financial markets, the existence of interest discourages bankers and investors from taking excessive risks. On the foreign exchanges, interest rates equilibrate the flow of capital between nations. Interest also influences the distribution of income and wealth. As Bastiat understood, a very low rate of interest may benefit the rich, who have access to credit, more than the poor. ([Location 571](https://readwise.io/to_kindle?action=open&asin=B09NS1CZ7W&location=571)) - Tags: [[blue]] - Temples were the main providers of loans in the Ancient Near East initially. Palaces also supplied credit. These institutional creditors used the interest on loans to redistribute resources, handing out food rations to widows and orphans and others. ([Location 704](https://readwise.io/to_kindle?action=open&asin=B09NS1CZ7W&location=704)) - Tags: [[blue]] - Keynes, who studied Babylonian monetary history while researching his Treatise on Money, believed that interest rates were determined by custom rather than market forces. As his disciple Joan Robinson put it, interest has a ‘Cheshire cat grin [which] … remains after the circumstances which gave rise to it in the past have completely vanished’.41 ([Location 773](https://readwise.io/to_kindle?action=open&asin=B09NS1CZ7W&location=773)) - Tags: [[blue]] - Recent research from the Bank for International Settlements suggests that interest rates over the past hundred years or so have been more influenced by the nature of the various monetary regimes (Gold Standard, Gold Exchange Standard, Bretton Woods and Dollar Standard) than by economic factors such as individual savings and investment decisions. ([Location 785](https://readwise.io/to_kindle?action=open&asin=B09NS1CZ7W&location=785)) - Tags: [[blue]] - In short, the ancient history of interest provides no strong support for any particular view as to how the rate of interest is formed. Law and custom obviously played an important role. Yet occasional changes in the quantity of money in circulation also appear to have influenced interest rates. Market forces were at play, to some extent at least. ([Location 823](https://readwise.io/to_kindle?action=open&asin=B09NS1CZ7W&location=823)) - Tags: [[blue]] - Böhm-Bawerk declared that the cultural level of a nation is mirrored by its rate of interest. In the ancient world, interest rates charted the course of great civilizations. In Babylon, Greece and Rome interest rates followed a U-shaped curve over the centuries; declining as each civilization became established and prospered, and rising sharply during periods of decline and fall.57 Very low interest rates appear to have been the calm before the storm. ([Location 830](https://readwise.io/to_kindle?action=open&asin=B09NS1CZ7W&location=830)) - Tags: [[blue]] - ‘The emergence of interest to incentivize lending is the most significant of all innovations in the history of finance,’ writes the financial historian William Goetzmann. ([Location 858](https://readwise.io/to_kindle?action=open&asin=B09NS1CZ7W&location=858)) - Tags: [[blue]] - In any society with private property, whether in Mesopotamia or later civilizations, the payment of interest is required to induce people to lend their resources. Without interest, they would inevitably have hoarded their capital. ([Location 865](https://readwise.io/to_kindle?action=open&asin=B09NS1CZ7W&location=865)) - Tags: [[blue]] - In ancient Babylon, a person with spare funds had a choice between buying and cultivating some land or lending the money to a third party who could use the loan to acquire a farm. It seems obvious that the rate of interest and the productivity of capital, in this case the farm surplus, should bear some relation to each other. ([Location 867](https://readwise.io/to_kindle?action=open&asin=B09NS1CZ7W&location=867)) - Turgot elaborated on Barbon’s insight: ‘Every capital in the form of money … is the equivalent of a piece of land producing a revenue equal to a particular fraction of this sum.’64 For Turgot, the world of finance was a mirror held up to the world, with real and financial assets exchangeable for each other. Since land, buildings and factories produce income, so money must yield interest. This important insight is too often overlooked by modern economists. ([Location 878](https://readwise.io/to_kindle?action=open&asin=B09NS1CZ7W&location=878)) - Tags: [[blue]] - Interest is a charge for the use of money over a certain period of time. ([Location 960](https://readwise.io/to_kindle?action=open&asin=B09NS1CZ7W&location=960)) - Tags: [[blue]] - These new financial practices added to the effective money supply and contributed to the decline in medieval interest rates. Loans in northern Italy were to be had for around 20 per cent in 1200. By Datini’s day, the rates on commercial loans in Genoa had fallen to 7 per cent. ([Location 1040](https://readwise.io/to_kindle?action=open&asin=B09NS1CZ7W&location=1040)) - Tags: [[blue]] - The ban on usury proved futile because as trade expanded, both at home and abroad, the demand for credit became overwhelming. ([Location 1068](https://readwise.io/to_kindle?action=open&asin=B09NS1CZ7W&location=1068)) - Tags: [[blue]] - Once the idea took hold that time not only had value but was an individual’s possession, clerical injunctions against usury lost much of their force. If a merchant gained from a loan, why shouldn’t the lender share in those profits? In fact, the idea that the lender should be protected against lost profits is embedded in the very concept of interest. ([Location 1079](https://readwise.io/to_kindle?action=open&asin=B09NS1CZ7W&location=1079)) - Tags: [[blue]] - By the early modern period, a distinction was made between consumer and commercial lending. Interest on consumption loans was still condemned as usury, but charging for the loan of productive capital was increasingly acceptable. ([Location 1093](https://readwise.io/to_kindle?action=open&asin=B09NS1CZ7W&location=1093)) - Tags: [[blue]] - Interest, he said, is the price of time. There is no better definition. ([Location 1127](https://readwise.io/to_kindle?action=open&asin=B09NS1CZ7W&location=1127)) - Tags: [[blue]] - From a technical viewpoint, capital consists of a stream of future income discounted to its present value. Without interest, there can be no capital. Without capital, no capitalism. ([Location 1155](https://readwise.io/to_kindle?action=open&asin=B09NS1CZ7W&location=1155)) - Tags: [[blue]] - Interest is the difference in monetary values across time, the rate at which present consumption is exchanged for future consumption. Interest represents the time value of money. ([Location 1169](https://readwise.io/to_kindle?action=open&asin=B09NS1CZ7W&location=1169)) - Tags: [[blue]] - Younger people may borrow and spend, paying back their loans later in life – what economists call ‘income-smoothing’. The interest rate they pay reflects their time preference. Older people are likely to have a lower time preference and be less inclined to borrow at interest, partly because their incomes are no longer growing. Countries with ageing populations tend to have falling interest rates. ([Location 1186](https://readwise.io/to_kindle?action=open&asin=B09NS1CZ7W&location=1186)) - Tags: [[blue]] - The formation of capital, said Rae, ‘implies the sacrifice of some smaller present good, for the production of some greater future good’. ([Location 1217](https://readwise.io/to_kindle?action=open&asin=B09NS1CZ7W&location=1217)) - Tags: [[blue]] - Interest – the time value of money – lies at the heart of valuation. At the turn of the eighteenth century, the brilliant Scotsman John Law (whom we encounter in Chapter 4) wrote that ‘anticipation is always at a discount. £100 to be paid now is of more value than £1,000 to be paid £10 a year for 100 years.’67 By discounting the future cash flow generated by a stock, bond, building or any other income-producing asset, interest allows us to arrive at its present value. ([Location 1220](https://readwise.io/to_kindle?action=open&asin=B09NS1CZ7W&location=1220)) - Tags: [[blue]] - For Hayek, it was axiomatic, but all too often overlooked, that ‘all economic activity is carried out through time.’71 When interest rates decline, he said, businesses are inclined to invest in projects with more distant pay-offs – in Hayek’s terminology, the ‘structure of production’ lengthens. If interest rates are kept below their natural level, misguided investments occur: too much time is used in production, or, put another way, the investment returns don’t justify the initial outlay. ([Location 1247](https://readwise.io/to_kindle?action=open&asin=B09NS1CZ7W&location=1247)) - Tags: [[blue]] - The decline in European interest rates in the late Middle Ages facilitated the accumulation of capital, which in turn produced a further lowering of rates. The expansion of banking speeded up the circulation of money, providing further downward pressure on interest rates. ([Location 1320](https://readwise.io/to_kindle?action=open&asin=B09NS1CZ7W&location=1320)) - Tags: [[blue]] - Child put the cart before the horse when he claimed that low interest rates were the cause of Dutch wealth. The lowness of interest in Holland, said Locke, was not ‘an effect of Law … but as the Consequence of great Plenty of ready Money’, just as the Scots were not poor because they paid high interest, but rather paid high interest because they were poor. ([Location 1398](https://readwise.io/to_kindle?action=open&asin=B09NS1CZ7W&location=1398)) - Tags: [[blue]] - The notion that interest must be free to find its own level underpins Locke’s argument. Any attempt to regulate interest, he believed, would only ‘increase the arts of lending’ as borrowers and lenders would seek to evade the law. ([Location 1432](https://readwise.io/to_kindle?action=open&asin=B09NS1CZ7W&location=1432)) - Tags: [[blue]] - in 1802, England was at war with France and the Bank of England had suspended convertibility of its notes into gold. An economic boom was under way, but the usury laws prevented the Bank from charging more than 5 per cent – an ‘unnatural and extraordinarily low’ level, in Thornton’s view. Borrowers were able to obtain loans cheaply: ‘That which they obtain too cheap they demand in too great quantity,’ lamented the prudent banker. In so many words, Thornton was suggesting that providing paper credit at below the natural rate of interest created the conditions for an unstable financial boom. The severe crisis that broke out in the City of London in the summer of 1810 appeared to vindicate Thornton’s view. ([Location 1454](https://readwise.io/to_kindle?action=open&asin=B09NS1CZ7W&location=1454)) - Tags: [[blue]] - the natural rate of interest is unobservable, a pure abstraction – in Wicksell’s description it is the rate at which capital would be lent in a world of barter, lacking any type of money. ([Location 1466](https://readwise.io/to_kindle?action=open&asin=B09NS1CZ7W&location=1466)) - Tags: [[blue]] - Like Locke, we may be fuzzy about where the natural rate of interest lies exactly, but we can tell its absence. When the cost of borrowing is set at too high a level, then businesses won’t borrow to invest, creditors gain unduly at the expense of debtors, capital values are depressed, workers remain idle and the economy stagnates. When bond yields far exceed the growth in national income, then existing debt becomes burdensome and bankruptcy beckons. (Economists refer to this state of affairs as a ‘debt trap’.) High interest is associated with deflation and what Bacon called ‘public poverty’. As we shall see, Britain suffered many of these ills after its ill-fated return to the Gold Standard in the 1920s caused interest rates to rise to unbearable levels. ([Location 1477](https://readwise.io/to_kindle?action=open&asin=B09NS1CZ7W&location=1477)) - Tags: [[blue]] - An excessively low rate of interest may be signalled by a rise in inflation. But it’s not just a question of changes in the level of consumer prices. When asset price bubbles proliferate, credit booms, finance crowds out honest endeavour, savings collapse and capital is misallocated on a grand scale, the chances are that market rates of interest are not aligned with the natural rate. ([Location 1482](https://readwise.io/to_kindle?action=open&asin=B09NS1CZ7W&location=1482)) - In short, Locke argued that a forced reduction in interest rates imparts no benefit to a society lacking in ‘industry and frugality’. ([Location 1492](https://readwise.io/to_kindle?action=open&asin=B09NS1CZ7W&location=1492)) - Tags: [[blue]] - this outbreak of speculative fever wasn’t a random event. In this chapter, we trace the source of the Mississippi bubble and its subsequent collapse to Law’s ambitious monetary experiment and, in particular, his policy of expanding France’s money supply and cutting interest rates. While Locke considered the inconveniences that might take the rate of interest below its natural level, Law conducted the world’s first experiment with easy money. His story of boom and bust is a cautionary tale for our times. ([Location 1553](https://readwise.io/to_kindle?action=open&asin=B09NS1CZ7W&location=1553)) - Tags: [[blue]] - Money, he said, did not derive its value from precious metals, as people like Locke believed. Rather, money was simply a yardstick of value; or, as he put it, ‘Money is not the Value for which Goods are exchanged, but the Value by which they are exchanged.’5 This clever switching of the prepositions – by in place of for – amounted to a monetary revolution. In essence, he was saying that since money lacked intrinsic value it need not be backed by gold or other precious metals. ([Location 1560](https://readwise.io/to_kindle?action=open&asin=B09NS1CZ7W&location=1560)) - Tags: [[blue]] - Law anticipates later monetarists. He argued that prosperity could be achieved by establishing a bank that issued paper money, collateralized with land rather than gold and silver. By severing the link between money and precious metals, Law opened the possibility of a managed currency. ([Location 1566](https://readwise.io/to_kindle?action=open&asin=B09NS1CZ7W&location=1566)) - Tags: [[blue]] - In his early pamphlets, Law argued that interest was determined by the supply of money and that a national bank could bring about a reduction in interest by increasing the money supply. He believed that the Dutch enjoyed lower borrowing costs because they had a greater quantity of money in circulation (not, as Locke and others supposed, because the Dutch were thrifty and possessed a greater stock of capital). ([Location 1602](https://readwise.io/to_kindle?action=open&asin=B09NS1CZ7W&location=1602)) - Tags: [[blue]] - Like Josiah Child before him, Law anticipated that great economic benefits would follow from a reduction in the cost of borrowing: ‘If lowness of interest were the consequence of a greater quantity of money, the stock applied to trade would be greater, and merchants would trade cheaper, from the easiness of borrowing, and the lower interest of money, without any inconveniences attending it,’ ([Location 1608](https://readwise.io/to_kindle?action=open&asin=B09NS1CZ7W&location=1608)) - Tags: [[blue]] - In modern language, Law was suggesting that a central bank could reduce interest rates by printing money; that this would alleviate the position of heavily indebted borrowers (in this case, French nobles), create jobs and revive the economy. At the same time, the cost of servicing government debt would fall and deflation come to an end. ([Location 1616](https://readwise.io/to_kindle?action=open&asin=B09NS1CZ7W&location=1616)) - Tags: [[blue]] - The main stimulus for the bubble came from the Royal Bank’s printing press. Over the course of 1719, the amount of paper money in circulation increased by an estimated billion livres.23 The bank employed eight printers around the clock to crank out notes in large denominations. The most commonly issued note was worth 10,000 livres. ([Location 1680](https://readwise.io/to_kindle?action=open&asin=B09NS1CZ7W&location=1680)) - Tags: [[blue]] - In his earlier writings, Law had expressed the view that East India Company shares were like money since they could be used for the settlement of debt. Under his System, bank money and Mississippi stock became interchangeable. Loans to speculators, supplied against share collateral, were provided by the Royal Bank at 2 per cent. ([Location 1699](https://readwise.io/to_kindle?action=open&asin=B09NS1CZ7W&location=1699)) - Tags: [[blue]] - At the market peak in late 1719, the yield on government debt stood at 2 per cent and loans for share purchases (margin loans) cost the same amount, while Mississippi shares traded at close to fifty times earnings and paid a dividend equal to 2 per cent of the market price (admittedly, the dividend was not quite covered by earnings). Law himself was aware that the valuation of the Company’s shares depended on the rate of interest. In early 1720, he even justified the high share price by reference to the low prevailing interest.30 Writing on the Mississippi Bubble some half a century later, the Scottish economist Sir James Steuart shrewdly commented that ‘value, in capital, really existed relatively to the rate of interest.’31 ([Location 1708](https://readwise.io/to_kindle?action=open&asin=B09NS1CZ7W&location=1708)) - Tags: [[blue]] - In the short-term, Cantillon averred, a national bank could drive down interest rates by purchasing government debt with newly printed money. Expectations of further declines in interest rates would induce the public to acquire bonds, further lowering market rates and raising the price of securities. Such banking operations were fraught with risk, however. The economy would prosper only as long as the extra money balances, created by the note issues, remained trapped within the financial system: ‘The excess banknotes, made and issued on these occasions, do not upset the circulation [i.e. produce inflation], because being used for the buying and selling of stock [i.e. financial assets] they do not serve for household expenses and are not changed into silver.’50 But once the money escaped into the wider economy, consumer prices were bound to rise. Besides, said Cantillon, it was all very well for the bank to buy stocks in a rising market. But to whom would it sell them in a falling one? ‘If the Bank alone raises the price of public stock by buying it, it will by so much depress it when it resells to cancel its excess issue of notes.’ ([Location 1812](https://readwise.io/to_kindle?action=open&asin=B09NS1CZ7W&location=1812)) - Tags: [[blue]] - The collapse of Lehman Brothers in September 2008 produced economic and financial conditions – a toxic mixture of deflation, high unemployment and soaring government debt – somewhat similar to France’s after the death of Louis XIV. Monetary policymakers responded to these conditions by taking a leaf from Law’s copybook, pushing down interest rates and acquiring large chunks of their national debt (although not going quite so far as Law) with newly printed money. There’s another similarity. After 2008, the Federal Reserve embarked on a deliberate policy of boosting asset prices by reducing the discount rate. While Law created Mississippi millionaires, his twenty-first-century imitators minted billionaires by the score. In the decade after the global financial crisis, central bankers justified their unconventional monetary policies on the grounds that consumer price inflation was quiescent. But, as Cantillon pointed out, when a national bank turns on the printing press and buys up government debt, the newly created money is initially trapped within the financial system, where it inflates financial assets rather than consumer prices, and only slowly seeps out into the wider economy.fn11 As we describe in later chapters, Defoe’s description of Law’s System as ‘an inconceivable species of mere air and shadow’ might equally well apply to the central-bank engineered economic recovery after 2008. ([Location 1861](https://readwise.io/to_kindle?action=open&asin=B09NS1CZ7W&location=1861)) - Tags: [[blue]] - ‘What central bankers are doing now is exactly what Law recommended,’ Law’s biographer Antoin Murphy wrote in the wake of the global financial crisis. ‘From this perspective, it may be argued that, notwithstanding the failure of the Mississippi System, Law’s banking successors have been Ben Bernanke, Janet Yellen and Mario Draghi.’ ([Location 1878](https://readwise.io/to_kindle?action=open&asin=B09NS1CZ7W&location=1878)) - Tags: [[blue]] - As in the twenty-first century, this nascent credit cycle was sensitive to banking accidents and the reversal of international capital flows. ([Location 1902](https://readwise.io/to_kindle?action=open&asin=B09NS1CZ7W&location=1902)) - Tags: [[blue]] - While Overstone elaborated the phases of the credit cycle, Bagehot looked into its causes. The cycle arose, he said, from ‘the different amounts of loanable capital which are available at different times for the supply of trade’.5 Any number of reasons might cause the amount of loanable capital to vary – a gold discovery, the excessive issue of banknotes or the expansion of trade. But there was also a psychological element. ‘Credit, the disposition of one man to trust another, is singularly varying,’ Bagehot wrote.6 Interest is the barometer of trust, rising and falling over the course of the cycle. Too much trust is a dangerous thing. ([Location 1919](https://readwise.io/to_kindle?action=open&asin=B09NS1CZ7W&location=1919)) - Tags: [[blue]] - ‘The crisis was occasioned by over speculation; over speculation was occasioned by the low rates of profit and of interest; and the low rates of profit and of interest – what was it which occasioned those?’ ([Location 1969](https://readwise.io/to_kindle?action=open&asin=B09NS1CZ7W&location=1969)) - Tags: [[blue]] - ‘Banking is a watchful, but not a laborious trade,’ asserted Bagehot. Caution was his watchword. The banker should constantly be looking out for unseen dangers and the bouts of idiocy that so often enveloped the world of finance. ([Location 1986](https://readwise.io/to_kindle?action=open&asin=B09NS1CZ7W&location=1986)) - Tags: [[blue]] - Bagehot observed that outbreaks of financial recklessness did not occur at random. Rather, they tended to appear at times when money was easy and interest rates low. He expressed this insight in his own inimitable fashion: ‘John Bull can stand many things, but he cannot stand two per cent.’14 When interest rates fell to such a low level, investors reacted to the loss of income by taking greater risks. In modern language, they engage in ‘yield-chasing’. ([Location 1990](https://readwise.io/to_kindle?action=open&asin=B09NS1CZ7W&location=1990)) - Tags: [[blue]] - Bagehot intuitively understood how people were habituated to a certain return on their investments and how, when the accustomed income was not available, investors were inclined to take more risk: ‘The fact is, that the owners of savings not finding, in adequate quantities, their usual kind of investments, rush into anything that promises speciously.’19 ([Location 2010](https://readwise.io/to_kindle?action=open&asin=B09NS1CZ7W&location=2010)) - Tags: [[blue]] - ‘as a rule, panics do not destroy capital; they merely reveal the extent to which it has previously been destroyed by its betrayal into hopelessly unproductive works.’ ([Location 2169](https://readwise.io/to_kindle?action=open&asin=B09NS1CZ7W&location=2169)) - Tags: [[blue]] - After the 2008 global financial crisis, US Treasury Secretary Tim Geithner, a former President of the New York Federal Reserve, referred to Lombard Street as the ‘bible of central banking’. ([Location 2214](https://readwise.io/to_kindle?action=open&asin=B09NS1CZ7W&location=2214)) - Tags: [[blue]] - Yet Bagehot’s stringent conditions were not followed. Modern lenders of last resort have only a tenuous connection with their Victorian antecedents. They do not lend at high interest but at the lowest rates. Their emergency loans are not provided for a short period, but for years on end. They do not lend against high-quality collateral but reach to the outer edges of the credit spectrum. Modern central bankers show far less concern for moral hazard than Bagehot – and their actions would give Thomson Hankey an acute case of neuralgia. ([Location 2219](https://readwise.io/to_kindle?action=open&asin=B09NS1CZ7W&location=2219)) - Tags: [[blue]] - In February 1876, Bagehot reflected on the foreign lending craze. It was a familiar story. Periods of low domestic interest rates, it seemed, made the specious promise of high yields on foreign debt particularly attractive: ([Location 2256](https://readwise.io/to_kindle?action=open&asin=B09NS1CZ7W&location=2256)) - Tags: [[blue]] - The outbreak of war in 1914 led most central banks to suspend gold payments (the United States was an exception). In 1922, finance ministers from several dozen nations met in Genoa to discuss how to reconstruct the international monetary order. They decided against resurrecting the Gold Standard that had prevailed before the war, proposing in its place a modified version.7 The main idea behind the Gold Exchange Standard, as it was called, was to economize on gold: under this new regime government securities held by a central bank were counted as reserves, alongside gold. ([Location 2374](https://readwise.io/to_kindle?action=open&asin=B09NS1CZ7W&location=2374)) - Tags: [[blue]] - The new monetary order was designed not merely to economize on gold, but also to prevent consumer prices from falling. ‘It was chiefly to avoid deflation that the gold exchange standard was recommended at Genoa,’ a contemporary economist observed. ([Location 2401](https://readwise.io/to_kindle?action=open&asin=B09NS1CZ7W&location=2401)) - Tags: [[blue]] - Benjamin Anderson, chief economist at Chase National Bank, believed that monetary policy was too loose. America’s central bank, Anderson lamented, had been created to provide assistance during a financial crisis, ‘but from early 1924 down to the spring of 1928, it was used … to finance a stock market boom’. ([Location 2434](https://readwise.io/to_kindle?action=open&asin=B09NS1CZ7W&location=2434)) - Tags: [[blue]] - By taming the business cycle, however, the Fed inadvertently encouraged speculative behaviour. As economist Perry Mehrling writes: ‘Intervention to stabilize seasonal and cyclical fluctuations produced low and stable money rates of interest, which supported the investment boom that fueled the Roaring Twenties but also produced an unsustainable asset price bubble.’ ([Location 2456](https://readwise.io/to_kindle?action=open&asin=B09NS1CZ7W&location=2456)) - Tags: [[blue]] - Wicksell claimed that the natural rate of interest derived from the economy-wide return on capital. Although the natural rate is unseen, it can be roughly surmised from an economy’s trend growth rate.fn6 ([Location 2469](https://readwise.io/to_kindle?action=open&asin=B09NS1CZ7W&location=2469)) - Tags: [[blue]] - If the index of consumer prices gave no sign that interest rates were too low it was because the supply-side improvements, which generated productivity gains, also kept inflation at bay.fn7 ([Location 2474](https://readwise.io/to_kindle?action=open&asin=B09NS1CZ7W&location=2474)) - Tags: [[blue]] - Benjamin Anderson thought the 1920s market similar to the late 1890s boom: ‘“Cheap money” characterized both “new eras,” and cheap money is the most dangerous intoxicant known to economic life, especially if it be prolonged through many years.’29 ([Location 2489](https://readwise.io/to_kindle?action=open&asin=B09NS1CZ7W&location=2489)) - Tags: [[blue]] - Easy money may kindle animal spirits, but a slight tightening of monetary policy is rarely sufficient to extinguish a speculative inferno, as America’s inexperienced central bankers were to discover. Credit growth continued to outpace US economic growth, broker loans continued soaring and the stock market continued its near vertical ascent (between February 1928 and August 1929, the Standard & Poor’s Composite index climbed by nearly 30 per cent). ([Location 2550](https://readwise.io/to_kindle?action=open&asin=B09NS1CZ7W&location=2550)) - Tags: [[blue]] - Paul Warburg, the head of the Wall Street firm Kuhn Loeb, and a founding father of the Federal Reserve, feared that the rapid expansion of the call loan market made the stability of the financial system dependent on the level of stock prices. Warburg believed interest rates should have risen earlier and faster.49 By 1929 it was too late. ‘The present position was exquisitely painful. A higher rate to break the stock market or a lower rate to repulse the attraction of call money – one or the other might furnish relief.’50 ([Location 2570](https://readwise.io/to_kindle?action=open&asin=B09NS1CZ7W&location=2570)) - Tags: [[blue]] - Even Keynes had second thoughts. In his Treatise on Money (1930), he expressed something close to a mea culpa: Anyone who looked only at the index of prices [during the 1920s] would see no reason to suspect any material degree of inflation; whilst anyone who looked only at the total volume of bank credit and the prices of common stocks would have been convinced of the presence of an inflation actual or impending. Keynes appeared to be suggesting that credit inflation, and not the inflation of consumer prices, was the true sign that interest rates were out of equilibrium – a position close to Hayek’s from which he soon reneged.fn13 ([Location 2650](https://readwise.io/to_kindle?action=open&asin=B09NS1CZ7W&location=2650)) - Tags: [[blue]] - Most financial histories of the 1920s and its aftermath fail to mention contemporary criticisms of the Federal Reserve’s price stabilization policy and pass over the coup de whisky delivered to the US stock market after the Long Island meeting. According to this orthodox narrative, there was nothing untoward about the US economy in the 1920s and there was no bubble in property or stocks. Everything was progressing just fine until Ben Strong sickened and retired from the New York Fed in late 1927. Thereafter, Strong’s former colleagues, taking fright at the speculative orgy on Wall Street, unduly tightened monetary policy, thereby inducing a sharp economic downturn. ‘The true story [of the Great Depression],’ maintained the future Federal Reserve chairman Ben Bernanke, ‘is that monetary policy tried overzealously to stop the rise in stock prices.’fn14 ([Location 2662](https://readwise.io/to_kindle?action=open&asin=B09NS1CZ7W&location=2662)) - Tags: [[blue]] - Hayek argued that the new technologies and efficiency improvements of the 1920s brought about a ‘good’ deflation, the type of deflation that Marshall was referring to in his comments to the Royal Commission. When policymakers ease monetary conditions to ward off such a benign decline in the price level, people are incentivized to borrow more. As Irving Fisher observed, debt deflation starts from a position of over-indebtedness – a point which Bernanke in his writings on the subject conspicuously overlooks. Thus, Hayek concluded that attempts to avoid a good deflation only make ‘bad’ deflation more likely. Furthermore, the bad deflation that appears during a financial crisis should be viewed as a symptom, rather than a cause of economic malaise. Debt deflation, Hayek concluded, is ‘a secondary phenomenon, a process induced by the maladjustments of industry left over from the boom’.74 ([Location 2709](https://readwise.io/to_kindle?action=open&asin=B09NS1CZ7W&location=2709)) - Tags: [[blue]] - In the late 1920s, Hayek claimed that monetary policy had taken the wrong course and predicted a deflationary bust. Irving Fisher, on the other hand, saw nothing wrong at the time with either America’s economy or its monetary policy, famously opining in the summer of 1929 that US stocks had reached a ‘permanently high plateau’. If accuracy of prediction is what matters for economic theory, as Milton Friedman later claimed, then Hayek’s interpretation should have become the received wisdom of his profession. Yet the Austrian’s interpretation of the 1920s and its aftermath has been more or less air-brushed from the history books, while Fisher’s monetarist view has become received wisdom. ([Location 2741](https://readwise.io/to_kindle?action=open&asin=B09NS1CZ7W&location=2741)) - Tags: [[blue]] - The most important lesson of the bubble, in their view, was that monetary policy should be conducted in a far-sighted manner: Price stability, which monetary policy should aim at, is not stability at any particular point in time but rather sustainable stability that can support economic growth over the medium to long term. Therefore, even when measured inflation is stable, it will become necessary to raise interest rates promptly. ([Location 2798](https://readwise.io/to_kindle?action=open&asin=B09NS1CZ7W&location=2798)) - Tags: [[blue]] - Had the BOJ not attempted to burst the bubble, or had the central bank loosened policy more quickly after the bubble started to deflate, then the monetarists’ hypothesis, first elaborated by Fisher and disputed by Hayek – that price stability is a necessary prerequisite for economic and financial stability – might have been properly tested. ([Location 2820](https://readwise.io/to_kindle?action=open&asin=B09NS1CZ7W&location=2820)) - Tags: [[blue]] - Volcker aimed to crush inflation by slowing the growth in the money supply – what he styled ‘practical monetarism’, as opposed to Friedman’s academic variety – and he didn’t care how high interest rates climbed to achieve his goal. ([Location 2836](https://readwise.io/to_kindle?action=open&asin=B09NS1CZ7W&location=2836)) - Tags: [[blue]] - Hailed as the ‘greatest central banker ever’ at the close of his near two-decade tenure, Greenspan’s real achievement was to inflate a series of asset price bubbles and protect investors from the worst of the fallout. ([Location 2863](https://readwise.io/to_kindle?action=open&asin=B09NS1CZ7W&location=2863)) - Tags: [[blue]] - Shortly afterwards, the Fed switched its attention from attempting to influence the growth of bank borrowing to directly targeting interest rates.fn3 Henceforth, monetary policy would remain focused on near-term inflation, while other financial imbalances – as reflected by current account deficits, credit growth and underwriting standards, private sector leverage, and asset price bubbles – elicited no response beyond the occasional attempt to pressurize the market into a correction. ([Location 2871](https://readwise.io/to_kindle?action=open&asin=B09NS1CZ7W&location=2871)) - Tags: [[blue]] - If the rate of interest tracks the return on capital, then American rates should have climbed in tandem. But this didn’t happen. Instead, short-term interest rates were held below the growth rate of the US economy for most of the period between early 1992 and the end of the decade. ([Location 2880](https://readwise.io/to_kindle?action=open&asin=B09NS1CZ7W&location=2880)) - Tags: [[blue]] - at a meeting of the Federal Open Market Committee (FOMC) on 14 March 2004, Governor Donald Kohn admitted that policy accommodation – and the expectation that it will persist – is distorting asset prices. Most of this distortion is deliberate and a desirable effect of the stance of policy. We have attempted to lower interest rates below long-term equilibrium rates and to boost asset prices in order to stimulate demand. ([Location 2922](https://readwise.io/to_kindle?action=open&asin=B09NS1CZ7W&location=2922)) - Tags: [[blue]] - Not everyone was convinced that the Greenspan Federal Reserve’s policy of focusing on consumer prices and ignoring other financial imbalances was quite the trick. Few dissenters, however, occupied exalted positions in monetary policymaking circles or enjoyed tenure at top universities. ([Location 2935](https://readwise.io/to_kindle?action=open&asin=B09NS1CZ7W&location=2935)) - Tags: [[blue]] - Like Hayek, White distinguished between good deflation that arises from productivity improvements and bad deflation that follows a credit bust. Past financial crises, White noted, had often appeared without any prior pick-up of inflation – the recent Asian crisis being a case in point. Credit growth, asset price inflation and large-scale capital inflows – in other words, the financial conditions then prevailing in the United States – were more reliable harbingers of a crisis. ([Location 2940](https://readwise.io/to_kindle?action=open&asin=B09NS1CZ7W&location=2940)) - Tags: [[blue]] - White also questioned the policy, championed by Bernanke, of dealing with the aftermath of a bubble rather than forestalling it. An over-indebted economy might enter a liquidity trap, rendering it impervious to monetary stimulus. If capital was misallocated during the boom, then low interest rates after the bust might contribute to economic sclerosis, as Japan had experienced over the previous decade. Reducing interest rates after a bubble’s collapse might discourage saving, thereby reducing the economy’s growth prospects: ‘If low rates are maintained for an extended period,’ White suggested, ‘they may or may not have the desired effect on aggregate demand, but they clearly have negative long-term effects with respect to aggregate supply.’ Finally, he predicted that low rates would drive a search for yield from insurance companies and defined benefit pension plans. ([Location 2944](https://readwise.io/to_kindle?action=open&asin=B09NS1CZ7W&location=2944)) - Chief among the non-seers, Bernanke inclined to the view that poor financial regulation was to blame for the credit excesses prior to the Lehman’s bankruptcy ([Location 2961](https://readwise.io/to_kindle?action=open&asin=B09NS1CZ7W&location=2961)) - Tags: [[blue]] - Among policymakers, the regulatory interpretation of the financial crisis won the day. ([Location 2963](https://readwise.io/to_kindle?action=open&asin=B09NS1CZ7W&location=2963)) - Tags: [[blue]] - Greenspan’s replacement also repudiated the notion that easy money had inflated the housing bubble: Economists [actually Federal Reserve economists, in his employ] who have investigated the issue have generally found that, based on historical relationships, only a small portion of the increase in house prices earlier this decade can be attributed to the stance of U.S. monetary policy. This conclusion has been reached using both econometric models and purely statistical analyses that make no use of economic theory. fn6 ([Location 2970](https://readwise.io/to_kindle?action=open&asin=B09NS1CZ7W&location=2970)) - Tags: [[blue]] - Bernanke’s analysis ignores the fact that the riskiest subprime loans were priced off short-term rates, including the option of adjustable-rate mortgages with their negative amortization feature (in which interest was rolled up with the principal). It was only after the Fed’s easy money policy was launched that credit growth picked up, financial leverage soared, housing markets bubbled, underwriting standards declined and the repackaging of subprime mortgage debt into collateralized debt obligations took off. Low interest rates fed the demand for credit, while financial innovation increased its supply. The explosive growth of the market for complex mortgage securities was driven in large part by a desperate search for yield at a time when interest rates were at multi-decade lows. ([Location 2981](https://readwise.io/to_kindle?action=open&asin=B09NS1CZ7W&location=2981)) - Tags: [[blue]] - Anna Schwartz, who had earlier extolled the goal of price stability, now pinned responsibility for the subprime crisis on the Fed: ‘the basic underlying propagator [of the crisis] was too-easy monetary policy and too-low interest rates that induced ordinary people’ to borrow and speculate.fn8 Professor John Taylor of Stanford University, author of the ‘Taylor Rule’, a central banker’s rule of thumb for setting interest rates (based on inflation expectations and estimates of spare capacity in the economy), suggested that ‘monetary excesses were the main cause of the boom and the resulting bust’.36 ([Location 2996](https://readwise.io/to_kindle?action=open&asin=B09NS1CZ7W&location=2996)) - Tags: [[blue]] - Such accounts overlook the fact that financial practices and regulations differed from one country to another. American banks may have originated dodgy mortgage debt instruments in order to distribute them, but in Spain mortgage bonds (cédulas) remained on banks’ balance sheets. The Bank of Spain even demanded that banks increase their capital reserves during the boom. Yet despite these safeguards, Spain suffered a worse financial shock than the United States and the near total collapse of its local savings banks (cajas). Since the crisis was global, it seems reasonable to suppose that its origins were also global. ([Location 3010](https://readwise.io/to_kindle?action=open&asin=B09NS1CZ7W&location=3010)) - Tags: [[blue]] - Why were the credit systems of so many different countries, from Australia to Iceland, so vulnerable at the time? The unifying factor appears to be the low-interest rate policy of the Federal Reserve at the turn of the century, which, owing to the special position of the dollar as the global reserve currency, created the conditions for a credit boom that engulfed much of the world’s economy. Prior to the crisis, global interest rates were negative in real terms and far below the growth rate of the world’s economy. Even countries with relatively high interest rates enjoyed no respite, since they were inundated with foreign capital flows.fn9 There’s no need to appeal to ad hoc explanations: easy money produced the boom and the boom was followed by the inevitable bust. ([Location 3017](https://readwise.io/to_kindle?action=open&asin=B09NS1CZ7W&location=3017)) - Tags: [[blue]] - It is telling that, in a 2010 survey, a large majority of academic economists believed that low rates caused, or at least greatly contributed to, the housing bubble, but most economists specializing in monetary policy continued to side with the Fed’s view.38 If Bernanke, as head of the Federal Reserve, held that the crisis wasn’t a failure of ‘economic science’ but one of economic management (regulation), it was only to be expected that the Fed’s own research team should follow their chief’s lead. ([Location 3031](https://readwise.io/to_kindle?action=open&asin=B09NS1CZ7W&location=3031)) - Tags: [[blue]] - adoption of inflation targets had provided no protection against the financial crisis, the roll-out continued after 2008. In early 2012, Bernanke achieved his long-held ambition of getting the Federal Reserve to adopt a formal inflation target.fn10 The Bank of Japan soon followed. ([Location 3054](https://readwise.io/to_kindle?action=open&asin=B09NS1CZ7W&location=3054)) - Tags: [[blue]] - ‘anything that can be measured and rewarded will be gamed.’ ([Location 3077](https://readwise.io/to_kindle?action=open&asin=B09NS1CZ7W&location=3077)) - Tags: [[blue]] - Charles Goodhart of the London School of Economics observed that whenever the Bank of England targeted a particular measure of money supply, that measure’s earlier relationship to inflation broke down. Goodhart’s Law states that any measure used for control is unreliable. ([Location 3080](https://readwise.io/to_kindle?action=open&asin=B09NS1CZ7W&location=3080)) - Tags: [[blue]] - The mistake in setting targets lies in assuming that relationships between variables – in this case a certain measure of the money supply and inflation – are stationary. In the real world, human behaviour responds to attempts at control. ‘The essence of Goodhart’s Law,’ write John Kay and Mervyn King in their book Radical Uncertainty, is that ‘any business or government policy which assumed stationarity of social and economic relationships was likely to fail because its implementation would alter the behaviour of those affected and therefore destroy that stationarity.’43 ([Location 3082](https://readwise.io/to_kindle?action=open&asin=B09NS1CZ7W&location=3082)) - Tags: [[blue]] - Paul Volcker, was even more critical of the inflation target. ‘I puzzle at the rationale,’ wrote the former Fed chief. ‘A 2 percent target, or limit, was not in my textbooks years ago. I know of no theoretical justification. It’s difficult to be a target and a limit at the same time.’ No price index could accurately capture the real change in consumer prices, Volcker added. Besides, in a growing economy there is a tendency for prices to move up and down a little, not sideways. As to the idea that monetary policy should be eased at a time when the economy was robust and unemployment low merely because inflation trailed the target, well, Volcker thought, ‘certainly, that would be nonsense.’45 ([Location 3091](https://readwise.io/to_kindle?action=open&asin=B09NS1CZ7W&location=3091)) - Tags: [[blue]] - Leijonhufvud maintained, the target encourages central banks to pursue policies that undermine financial stability.46 As we shall see, the pursuit of a 2 per cent inflation target at a time of lingering deflation in fact forced central bankers to set interest rates at extremely low and even negative levels, thereby encouraging speculative borrowing and other forms of financial risk-taking.fn12 ([Location 3098](https://readwise.io/to_kindle?action=open&asin=B09NS1CZ7W&location=3098)) - Tags: [[blue]] - Through thick and thin, central bankers would cling to the sacrosanct target. Their credibility depended on it.52 Never mind that the policies called forth by inflation targeting appeared to be killing economic growth. Never mind that zero interest rates discouraged savings and investment, and impaired productivity growth. Never mind that ultra-low rates, by keeping zombie companies on life-support, resulted in the survival of the least fit. Never mind that central bank policies contributed to rising inequality, undermined financial stability, encouraged ‘hot money’ capital flows and fostered numerous asset price bubbles, from luxury apartments to cryptocurrencies. ([Location 3129](https://readwise.io/to_kindle?action=open&asin=B09NS1CZ7W&location=3129)) - Tags: [[blue]] - so long as capital is free to move between countries, interest rates should be determined by global forces. ([Location 3212](https://readwise.io/to_kindle?action=open&asin=B09NS1CZ7W&location=3212)) - Tags: [[blue]] - Summers, once a favourite to replace Bernanke as Chair of the Fed, now laid the blame fair and square upon central bankers: ‘Will they [central bankers],’ Summers tweeted in the summer of 2019, ‘not consider the possibility that ultra-low nominal yields might actually reduce aggregate demand while breeding financial instability, bank failure, “zombification” and reduced economic dynamism.’ The claim that ultra-low rates might be responsible for secular stagnation, rather than the other way round, was a radical thought. ([Location 3267](https://readwise.io/to_kindle?action=open&asin=B09NS1CZ7W&location=3267)) - Tags: [[blue]] - Borio cast aside the money veil to reveal a world of asset price bubbles, financial cycles, and credit booms and busts: ‘Think monetary! Modelling the financial cycle correctly … requires recognising fully the fundamental monetary nature of our economies,’ was Borio’s clarion call.7 The financial system, he asserted, doesn’t just allocate resources, it generates purchasing power. It has a life of its own. Finance and macroeconomics are ‘inextricably linked’. We inhabit a looking-glass world. Finance does not mirror reality, but acts upon it.fn2 Economics without finance, said Borio, is like Hamlet without the prince. ([Location 3322](https://readwise.io/to_kindle?action=open&asin=B09NS1CZ7W&location=3322)) - Tags: [[blue]] - After China flooded the West with cheap exports, the rate of inflation declined in the United States and elsewhere. Falling consumer prices weren’t in themselves an unmitigated disaster, and episodes of deflation didn’t reliably forecast economic calamity. Instead, Borio found that strong credit growth and real estate bubbles were more reliable red flags. ([Location 3331](https://readwise.io/to_kindle?action=open&asin=B09NS1CZ7W&location=3331)) - Tags: [[blue]] - Borio’s team scoured the historical data for evidence of Hume’s contention that the rate of interest was determined by real factors. But they found little relationship between interest rates and savings, investment or profits. There wasn’t even a stable link between demographics and interest rates.fn3 Instead, the BIS suggested that interest rates were influenced by monetary regimes. ([Location 3334](https://readwise.io/to_kindle?action=open&asin=B09NS1CZ7W&location=3334)) - as the Chicago economist (and former head of the Reserve Bank of India) Raghuram Rajan pointed out, central banks influence the expectations of bond investors: if the short-term interest rate is expected to remain low over the next ten years, the long-term interest rate will be low … By holding down the short-term rate, especially if the market believes it will be held low for a sustained period, the Fed can influence expectations of the future short-term rate and hence the long-term interest rate.8 ([Location 3343](https://readwise.io/to_kindle?action=open&asin=B09NS1CZ7W&location=3343)) - Tags: [[blue]] - The idea that errors in monetary policy might produce economic distortions, other than disturbances to the price level, was not countenanced by the central banking establishment. But Borio’s research led inexorably to this conclusion. Financial imbalances – a polite term for credit booms and speculative manias – tend to form during periods of low interest rates and low inflation, he noted.fn5 Before the financial crisis, global interest rates were low both in real terms and relative to the growth rate of the global economy. Credit booms and real estate bubbles often produce nasty economic shocks and are followed by weak recoveries. The post-Lehman economy conformed to earlier precedents, notably Japan’s after 1990. Central bankers responded to economic stagnation after 2008 by pushing rates even lower. Thus, low rates begat low rates. ([Location 3369](https://readwise.io/to_kindle?action=open&asin=B09NS1CZ7W&location=3369)) - Tags: [[blue]] - Debt was the missing link in the secular stagnation narrative, said Borio. The path to ever lower rates traversed a mountain of debt. The BIS defined interest as the ‘price of leverage’. It was only to be expected that as the price of leverage – borrowing – declines the stock of debt should increase. The residue of debt left behind by the crisis produced what Borio called a ‘financial drag’. As overburdened households turned to repairing their balance sheets, they borrowed and spent less. Borio and his colleagues found that the share of society’s income used for servicing debt (the debt–service ratio) tends to remain constant over time. Thus, ever lower interest rates are needed to sustain a rising stock of debt. A vicious cycle begins, with more debt requiring lower rates, and lower rates resulting in yet more debt. Some commentators referred to this decades-long process as the ‘debt supercycle’. ([Location 3375](https://readwise.io/to_kindle?action=open&asin=B09NS1CZ7W&location=3375)) - ultra-low interest rates eroded the banks’ ‘net interest margin’, damaging their profitability and making them reluctant to initiate new loans.15 And while extreme monetary policies appeared to make banks risk averse, they had the opposite effect on investors. Faced with a loss of deposit income, the BIS found that savers fled conventional banks to invest in financial markets, where they took greater risks in pursuit of higher returns. ([Location 3401](https://readwise.io/to_kindle?action=open&asin=B09NS1CZ7W&location=3401)) - Tags: [[blue]] - The Federal Reserve’s reflexive tendency to ease monetary conditions whenever markets became turbulent encouraged yet more risk-taking. Borio observed that central bankers were slow to hike rates during booms but rushed to ease them after every bust. Their asymmetrical approach imparted a downward bias to interest rates and an upward bias to debt, he noted. ([Location 3408](https://readwise.io/to_kindle?action=open&asin=B09NS1CZ7W&location=3408)) - Tags: [[blue]] - Printing money and manipulating interest rates changed the world after 2008, and not necessarily for the better. The financial panic was doused, but the world ended up with more debt, more bubbles, more zombies and more financial risk. Viewed from Borio’s perspective, secular stagnation was a monetary disease. ([Location 3459](https://readwise.io/to_kindle?action=open&asin=B09NS1CZ7W&location=3459)) - Tags: [[blue]] - In his book Capitalism, Socialism and Democracy, Joseph Schumpeter describes capitalism as a ‘process of industrial mutation … that incessantly revolutionizes the economic structure from within, incessantly destroying the old one, incessantly creating a new one. This process of Creative Destruction is the essential fact about capitalism.’ ([Location 3473](https://readwise.io/to_kindle?action=open&asin=B09NS1CZ7W&location=3473)) - Tags: [[blue]] - Hadley argued that interest ‘helps the natural selection of the most competent employers and the best processes, and the elimination of the less competent employers and worse processes’. Interest helps to eliminate the ‘industrially unfit’. By guiding selection of the most efficient businesses, Hadley added, interest ensures the ‘productive forces of the community are better utilized’. ([Location 3482](https://readwise.io/to_kindle?action=open&asin=B09NS1CZ7W&location=3482)) - Tags: [[blue]] - interest is not a deadweight but a spur to efficiency – a hurdle that determines whether an investment is viable or not. The rate of interest, Schumpeter wrote, ‘enters into every economic deliberation’. ([Location 3493](https://readwise.io/to_kindle?action=open&asin=B09NS1CZ7W&location=3493)) - Tags: [[blue]] - Matthew Klecker, a Chicago-based investor, compares the interest rate to the shot clock in professional basketball, whose purpose is to speed up the game. According to NBA rules, players on the offensive team have only 24 seconds of possession in which to score. ‘Zero-percent rates,’ writes James Grant, ‘institutionalize delay in everyday business and investment transactions. They lead to postponement of needed adjustments.’ ([Location 3494](https://readwise.io/to_kindle?action=open&asin=B09NS1CZ7W&location=3494)) - The Great Depression propelled productivity improvements across many other industries, ranging from airlines to warehousing. In his book The Great Leap Forward, Alexander Field of Santa Clara University claims that the 1930s were the most technologically progressive decade in American history. ([Location 3527](https://readwise.io/to_kindle?action=open&asin=B09NS1CZ7W&location=3527)) - Tags: [[blue]] - Note: Tougher conditions create an incentive for innovation and efficiency. Low interest rate environments can support suboptimal and inefficient processes for longer, wasting human capital. But how do we know what the right interest rate is? If it’s related to the speed of growth of the economy, then an interest rate around 2% is probably correct for the US. But also - different parts of the country grow at different rates. Can a nationwide interest rate capture this complexity? - As the saying attributed to the former astronaut and airline boss Frank Borman goes, ‘capitalism without bankruptcy is like Christianity without hell.’ ([Location 3547](https://readwise.io/to_kindle?action=open&asin=B09NS1CZ7W&location=3547)) - Tags: [[blue]] - In the early years of the century, the European Central Bank conducted monetary policy to meet the needs of a lethargic Germany, setting rates too low for booming Ireland and Greece. ([Location 3559](https://readwise.io/to_kindle?action=open&asin=B09NS1CZ7W&location=3559)) - Tags: [[blue]] - Once the party was over, the PIIGS (Portugal, Italy, Ireland, Greece and Spain) found themselves deep in the mire. The decline in interest rates since the creation of the euro had skewed the economies of Southern Europe towards construction. Borio’s colleagues at the BIS found that building booms had a lasting negative impact on economic growth. As Gita Gopinath, a Harvard scholar and future International Monetary Fund chief economist, noted, the shift towards construction depressed productivity: ‘By lowering interest rates and encouraging an inflow of capital, the adoption of the euro may have been partly responsible for the misallocation of capital and the low productivity observed in the South [of Europe].’ ([Location 3562](https://readwise.io/to_kindle?action=open&asin=B09NS1CZ7W&location=3562)) - Tags: [[blue]] - Bound by euro-fetters, members of the Eurozone could not regain competitiveness by devaluing their currencies. Instead, interest rates across the region diverged, with highly indebted countries, including Italy and Greece, suddenly forced to pay hefty risk premiums. Meanwhile German bond yields headed into negative territory. Deflation beckoned. Deleveraging was in order. To bring down labour costs, the PIIGS were going to have to embrace deep structural reforms. Unemployment in Spain climbed to Great Depression levels. Schumpeter’s forces of creative destruction were about to be unleashed, big time. ([Location 3569](https://readwise.io/to_kindle?action=open&asin=B09NS1CZ7W&location=3569)) - Tags: [[blue]] - Backed by Draghi’s hard commitment, banks in Spain, Portugal and Italy used cheap loans from the ECB to buy their own sovereign debt, pushing down credit spreads and making a lot of money in the process.16 Draghi successfully extinguished Europe’s debt crisis and saved the Single Currency, but soon enough a different problem became evident. ([Location 3580](https://readwise.io/to_kindle?action=open&asin=B09NS1CZ7W&location=3580)) - Tags: [[blue]] - Gresham’s Law states that bad money drives out good money. Under certain conditions, it applies to business conditions too. ‘In a kind of Gresham’s Law scenario, bad zombie thrifts tend to drive out healthy competition,’ wrote economist Edward Kane in 1989.17 ([Location 3587](https://readwise.io/to_kindle?action=open&asin=B09NS1CZ7W&location=3587)) - Tags: [[blue]] - studies showed that loss-making Japanese firms enjoyed better access to bank credit than profitable ones. Gresham’s Law was at work, once again. The zombification of Japan’s economy was associated with excess capacity across many industries – ranging from fridge makers to car manufacturing – that lingered for years. Corporate profits and returns on capital declined. Productivity growth suffered. Deflation lingered. With the forces of creative destruction stilled, Japan Inc. appeared increasingly sclerotic. ([Location 3593](https://readwise.io/to_kindle?action=open&asin=B09NS1CZ7W&location=3593)) - Tags: [[blue]] - Aside from buying their governments’ debt, Eurozone banks boosted lending to their most heavily indebted and least profitable corporate clients.20 Zero interest rates kept loss-making companies on life support. By 2016, the Organisation for Economic Co-operation and Development found that 10 per cent of firms were unable to cover their interest payments from profits – the OECD’s definition of a zombie. Europe, it seemed, was turning Japanese. ([Location 3605](https://readwise.io/to_kindle?action=open&asin=B09NS1CZ7W&location=3605)) - Tags: [[blue]] - Note: Cheap loans allow loss-making companies to continually take out new loans to cover their expenses. This process can continue for much longer (almost indefinitely) if rates hover near 0% - The zombie phenomenon was not confined to continental Europe. In both the United States and United Kingdom, ultra-low rates forestalled corporate bankruptcies. The default rate on US junk bonds after the Great Recession was just half the average of the two previous downturns. ‘The Fed’s extraordinary intervention,’ credit analyst Martin Fridson suggested, ‘enabled companies [to survive] that should have failed.’ ([Location 3609](https://readwise.io/to_kindle?action=open&asin=B09NS1CZ7W&location=3609)) - The lowest insolvency rates were reported by Greece, Spain and Italy – the countries hit hardest by the sovereign debt crisis and where one might have expected to see the greatest concentration of bankruptcies. Italy had the worst zombie infestation. ([Location 3618](https://readwise.io/to_kindle?action=open&asin=B09NS1CZ7W&location=3618)) - Tags: [[blue]] - Italian clothing company Stefanel was a typical zombie. Out-performed by strong competitors, the Veneto-based fashion firm produced a string of losses and went through several debt restructurings. Its share price collapsed. Stefanel clung on thanks to loan forbearance from its banks and the ECB’s negative interest-rate policy. Eventually, in June 2019, its shares were suspended after the company announced it was applying for special administration under bankruptcy law. ([Location 3621](https://readwise.io/to_kindle?action=open&asin=B09NS1CZ7W&location=3621)) - Tags: [[blue]] - Weighed down with old non-performing loans, European banks became reluctant to advance new loans. (The flattening of banks’ net interest margins by monetary policy exacerbated this problem.) A curious case of adverse selection appeared: more efficient firms in industries dominated by zombies were forced to pay more for their bank loans than those in other sectors.27 ([Location 3630](https://readwise.io/to_kindle?action=open&asin=B09NS1CZ7W&location=3630)) - Tags: [[blue]] - In the fifteen years since the start of the euro project, Italy enjoyed no increase in income per capita and labour costs climbed relative to Germany’s, rendering Italian exports uncompetitive. Italy’s public debt trailed only Japan’s and Greece’s. Italian banks were loaded down with hundreds of billions of euros of bad debts. Many of its largest businesses were certified zombies. Political sclerosis accompanied the economic version. The IMF warned that ‘in the absence of deeper structural reforms, medium-term growth is projected to remain low.’30 ([Location 3642](https://readwise.io/to_kindle?action=open&asin=B09NS1CZ7W&location=3642)) - Tags: [[blue]] - Easy money encourages people to invest in projects whose returns lie in the distant future.31 Residential property is a long-duration asset and construction booms facilitated by low interest rates are a common form of ‘malinvestment’. ([Location 3651](https://readwise.io/to_kindle?action=open&asin=B09NS1CZ7W&location=3651)) - Tags: [[blue]] - ‘A little-known fact about unicorns,’ mused James Grant, ‘is that they feed on interest rates. They like low, little rates – the tinier, the better.’34 Low rates induced investors to opt for ‘growth’, taking stakes in companies whose profits lay somewhere in the remote future. Low interest rates inured them to years of losses. Low interest rates justified the unicorns’ fabulous valuations. ([Location 3660](https://readwise.io/to_kindle?action=open&asin=B09NS1CZ7W&location=3660)) - Tags: [[blue]] - Note: Low rates mean many investments with low probability of payoff become viable - the safe alternative is treasuries that pay negative real rates - ‘What Uber has disrupted is the idea that competitive consumer and capital markets will maximize overall economic welfare by rewarding companies with superior efficiency. Its multibillion-dollar subsidies completely distorted marketplace price and service signals, leading to a massive misallocation of resources.’ ([Location 3684](https://readwise.io/to_kindle?action=open&asin=B09NS1CZ7W&location=3684)) - Tags: [[blue]] - Note: Easy money subsidizing loss-making startups distorts market signals - prices are able to be kept artificially low, pushing demand artificially high. In an environment without such easy money, Uber would have a much harder time competing with public transportation - Unicorns could be seen as a second class of zombie, wrote a correspondent to the Financial Times, ‘whose owners and investors can keep them alive by constant waves of propaganda about their cutting edge technology which has yet to produce a profit (Uber, for example) but are supposedly part of ‘disruption’ culture. This advertising keeps the flow of investments going. These companies are using the talent of engineers and coders, and marketing specialists that could be used in more productive enterprises. The hope that someday they will be profitable does not justify the destruction of useful and profitable business models.39 ([Location 3696](https://readwise.io/to_kindle?action=open&asin=B09NS1CZ7W&location=3696)) - Tags: [[blue]] - Note: Misallocation of some of the most valuable human capital in the world into companies that cannot turn a profit and rely on easy money - Ultra-low rates were supposed to induce companies to borrow and invest. But despite the central banks’ best efforts, investment collapsed throughout the developed world and remained low for years. ([Location 3740](https://readwise.io/to_kindle?action=open&asin=B09NS1CZ7W&location=3740)) - Tags: [[blue]] - When too many resources are stuck in low productivity areas and in zombie businesses – businesses that are too weak to invest in their underlying operations but have enough income from somewhere to survive – then the potential for the wider positive impact of particular innovative business investments will be frustrated.51 ([Location 3761](https://readwise.io/to_kindle?action=open&asin=B09NS1CZ7W&location=3761)) - Tags: [[blue]] - Ultra-low interest rates, he said, explained both the zombie phenomenon and the fact that once zombified, a company remained for longer among the living dead. The BIS found a close relationship between the share of zombie companies and the decline in policy rates. Low rates begot zombies, and zombies begot lower rates.fn9 The rate of interest both reflects and determines the return on capital, according to this view. Ultra-low interest rates lowered the hurdle rate for investment. As more capital was trapped in low-return businesses, whether zombies or unicorns, the marginal rate of return on capital declined. ([Location 3770](https://readwise.io/to_kindle?action=open&asin=B09NS1CZ7W&location=3770)) - Tags: [[blue]] - we observe striking similarities between the financial conditions of the early twentieth century and those of the post-Lehman era. Once again, the ‘price paid for the control of industry’ was at an all-time low, creating the conditions for a wave of anti-competitive mergers. Once again, Wall Street’s efforts were directed towards the manipulation of share prices, and the promoter’s profit was extracted at the expense of productive investment. And once again, workers felt the pinch and talk of economic stagnation filled the air. ([Location 3917](https://readwise.io/to_kindle?action=open&asin=B09NS1CZ7W&location=3917)) - Tags: [[blue]] - More important than Washington’s passivity towards nascent trusts was the collapse in corporate borrowing costs. Mergers were facilitated by a ‘strong appetite from debt investors (particularly for quality credits) and low interest rates [which] enabled acquirers to obtain financing on attractive terms’.23 Large companies could borrow at a lower rate than they earned on their capital, creating an opportunity for bankers to extract a ‘promoter’s profit’. ([Location 3932](https://readwise.io/to_kindle?action=open&asin=B09NS1CZ7W&location=3932)) - Tags: [[blue]] - Economists at the University of Michigan found that price-fixing cartels are more influenced by the level of interest rates than by any other factor. Cartels tend to form at times of low interest rates and break up when rates are high. ([Location 3956](https://readwise.io/to_kindle?action=open&asin=B09NS1CZ7W&location=3956)) - Tags: [[blue]] - while ‘low interest rates have traditionally been viewed as positive for economic growth … extremely low interest rates may lead to slower growth by increasing market concentration.’fn2 ([Location 3963](https://readwise.io/to_kindle?action=open&asin=B09NS1CZ7W&location=3963)) - Tags: [[blue]] - The buyout business model normally involved acquiring healthy firms and putting them through the financial wringer: juicy returns derived from applying leverage. Research suggested that most buyouts saw little improvement in operations or business strategy. A 2018 study found that most private equity firms actually cut long-term investment. ‘This [buyout] harvest is all about wealth extraction, not wealth creation,’ concludes one commentator. ([Location 3983](https://readwise.io/to_kindle?action=open&asin=B09NS1CZ7W&location=3983)) - Tags: [[blue]] - The great management consultant Peter Drucker once wrote that profits were not the rationale of business decisions, but rather the test of their efficacy.32 What Drucker meant was that if a company does its job well, delivering goods or services to customers at competitive prices, then profits should be forthcoming. ([Location 3988](https://readwise.io/to_kindle?action=open&asin=B09NS1CZ7W&location=3988)) - Tags: [[blue]] - Note: Profits provide information on action take action and see if profits increase or decrease. This is THE barometer that one should be measured by when trying to create a long term business. Maximizing profit (over a long timescale) ensures a healthy business. Maximizing valuation and stock price does not - Under the mantra of shareholder value, managements were encouraged to replace ‘expensive’ equity with ‘cheap’ debt. As long as the cost of borrowing was low enough, executives could boost their company’s earnings by repurchasing their shares with debt (see box, p. 165). Since companies with robust earnings growth performed well in the stock market, senior executives earned windfall gains from this simple feat of financial engineering. ([Location 3997](https://readwise.io/to_kindle?action=open&asin=B09NS1CZ7W&location=3997)) - Tags: [[blue]] - From the turn of the century, the cost of debt in the United States was held below the cost of equity. This ‘funding gap’ provided the impetus for share buybacks. ([Location 4001](https://readwise.io/to_kindle?action=open&asin=B09NS1CZ7W&location=4001)) - Tags: [[blue]] - The monetary authorities had hoped that companies would use their access to cheap debt to boost investment. But a very low interest rate, combined with a tax structure that favoured debt over equity, noted the OECD, ‘works directly against long-term investment’. ([Location 4005](https://readwise.io/to_kindle?action=open&asin=B09NS1CZ7W&location=4005)) - Tags: [[blue]] - As a share of cash flow, corporate investment fell to an all-time low in 2014.37 The Office for Financial Research, an independent offshoot of the US Treasury, warned that financial engineering was detracting ‘from opportunities to invest capital to support longer-term organic growth’. ([Location 4012](https://readwise.io/to_kindle?action=open&asin=B09NS1CZ7W&location=4012)) - Tags: [[blue]] - the use of low-cost debt to repurchase shares artificially boosts profitability and stock valuations. Given that executive compensation is generally linked to measures that are enhanced by financial engineering – such as returns on equity, EPS growth and stock performance – senior management has a strong incentive to play the game. Short-term investors, bankers and senior corporate executives benefit from this financial engineering, but no one else is better off. ([Location 4039](https://readwise.io/to_kindle?action=open&asin=B09NS1CZ7W&location=4039)) - Tags: [[blue]] - Thanks to the miracle of financial engineering, the earnings per share of S&P 500 companies grew faster than reported profits and sales.42 Even companies with declining profits were able to report a rise in per-share earnings.43 Some firms, including Exxon and IBM, operated what were in effect Ponzi schemes by distributing more in buybacks and dividends than they earned by way of profit. ([Location 4053](https://readwise.io/to_kindle?action=open&asin=B09NS1CZ7W&location=4053)) - Tags: [[blue]] - Under the influence of shareholder value, the distinction between financial and non-financial corporations was eroded. Corporate finance took precedence over ordinary business operations as the financial operations within firms accounted for an increasing share of profits.45 As one commentator put it, ‘the productive activities of the modern corporation are therefore incidental to the restructuring of corporate balance sheets and the making of money by buying and selling subsidiaries.’ ([Location 4059](https://readwise.io/to_kindle?action=open&asin=B09NS1CZ7W&location=4059)) - Tags: [[blue]] - Note: The focus on improving shareholder value, and thereby the price of shares, refocuses company management on financial engineering (ESPECIALLY when low interest rate and lax regulatory environments facilitate this). This redirects money from corporate investment to financial projects, while also taking the focus off the operational efficiency of the business. In effect, TO BE SUCCESSFUL IN BUSINESS DOES NOT REQUIRE ACTUALLY RUNNING THE BUSINESS. Finance becomes a substitute for commerce. The symbol subsumes the reality it represents - Countries, such as the United States and Britain, whose current account deficits were funded with cheap foreign loans experienced a loss of export competitiveness. Their economies shifted away from manufacturing towards services – banking in particular – which generated less productivity growth. ([Location 4088](https://readwise.io/to_kindle?action=open&asin=B09NS1CZ7W&location=4088)) - Tags: [[blue]] - Beyond a certain point, the BIS concluded, ‘the growth of a country’s financial system is a drag on productivity growth. That is, higher growth in the financial sector reduces real growth.’54 ([Location 4095](https://readwise.io/to_kindle?action=open&asin=B09NS1CZ7W&location=4095)) - Tags: [[blue]] - While Lampert failed as a retailer, he succeeded in extracting more than a billion dollars from his involvement with Sears and Kmart. ([Location 4139](https://readwise.io/to_kindle?action=open&asin=B09NS1CZ7W&location=4139)) - Tags: [[blue]] - In 1981, Jack Welch took over as chief executive at GE. A chemical engineer by training, Welch turned out to excel at financial alchemy. During his two decades at the helm, he returned the firm’s culture to its origins in the 1890s, when corporations operated ‘at the absolute service and mercy of the votaries of frenzied finance’. General Electric became a model of financialization. Welch streamlined its business, disposing of subsidiaries that lacked dominant market positions and buying up firms that competed with retained operations. Tens of thousands of employees were laid off, earning Welch the sobriquet ‘Neutron Jack’ (since the buildings were left standing after the workers had been terminated). He built up a financial services division, GE Capital, that in time accounted for more than half the conglomerate’s profits. Divisional heads were instructed to run their businesses to maximize the share price and were handsomely rewarded for doing so. During Welch’s tenure, GE reported more than a hundred consecutive quarters of earnings growth – an impossible feat achieved through the use of ‘cookie-jar’ accounting. While earnings increased eightfold under Welch’s watch, the stock price soared more than forty times. ([Location 4144](https://readwise.io/to_kindle?action=open&asin=B09NS1CZ7W&location=4144)) - Tags: [[blue]] - The rise and fall of General Electric provides a case study in the perils of financialization. The profits created by financial engineering and the valuations applied to those profits are chimerical, while the costs only become clear in the long run. Running a company with the sole aim of maximizing the share price often leads to bad corporate decisions. In retirement, even Welch acknowledged that shareholder value was probably ‘the dumbest idea in the world’. ([Location 4165](https://readwise.io/to_kindle?action=open&asin=B09NS1CZ7W&location=4165)) - Tags: [[blue]] - In his Theory of Interest (1930), Irving Fisher deliberated on the relationship between house prices and interest rates: ‘the price of a house is the discounted value of its future income. In the process of discounting there lurks a rate of interest. The value of houses will rise or fall as the rate of interest falls or rises.’ Not long after Fisher, another American economist, John Burr Williams, described how the act of discounting was key to valuation. ‘Investment Value,’ Williams wrote in The Theory of Investment Value (1938), is ‘defined as the present worth of future dividends, or of future coupons and principal’.2 Since then students of economics and business have been taught how to discount future cash flows and to calculate present values. Capitalization without interest, as Sir William Petty understood, is absurd ([Location 4191](https://readwise.io/to_kindle?action=open&asin=B09NS1CZ7W&location=4191)) - Tags: [[blue]] - Stock market bubbles often favour technology companies. This has been the case from the 1690s’ mania in London’s Exchange Alley for diving-bell stocks through to the internet bubble three centuries later. Exciting new innovations attract speculators because their profitability can only be imagined. But there’s another reason: since most of their profits lie in the distant future, the valuation of technology companies (also known as ‘growth companies’) is inflated when the discount rate falls. During manias, speculators are said to engage in ‘hyperbolic discounting’. ([Location 4263](https://readwise.io/to_kindle?action=open&asin=B09NS1CZ7W&location=4263)) - Tags: [[blue]] - Note: Super low discount rates essentially make future profits the “same” as current profits when it comes to valuation. If you can sell your company as one with a realistic path to monopolizing a massive market, it leads to insane valuations, no matter how far in the future that market dominance might come - In the era of ultra-low interest rates, time had no cost. Investors’ appetite for concept stocks at nosebleed valuations extended well beyond autonomous cars (Tesla) to animal-free protein (Beyond Meat), biotech (gene therapy stocks), Chinese internet (Alibaba, Tencent) and cloud computing. ([Location 4287](https://readwise.io/to_kindle?action=open&asin=B09NS1CZ7W&location=4287)) - Tags: [[blue]] - as fans of this ‘digital gold’ argued, the debasement of currencies by central banks meant a new type of money was needed. Cryptocurrencies were popular with millennials, not just because they were tech savvy but because low prospective returns on conventional investments forced them to go for broke. ([Location 4333](https://readwise.io/to_kindle?action=open&asin=B09NS1CZ7W&location=4333)) - Tags: [[blue]] - In financial terms, Bitcoin can be seen as a zero-coupon perpetual note, something intrinsically worthless. In the age of ultra-low interest rates a variety of assets that produced no income, whether gold, vintage cars, contemporary art or cryptocurrencies, were proving wildly popular. With little by way of a discount rate and no cash flow, rational valuations were impossible. ([Location 4335](https://readwise.io/to_kindle?action=open&asin=B09NS1CZ7W&location=4335)) - The Victorian philosopher and economist John Stuart Mill argued that wealth consists of anything, ‘though useless in itself’, which enables a person ‘to claim from others a part of their stock of things useful or pleasant’. By Mill’s definition, a high-flying but otherwise useless cryptocurrency was wealth, as were other evanescent assets: ([Location 4345](https://readwise.io/to_kindle?action=open&asin=B09NS1CZ7W&location=4345)) - Tags: [[blue]] - Note: In this definition, wealth is not useful in itself but can be easily transferred for something that IS useful - Mill’s contemporary John Ruskin took issue. The Victorian art critic pointed out that wealth was derived from the Latin, valor, valere, meaning to be well or strong. Real wealth, in his view, came from ‘the possession of useful articles which we can use’. It did not exist in exchange but must have some inner quality: ‘where there is either no intrinsic value, or no acceptant capacity, there is no effectual value; that is to say, no wealth. A horse is no wealth to us if we cannot ride.’ By extension, a crypto that cannot be used in exchange is not wealth. ([Location 4354](https://readwise.io/to_kindle?action=open&asin=B09NS1CZ7W&location=4354)) - Tags: [[blue]] - Note: This definition of wealth focuses on utility. There is no objective barometer of wealth (like net worth), because the utility of any given object varies from person to person. A builder gets much more utility from a power drill than does a software engineer - ‘Real wealth,’ wrote Smith, derives from ‘the annual produce of the land and labour of the society’.32 By this light, much millennial wealth wasn’t real at all, but mere claims to wealth whose market value multiplied as the discount rate declined. ([Location 4371](https://readwise.io/to_kindle?action=open&asin=B09NS1CZ7W&location=4371)) - Tags: [[blue]] - This viewpoint was expressed by Professor John C. Edmunds of Babson College, Boston, in an article for Foreign Policy in the summer of 1996. Edmunds extolled the potential of what he called a ‘New World Wealth Machine’: Many societies, and indeed the entire world, have learned how to create wealth directly. The new approach requires that a state find ways to increase the market value of its stock of productive assets … An economic policy that aims to achieve growth by wealth creation therefore does not attempt to increase the production of goods and services, except as a secondary objective.33 The simplest and most effective way to inflate the value of productive (and not so productive) assets was by lowering the rate of interest. This was the path chosen by the Federal Reserve after 2008. The rationale for ultra-low rates was expressed by Chairman Bernanke in a November 2010 op-ed for the Washington Post: ‘Lower corporate bond rates will encourage investment. And higher stock prices will boost consumer wealth and help increase confidence, which can also spur spending. Increased spending will lead to higher incomes and profits that, in a virtuous circle, will further support economic expansion.’ ([Location 4376](https://readwise.io/to_kindle?action=open&asin=B09NS1CZ7W&location=4376)) - Tags: [[blue]] - Note: Low interest rates were directly intended to inflate asset prices, making Americans feel richer in paper. This was intended to spur spending and kickstart the economy. We’ve seen that low interest rates did not spur corporate investment as intended (corporations borrowed to buy back shares rather than to invest in operational improvements), so did this work either? - The US economy was slowly financialized. Before the financial crisis most newly created jobs were in construction or services, such as banking, that benefited from the real estate and credit boom. The output of the finance, insurance and real estate sectors (FIRE) rose to be 50 per cent larger than manufacturing. The country possessed more estate agents than farmers. ([Location 4405](https://readwise.io/to_kindle?action=open&asin=B09NS1CZ7W&location=4405)) - Tags: [[blue]] - Between 2010 and 2014, total profits (as share of US GDP) were around 40 per cent above their post-war average. The most important contributor to rising profitability was the steep decline in corporate borrowing costs. ‘The single largest input to higher [profit] margins … is likely to be the existence of much lower real interest rates since 1997,’ concluded the Boston money manager Jeremy Grantham. ([Location 4423](https://readwise.io/to_kindle?action=open&asin=B09NS1CZ7W&location=4423)) - Tags: [[blue]] - What is meant by a bubble economy? The phrase came into popular usage in the late 1980s to describe Japan’s bubble-distorted economy. The baburu keiki (bubble economy) described the condition by which inflation in real estate and the stock market had entered deep into the sinews of Japan’s economy: corporate profits boosted by financial engineering; business investment fuelled by warrant bonds, which linked the corporate cost of capital to the price of the issuer’s shares; and spending on luxuries (gold flakes sprinkled on breakfast cereals, etc.) and other consumer items stimulated by rising asset prices and credit growth. By the end of the decade, the bubble infected everything – as the Japanese themselves were well aware. ([Location 4439](https://readwise.io/to_kindle?action=open&asin=B09NS1CZ7W&location=4439)) - Tags: [[blue]] - As Oxford’s first Professor of Political Economy, Nassau Senior, put it in 1836: ‘To abstain from the enjoyment which is in our power, or to seek distant rather than immediate results, are among the most painful exertions of the human will.’1 Interest is the wage of abstinence, said Senior. ([Location 4511](https://readwise.io/to_kindle?action=open&asin=B09NS1CZ7W&location=4511)) - Tags: [[blue]] - ‘To save,’ wrote Frédéric Bastiat, ‘is deliberately to put an interval between the moment when the services are made for the society, and that when the equivalent is received from it.’3 The reward for this ajournement is interest. ([Location 4522](https://readwise.io/to_kindle?action=open&asin=B09NS1CZ7W&location=4522)) - Tags: [[blue]] - This delicate balance is upset when the market rate of interest falls below society’s ‘crystallized impatience’. When the interest rate is higher than an individual’s time preference, he or she will save more for the future. Conversely, when the market rate is below the public’s time preference people borrow to consume. An abnormally low rate of interest boosts current spending, but the benefits don’t last. ([Location 4538](https://readwise.io/to_kindle?action=open&asin=B09NS1CZ7W&location=4538)) - Tags: [[blue]] - the policy of ultra-low interest rates, which started with the Dotcom bust and was revived after the subprime crisis, reduced the level of saving in the United States and elsewhere. The collapse in interest rates also lowered the return on retirement investments and raised the value of retirement liabilities. As a result, a pensions crisis appeared in the United States and Europe. Retirees around the world faced the grim prospect of outliving their savings and dying in penury. ([Location 4577](https://readwise.io/to_kindle?action=open&asin=B09NS1CZ7W&location=4577)) - Tags: [[blue]] - ‘In a world of ultra-low rates, most households have no hope of wealth accumulation, no matter how much they save. Indeed, they are better off being profligate.’ ([Location 4623](https://readwise.io/to_kindle?action=open&asin=B09NS1CZ7W&location=4623)) - Tags: [[blue]] - Over the long run, equity returns are inversely correlated with the market’s valuation. As with bonds, elevated stock prices imply lower future returns. In the United States, a balanced portfolio comprising of stocks and bonds has historically returned around 5 per cent after inflation.30 Ten years after the financial crisis, with the valuation of the US stock market at close to a record high and the yield on Treasuries near an all-time low, the expected return on a balanced investment portfolio was around half its historic average. ([Location 4659](https://readwise.io/to_kindle?action=open&asin=B09NS1CZ7W&location=4659)) - Tags: [[blue]] - In the short run, ultra-low interest rates boosted consumption by substituting bubble wealth for savings, but in the long run it was a disaster. Savings are needed for the accumulation of capital. Societies that don’t invest enough are doomed to stagnate. ([Location 4688](https://readwise.io/to_kindle?action=open&asin=B09NS1CZ7W&location=4688)) - Tags: [[blue]] - The historian R. H. Tawney described the changing attitudes to usury in sixteenth-century England: The theory of usury had been designed for an age in which the lender was rich and the borrower poor. Now the borrower was often a merchant who raised a loan in order to speculate on the exchanges or to corner the wool crop, and the lender an economic innocent, who sought a secure investment for his savings.5 ([Location 4821](https://readwise.io/to_kindle?action=open&asin=B09NS1CZ7W&location=4821)) - Tags: [[blue]] - Marx may have excoriated usury in the ancient world, but he also understood that interest in a capitalist world was different. Interest under capitalism, he said, should be viewed as a division of the economic surplus between lenders (whom he called ‘money capitalists’) and borrowers (‘industrial capitalists’). A decline in interest rates didn’t necessarily benefit workers, Marx wrote, since ‘interest is a relationship between two capitalists, not between capitalist and labourer.’6 ([Location 4827](https://readwise.io/to_kindle?action=open&asin=B09NS1CZ7W&location=4827)) - Tags: [[blue]] - justice is violated when lenders receive little or nothing while borrowers make fat profits from their loans. An equitable rate of interest is one that is neither too high nor too low. When the scales are tipped too far in the direction of low interest rates it’s plain unfair. ([Location 4847](https://readwise.io/to_kindle?action=open&asin=B09NS1CZ7W&location=4847)) - Tags: [[blue]] - In their history of inequality in the United States, Unequal Gains, Peter Lindert and Jeffrey Williamson suggest that inequality picks up when financial development outpaces economic growth. ([Location 4871](https://readwise.io/to_kindle?action=open&asin=B09NS1CZ7W&location=4871)) - Tags: [[blue]] - The Great Depression kicked off a multi-decade decline in inequality, what economists refer to as the Great Compression. ([Location 4883](https://readwise.io/to_kindle?action=open&asin=B09NS1CZ7W&location=4883)) - Tags: [[blue]] - inequality in the United States only took off after interest rates started to fall in the 1980s. In the wake of the Dotcom bust, easy money inflated a wealth bubble, and the wealth bubble exacerbated inequality. The rise in inequality, in turn, lowered the economy’s growth prospects, and as the economy stagnated, so did workers’ incomes. In other words, low rates begot inequality and inequality begot lower rates. ([Location 4934](https://readwise.io/to_kindle?action=open&asin=B09NS1CZ7W&location=4934)) - Tags: [[blue]] - The aftermath of the global financial crisis could scarcely have been more different to the post-1929 experience. A second Great Depression was avoided, but so too was another Great Compression. Unconventional monetary policies arrested Wall Street’s collapse. Bondholders were bailed out. Financial insiders with access to the Fed’s emergency lending facilities got to buy up distressed securities at bargain prices with subsidized loans. Despite record losses on Wall Street, billions of dollars in bonuses were distributed. The Fed, writes Philip Mirowski, ‘bestowed upon the banks seemingly permanent options to reward executives and shareholders by capping the downside while permitting an unlimited upside’. ([Location 4937](https://readwise.io/to_kindle?action=open&asin=B09NS1CZ7W&location=4937)) - Tags: [[blue]] - Five years after Lehman’s bankruptcy, US corporate profits reached their highest level since 1929.76 While the incomes of the richest Americans rose with profits (thanks largely to stock-based compensation), the wages of the bottom 90 per cent of workers were inversely correlated with the stock market.77 ([Location 5064](https://readwise.io/to_kindle?action=open&asin=B09NS1CZ7W&location=5064)) - Tags: [[blue]] - Nowhere in the academic literature was the impact of ultra-low interest rates given due consideration. It was left to a Rothschild banker to provide the missing link. In a letter to the Financial Times in early 2018, Yves-André Istel pointed out that since the early 1980s interest rates had declined from 15 per cent to less than 2 per cent: By itself, the mechanical effect of reducing accordingly the discount rate applied to estimated future cash flows explains largely the rise in value of equities (thus stock options and chief executive compensation), and real estate values. Bond prices rose equally, yields declined. Search for returns became desperate, and massive liquidity encouraged easy low-cost borrowing and leverage. All this benefited, obviously, those holding these assets, with a corresponding effect on inequality in the west.112 ([Location 5155](https://readwise.io/to_kindle?action=open&asin=B09NS1CZ7W&location=5155)) - Tags: [[blue]] - Thomas Piketty’s Capital in the Twenty-First Century became an overnight publishing sensation when it appeared in English translation in the spring of 2014 – more bought than read, but much discussed.125 Piketty rejected conventional explanations for inequality based on education and technology.126 Instead, he proposed a fundamental law: inequality rises whenever the return on capital (comprising profits, interest, dividends and rents) exceeds the growth rate of an economy. Piketty expressed this insight with the notation r > g, with r representing the return on capital and g the rate of economic growth. This formula, simple for even non-economists to grasp, became the slogan of the new class war, printed on T-shirts and paraded on banners at Occupy Wall Street demonstrations. ([Location 5206](https://readwise.io/to_kindle?action=open&asin=B09NS1CZ7W&location=5206)) - Tags: [[blue]] - Our alternative ‘iron law of inequality’ can be annotated as r < g, with r signifying the rate of interest and g the economy’s trend growth. This formula, which is the inverse of Piketty’s, can explain both changes in the distribution of income and wealth during the 1920s and the rise in inequality since the 1980s and, in particular, the Great Immoderation of the post-Lehman decade. ([Location 5239](https://readwise.io/to_kindle?action=open&asin=B09NS1CZ7W&location=5239)) - Tags: [[blue]] - Galiani saw that probability calculus, which in his day was already applied to commercial insurance, might also be used in the lending business. Interest, he wrote, ‘bears the same ratio to the capital as the probability of loss bears to the probability of repayment’. Since each loan carries a different risk, interest is as varied as are the almost infinite degrees of probability of loss, which is very great in some cases (as in maritime usury), sometimes falls to zero (as in the banks and companies of republics), and sometimes even below zero, becoming a negative quantity (as happened in France in the time of Law’s System).fn1 Viewed from this perspective, interest, said Galiani, can be seen as the ‘price of insurance’.5 ([Location 5269](https://readwise.io/to_kindle?action=open&asin=B09NS1CZ7W&location=5269)) - Tags: [[blue]] - Note: Higher risk leads to higher risk premiums - A bank acts much like an insurance company. The spread between what the bank charges for its loans and pays on deposits is akin to an insurance premium.fn2 In fact, bonds can be replicated with insurance contracts, known as credit default swaps (CDS). The yields on CDS vary with the probability of default, as Galiani thought should be the case. ([Location 5281](https://readwise.io/to_kindle?action=open&asin=B09NS1CZ7W&location=5281)) - Tags: [[blue]] - When the price of risk is set too low, too much risk is assumed, new risks multiply and the financial system becomes unstable. ([Location 5294](https://readwise.io/to_kindle?action=open&asin=B09NS1CZ7W&location=5294)) - Tags: [[blue]] - Modern finance theory states that this shouldn’t be the case. But investors ‘have a deeply ingrained notion that saving is the preservation of wealth and wealth should grow at a “decent” rate’. They won’t accept a loss of income. What’s more, their propensity to assume risk moves inversely with the interest rate. Bagehot was mistaken in one small detail. According to Ma and Zijlstra, risk-taking becomes extreme when bond yields fall below 3 per cent – not the 2 per cent level that drove John Bull to fabled acts of impetuosity.6 ([Location 5297](https://readwise.io/to_kindle?action=open&asin=B09NS1CZ7W&location=5297)) - Tags: [[blue]] - When short-term rates are low, investors have an incentive to take out loans to buy assets that yield more income. The difference between the cost of borrowing and the return on risky loans is known as the ‘carry’. There are numerous types of carry trades, from hedge funds using leverage to buy mortgage-backed securities to landlords taking out mortgages on their rental properties. The returns from carry trades are asymmetric: investors generally enjoy a steady stream of small gains but are exposed to sudden large losses. In market parlance, carry traders are said to pick up nickels in front of steamrollers. (More crudely, they are said to ‘eat like a bird, shit like an elephant’.) ([Location 5303](https://readwise.io/to_kindle?action=open&asin=B09NS1CZ7W&location=5303)) - Tags: [[blue]] - Duration even paid for owners of bonds with negative yields. Some $12 trillion-worth of bonds belonged to this category by the summer of 2016.23 ‘Yields don’t matter,’ declared a Tokyo insurance executive as the redemption yield on a thirty-year Japanese government bond turned negative.24 This comment was not as crazy as it may appear, since any loss of income experienced by bondholders was more than offset by the prospect of capital gains as interest rates declined. ([Location 5396](https://readwise.io/to_kindle?action=open&asin=B09NS1CZ7W&location=5396)) - Tags: [[blue]] - Duration may be profitable during a bond bull market, but it is also a risk factor. When interest rates rise, bondholders who own long-dated securities suffer most. As duration lengthened and the size of the global bond market expanded after 2008, the total loss exposure for fixed-income investors climbed inexorably. With trillions of dollars’ worth of bonds trading at negative yields, bondholders faced huge losses if interest rates were to rise unexpectedly. ([Location 5412](https://readwise.io/to_kindle?action=open&asin=B09NS1CZ7W&location=5412)) - Tags: [[blue]] - If liquidity represents the ability to trade securities without moving their prices, volatility measures the price movement between trades. Liquidity and volatility are inversely related: volatility declines when liquidity is abundant, but as liquidity dries up volatility takes off. Finance theory sees volatility as a measure of risk, while market practitioners describe it as the price of uncertainty. Volatility has also been called the price of market liquidity. The most frequently cited measure of volatility is provided by the VIX index, which calculates the implied volatility of the US stock market from the options prices on the individual companies which constitute the S&P 500 index. ([Location 5478](https://readwise.io/to_kindle?action=open&asin=B09NS1CZ7W&location=5478)) - Tags: [[blue]] - Dan Galai, the Israeli finance professor who created the VIX, suggested a link between ultra-low interest rates and ultra-low market volatility: ‘With so much liquidity in the market, it suppresses volatility,’ Galai mused as the VIX approached an all-time low in September 2017, ‘and that comes with interest rates [being] so low. Volatility being low for a long time is relatively new, but maybe it’s correlated, with the same causes.’ ([Location 5489](https://readwise.io/to_kindle?action=open&asin=B09NS1CZ7W&location=5489)) - Tags: [[blue]] - ‘[A] prolonged period of low interest rates, of the sort we are experiencing today,’ said Stein, ‘can create incentives for agents to take on greater duration or credit risks, or to employ additional financial leverage, in an effort to “reach for yield”.’ Low rates, he added, had spurred the development of new financial products to satisfy the demand for investment income.fn8 Regulation was all very well, said Stein, but only monetary policy ‘gets into all the cracks’. Stein later pointed out that the Fed’s policy of hiking interest rates by small increments, or ‘baby steps’, so as not to frighten the markets, backfired. The central bank’s predictability encouraged financial players to take on more leverage. The more the Fed fretted about Wall Street, the more cautious it became, and the lower interest rates fell. ([Location 5537](https://readwise.io/to_kindle?action=open&asin=B09NS1CZ7W&location=5537)) - Tags: [[blue]] - Could it be that the monetary policy experiments after the Lehman crisis did more harm than good? That was the view of PIMCO’s ‘Bond King’ Bill Gross, who, displaying his own science credentials, suggested that just as Newtonian physics breaks down at the speed of light, so a market economy ceases to function normally when interest rates approach the zero lower bound.4 Harvard economist Kenneth Rogoff stuck with this theme: Just as the normal laws of physics seem to be upended when an object approaches a black hole (or, to be more precise, the normal laws imply weird consequences), the laws of economics seem to be upended when a recession-stricken economy hits (or at least approaches) the zero bound. ([Location 5612](https://readwise.io/to_kindle?action=open&asin=B09NS1CZ7W&location=5612)) - Tags: [[blue]] - PIMCO’s bond manager described how the financial system needs a positive spread or carry between borrowing and lending rates. At zero rates, money market funds are forced to contract, and banks find it unprofitable to lend. Gross compared carry to the oxygen that feeds the blood. ‘Safe carry’, he maintained, was essential to capitalism. At zero rates, the blood becomes anaemic, oxygen-starved, even leukaemic.6 ([Location 5620](https://readwise.io/to_kindle?action=open&asin=B09NS1CZ7W&location=5620)) - Tags: [[blue]] - Note: The spread between 0% interest savings accounts and near 0% loans is too small to make a profit, forcing banks to engage in riskier behavior - As Gross pointed out, banks need a positive lending spread (net interest margin) to encourage them to advance loans.fn2 If banks don’t lend, they don’t create money either. Quantitative easing boosted asset prices and shrank credit spreads, but most of this newly created money wasn’t lent to consumers or businesses but was deposited by the banks at the Federal Reserve. The fact that the Fed in 2008 started paying interest on excess reserves (i.e. bank deposits at the central bank) gave banks even less reason to lend. The circulation of money through the economy slowed.8 In short, the Fed’s policy of keeping rates close to zero didn’t create inflation, but rather produced a lingering deflation. ([Location 5632](https://readwise.io/to_kindle?action=open&asin=B09NS1CZ7W&location=5632)) - Tags: [[blue]] - the unintended consequence of unconventional monetary policies was to reduce the economy’s trend growth rate, thereby lowering the natural rate of interest. Although the Federal Reserve didn’t take responsibility for this outcome, central bankers slowly came to understand that the natural rate was on a downward trend. A few years after the crisis, the Federal Open Market Committee – the body which sets the Fed funds rate – started to publish charts of each member’s prediction for the future course of interest rates. These ‘dot plots’, as they were called, showed that America’s monetary policymakers consistently overestimated the future level of interest rates. The FOMC’s median forecast for the ‘long term’ rate (the expected normal level of interest rates) trended downwards over time.9 ([Location 5661](https://readwise.io/to_kindle?action=open&asin=B09NS1CZ7W&location=5661)) - Tags: [[blue]] - Monetary interventions became progressively bolder. The Fed had started out in 2008 by acquiring a few hundred billion dollars’ worth of short-dated Treasury Bills, but later turned to buying bonds with lengthier maturities in order to push down long-term rates. The US central bank also assumed credit risk by acquiring mortgage securities. Even as memories of the financial crisis faded, the pace of the Fed’s securities purchases picked up.13 Former Fed Chairman Paul Volcker lamented that the Federal Reserve had ‘extended to the very edge of its lawful and implied power, transcending certain long embedded central banking principles and practices’.14 ([Location 5708](https://readwise.io/to_kindle?action=open&asin=B09NS1CZ7W&location=5708)) - Tags: [[blue]] - From the outset, negative rates created a tremendous challenge for conventional banks. When they were introduced into Europe, the head of Portugal’s central bank viewed them as a threat to the financial system.24 European banks felt unable to pass on the cost to depositors. German banks suffered huge losses, which they compensated for by taking more risk.25 The solvency problems at European life insurers and pension funds deteriorated.26 Liquidity in the bond markets dried up. The repo market likewise suffered.27 Real estate bubbles inflated in Switzerland and Sweden.28 ([Location 5805](https://readwise.io/to_kindle?action=open&asin=B09NS1CZ7W&location=5805)) - Tags: [[blue]] - The great Swedish economist Gustav Cassel, author of The Nature and Necessity of Interest, dismissed the ‘absolute absurdity of thinking’ that the rate of interest could ever fall to zero or less.45 The invitation to waste capital, Cassel said, would be overwhelming. ([Location 5851](https://readwise.io/to_kindle?action=open&asin=B09NS1CZ7W&location=5851)) - Tags: [[blue]] - The Nobel laureate Paul Samuelson likewise believed that the concept of a negative interest rate was absurd. The MIT economist suggested that if negative rates were maintained for long enough it might become profitable to level the Rockies to save on the fuel used by vehicles climbing steep gradients.47 UCLA economist Axel Leijonhufvud thought that if long-term rates turned more negative than short-term rates it could only be a sign of a decaying world.48 The world would be turned on its head. Banks would have to borrow long and lend short, and households would have to pay banks for the custody of their cash. The financial system, said Leijonhufvud, could never survive interest rates moving deeply into negative territory. ([Location 5857](https://readwise.io/to_kindle?action=open&asin=B09NS1CZ7W&location=5857)) - Tags: [[blue]] - Interest rates have always regulated international capital flows. In the era of the Gold Standard, this job was done automatically. If the Bank of England brought rates much below foreign levels, gold would leave its vaults for foreign shores. ‘Loanable capital, like every other commodity, comes where there is most to be made of it,’ wrote Bagehot of Victorian lending practices. In order to attract gold back to the City of London, the Bank of England would have had to raise its lending rate. ([Location 5883](https://readwise.io/to_kindle?action=open&asin=B09NS1CZ7W&location=5883)) - Tags: [[blue]] - Stanford economist Ronald McKinnon argued that the Arab Spring originated with ultra-low interest rates in the United States, which, as we have seen, drove capital flows into the emerging world and caused ‘overheating’ of the non-climate variety. China’s voracious demand for raw materials, in particular, stoked the ‘commodity super-cycle’.19 Easy money also stoked speculation in commodities, touted on Wall Street as a hot ‘alternative asset class’. McKinnon posed a tantalizing counterfactual: ‘If the Arab Spring had been recognized as mainly a food riot, the response of Western governments would have been more measured in taking sides, while focusing more actively on monetary measures to dampen cycles in primary commodity prices.’ ([Location 5984](https://readwise.io/to_kindle?action=open&asin=B09NS1CZ7W&location=5984)) - Tags: [[blue]] - A feedback loop exists between globalization and interest rates: more trade between countries tends to reduce inflation pressures and weaken the bargaining power of labour, both of which have an impact on the level of interest rates. The first wave of globalization, which dates from the 1860s to the end of the century, was accompanied by mild deflation and falling long-term interest rates.fn4 During the recent globalization phase, from 1980 onwards, China and other developing countries grabbed an increased share of world trade. Traded goods’ prices declined and millions of manufacturing jobs were ‘off-shored’ to emerging markets. Thus, globalization reduced both inflation and wage growth, which, in turn, allowed Western central banks to reduce interest rates, thereby spurring the greatest bull market in bonds in history. ([Location 6088](https://readwise.io/to_kindle?action=open&asin=B09NS1CZ7W&location=6088)) - Tags: [[blue]] - In the early 1970s, Stanford economist Ronald McKinnon coined the pejorative term ‘financial repression’ to describe the negative consequences of keeping interest rates below the level of inflation. Under such circumstances, borrowers benefit at the expense of savers. Market forces no longer determine how credit is dispensed. Banks become risk averse, preferring to lend to large corporations and state-related entities. Savers look to protect their wealth from inflation by investing in real estate or taking their money abroad. In short, financial repression stifles economic development and weakens the financial system. ([Location 6164](https://readwise.io/to_kindle?action=open&asin=B09NS1CZ7W&location=6164)) - Tags: [[blue]] - Financial deepening – defined as the accumulation of financial assets faster than non-financial wealth – played an important role in what has been called the China miracle.11 World Bank economists Robert King and Ross Levine find a strong relationship between the expansion of the financial sector and subsequent income growth. Their research suggests that finance leads growth, rather than the other way around. As King and Levine write, ‘When countries have relatively high levels of financial development, economic growth tends to be relatively fast over the next 10 to 30 years.’12 ([Location 6202](https://readwise.io/to_kindle?action=open&asin=B09NS1CZ7W&location=6202)) - Tags: [[blue]] - Most people look upon savings as a ‘real’ phenomenon; that’s to say, they assume that savings arise when individuals voluntarily refrain from consuming their income. But this isn’t how things work in the real world, says Borio. In the real world, banks create credit out of thin air. Savings and investment are two sides of the same coin. Thus, when a bank loan is used for the purposes of investment there occurs an automatic increase in reported savings.27 In China, financial repression stimulated credit growth; much of the new credit was invested, which, in turn, pushed up the savings rate. ([Location 6271](https://readwise.io/to_kindle?action=open&asin=B09NS1CZ7W&location=6271)) - Tags: [[blue]] - By late 2016 total real estate was valued at $43 trillion, equivalent to nearly four times GDP and on a par with the aggregate value of Japanese real estate (relative to GDP) at its bubble peak.47 Like Japan three decades earlier, China had transformed into a ‘land bubble’ economy. The French bank Société Générale had calculated back in 2011 that over the previous decade China had built 16 billion square metres of residential floor space. This was equivalent to building modern Rome from scratch every fourteen days, over and over again. ([Location 6372](https://readwise.io/to_kindle?action=open&asin=B09NS1CZ7W&location=6372)) - Tags: [[blue]] - The ostensible rationale for China’s incredible building spree was urban migration. Yet while hordes of migrants worked on construction sites, they couldn’t afford to acquire the properties they built. Instead, much of the demand for new homes came from investors. ([Location 6379](https://readwise.io/to_kindle?action=open&asin=B09NS1CZ7W&location=6379)) - Tags: [[blue]] - China’s real estate bubble threatened the country’s economic miracle, by lowering productivity growth and fuelling corruption.53 As a retired senior Beijing official described the situation: ‘The real estate industry’s excessive prosperity has not only kidnapped local governments but also kidnapped financial institutions – restraining and even harming the development of the real economy, inflating asset bubbles and accumulating debt risk.’54 Real estate was the one thing in China more powerful than its imperial President. ([Location 6394](https://readwise.io/to_kindle?action=open&asin=B09NS1CZ7W&location=6394)) - Tags: [[blue]] - Spending on infrastructure normally tracks economic development: bridges are built, tunnels dug and railway tracks laid because there is an existing demand for their services. In China, however, investment plans were lifted from the Field of Dreams’ script: ‘if you build it, he will come.’ New infrastructure would supposedly drive urbanization and boost productivity. But researchers at Oxford’s business school found that ‘Far from being an engine of economic growth, a typical infrastructure investment has destroyed economic value in China.’59 ([Location 6421](https://readwise.io/to_kindle?action=open&asin=B09NS1CZ7W&location=6421)) - Tags: [[blue]] - A much-cited factoid from the US Geological Survey claimed that in the three years after 2008 China consumed nearly one and a half times as much cement as the United States had used over the course of the twentieth century. ([Location 6448](https://readwise.io/to_kindle?action=open&asin=B09NS1CZ7W&location=6448)) - Tags: [[blue]] - As a share of GDP, China invested far more than any other Asian country had ever attempted. As investment climbed to unprecedented levels, the efficiency of investment – what economists call the ‘incremental capital to output ratio’ – spiralled downwards.fn10 All those immense sums spent on bridges, high-speed trains and roads were failing to generate the much-touted improvements to productivity. The People’s Republic was trapped on an investment ‘treadmill to hell’.80 But stepping off the treadmill would amount to ‘drinking poison to cure thirst’. ([Location 6493](https://readwise.io/to_kindle?action=open&asin=B09NS1CZ7W&location=6493)) - Tags: [[blue]] - The surge of credit unleashed by Beijing’s stimulus in 2009 acted like a gigantic defibrillator placed over the heart of a faltering economy. But credit is an addictive substance whose effect diminishes with excessive use. Even as China’s growth slowed over the following years, its economy required ever larger doses. After the stimulus, the boost to GDP from 100 yuan of new credit fell to 30 yuan, around a third of its prior level.81 The waning contribution of credit to economic growth matched the declining efficiency of investment. This was only to be expected since most investment was financed with debt.82 ([Location 6499](https://readwise.io/to_kindle?action=open&asin=B09NS1CZ7W&location=6499)) - Tags: [[blue]] - Former Finance Minister Lou Jiwei put his finger on Beijing’s dilemma: ‘The first problem is to stop the accumulation of leverage,’ Lou said. ‘But we also can’t allow the economy to lose speed.’96 Since these twin ambitions are incompatible, Beijing chose the path of least resistance. A decade after the stimulus launch, China’s ‘Great Wall of Debt’ had reached 250 per cent of GDP, up 100 percentage points since 2008.97 ([Location 6554](https://readwise.io/to_kindle?action=open&asin=B09NS1CZ7W&location=6554)) - Tags: [[blue]] - There were countless ways, legal and illegal, for citizens to evade capital controls. In Macau, casinos provided a ‘laundry service’ taking in yuan and paying out in Hong Kong dollars. ([Location 6658](https://readwise.io/to_kindle?action=open&asin=B09NS1CZ7W&location=6658)) - Tags: [[blue]] - Note: Incentive for the government to take tighter control over Hong Kong - The credit binge launched by the 2008/9 stimulus enhanced Beijing’s sway over the economy. As the state has advanced, productivity growth has declined. Because interest rates neither reflect the return on capital nor credit risk, China’s economy has suffered from the twin evils of capital misallocation and excessive debt. Real estate development, fuelled by low-cost credit, delivered what President Xi called ‘fictional growth’. By 2019 Chinese GDP growth (per capita) had fallen to half its 2007 level. ([Location 6743](https://readwise.io/to_kindle?action=open&asin=B09NS1CZ7W&location=6743)) - Tags: [[blue]] - The Global Financial Crisis brought about a massive increase in public debt, and rising indebtedness provided monetary policymakers with another reason to maintain low interest rates.2 As long as the yield on government bonds was held below the level of inflation, then, over time national debt could be inflated away. This was the West’s version of financial repression. ([Location 6769](https://readwise.io/to_kindle?action=open&asin=B09NS1CZ7W&location=6769)) - Tags: [[blue]] - Between 1945 and 1980, interest rates in the United States and the United Kingdom averaged in real terms (i.e., after inflation) minus 3.5 per cent. Negative real rates provided an annual subsidy to the US government equivalent to a fifth of tax revenues. Thanks to financial repression, America’s national debt (relative to GDP) declined by nearly three-quarters. The British liquidated their war debts in a similar fashion. ([Location 6778](https://readwise.io/to_kindle?action=open&asin=B09NS1CZ7W&location=6778)) - Tags: [[blue]] - Note: Potential benefit of low interest rates? Likely would need to be accompanied by restricted government spending (so monetary and fiscal partnership). The next section talks about also needing capital controls to prevent money leaving to foreign economies. Why? - With the prospect of short-term interest rates being held below inflation for years without end, the hedge fund tycoon Ray Dalio anticipated what he called a ‘beautiful deleveraging’.11 Contrary to Dalio’s expectation, public and private debt kept on rising. The lure of financial engineering prompted companies to take on more debt, while the decline in government bond yields removed any incentive to fiscal prudence. ([Location 6799](https://readwise.io/to_kindle?action=open&asin=B09NS1CZ7W&location=6799)) - Tags: [[blue]] - Note: Why did this not happen in the post war period, when negative real rates DID lead to widespread deleveraging? - In Europe, the central bankers’ dominion over the credit markets was most firmly established. In 2014, the European Central Bank launched a programme to provide free long-term finance for banks against the collateral of loans to companies and households.18 By deciding which debt was eligible for support, the ECB effectively directed credit towards what it deemed desirable ends. Two years later, the ECB added the debt of investment-grade corporations to its list of qualifying assets, thereby favouring large companies over small ones.19 Across the Channel, the Bank of England extended its bond purchases to include the securities of large foreign companies on the grounds that they contributed to the UK economy.20 ([Location 6836](https://readwise.io/to_kindle?action=open&asin=B09NS1CZ7W&location=6836)) - Tags: [[blue]] - A couple of years before the appearance of The Road to Serfdom, Hayek’s Austrian contemporary Joseph Schumpeter published an equally notable book. Capitalism, Socialism and Democracy (1942) is best known for introducing the idea of creative destruction (as discussed in Chapter 10). Schumpeter believed that a capitalist economic system would atrophy if it ever became stationary. At which point, Schumpeter predicted, profits and interest would converge towards zero: The bourgeois strata that live on profits and interest would tend to disappear. The management of industry and trade would become a matter of current administration, and the personnel would unavoidably acquire the characteristics of a bureaucracy. Socialism of a very sober type would almost automatically come into being.38 ([Location 6919](https://readwise.io/to_kindle?action=open&asin=B09NS1CZ7W&location=6919)) - Tags: [[blue]] - Schumpeter believed that capitalism was under attack from intellectuals – a group distinguished by their ‘absence of direct responsibility for practical affairs’, whose ranks were swollen by rising numbers of university graduates filled with a ‘righteous indignation about the wrongs of capitalism’.39 At one stage, Schumpeter poses the question, ‘Can capitalism survive?’ To which he answers, gloomily, ‘No. I do not think it can.’ ([Location 6929](https://readwise.io/to_kindle?action=open&asin=B09NS1CZ7W&location=6929)) - Tags: [[blue]] - So far, each step we have taken on this new road to serfdom has been incremental and justified on the grounds of expediency. Little thought has been given to the general direction in which we have been travelling. There is no grand master plan, unlike in Marxism, to concentrate minds. Rather, we have blundered – to use Hayek’s term – into greater government control of the economy. And the more we blunder, the more the system appears to fail, which in turn justifies further interventions. ([Location 6950](https://readwise.io/to_kindle?action=open&asin=B09NS1CZ7W&location=6950)) - Tags: [[blue]] - As Hayek realized, the public’s willingness to accept inequality depends on a shared belief that unequal outcomes reflect either differences in economic contribution or are a matter of luck. Few begrudge the fortunes earned by successful entrepreneurs and sports personalities. But when senior executives gain fabulous wealth by cutting investment and taking on debt, thereby lowering their company’s (and the economy’s) growth prospects, and when laid-off workers are forced to accept lower wages with reduced benefits elsewhere, then resentment against the system starts to build. ([Location 6973](https://readwise.io/to_kindle?action=open&asin=B09NS1CZ7W&location=6973)) - Tags: [[blue]] - In the early 1930s, Hayek argued that the cure for a credit boom wouldn’t come from lowering interest rates or by running large fiscal deficits. If interest rates had been too low before the crisis, then reducing them further was not the answer. Instead, he believed that interest rates should be allowed to rise, along with savings (which had been too low beforehand). Bad investments should be liquidated, he added. The Austrian economist failed to convince people at the time. Yet Iceland adopted many of Hayek’s prescriptions, out of necessity rather than ideological fervour, and emerged from the crisis in better shape than most. ([Location 7029](https://readwise.io/to_kindle?action=open&asin=B09NS1CZ7W&location=7029)) - Tags: [[blue]] - The recognition of the insuperable limits to his knowledge ought indeed to teach the student of society a lesson of humility which should guard him against becoming an accomplice in men’s fatal striving to control society – a striving which makes him not only a tyrant over his fellows, but which may well make him the destroyer of a civilization which no brain has designed but which has grown from the free efforts of millions of individuals.fn6 ([Location 7060](https://readwise.io/to_kindle?action=open&asin=B09NS1CZ7W&location=7060)) - Tags: [[blue]] - Note: Controlling a complex system that arose from the bottom up using top-down means is impossible. Hayek understood this. Instead, the conditions for efficient bottom-up growth need to be put in place. This involves facilitating individual freedoms and commerce, as well as allowing capital to be allocated naturally (through non state or central bank means) to the appropriate industries - Warren Buffett agreed that ultra-high valuations were supported by ultra-low interest rates. ‘Interest rates,’ said the Sage of Omaha, ‘basically are to the value of assets what gravity is to matter.’fn1 Once this gravitational force was removed, Dogecoins, NFTs, meme stocks and other speculative assets were free to float into the stratosphere. ([Location 7158](https://readwise.io/to_kindle?action=open&asin=B09NS1CZ7W&location=7158)) - Tags: [[blue]] - As globalization reverses and China’s workforce declines, inflation is likely to pick up and interest rates will have to rise to contain it.13 Claudio Borio’s ‘epoch-defining seismic rupture’ – a toxic mixture of high inflation, financial and trade protectionism and stagnation – no longer seems such a distant prospect. ([Location 7217](https://readwise.io/to_kindle?action=open&asin=B09NS1CZ7W&location=7217)) - Tags: [[blue]] - Something is needed to ensure the equality between the amount of tea which sellers are willing to put on to the market and the amount which buyers are willing to take off it; and that something is a certain price of tea. Similarly, something is needed to ensure equality between the amount of money which lenders are willing to put on the market for loans and the amount of money which borrowers are willing to take off it; and that something is a certain rate of interest.14 ([Location 7225](https://readwise.io/to_kindle?action=open&asin=B09NS1CZ7W&location=7225)) - Tags: [[blue]] - The source of the problem is that, whereas capital is limited, the medium by which savings are transferred – namely, money – can be created without limit by central banks (fiat money) and by commercial banks (fountain-pen money). As a result, the interest rate on money loans becomes detached from savings. ([Location 7232](https://readwise.io/to_kindle?action=open&asin=B09NS1CZ7W&location=7232)) - Tags: [[blue]] - Hayek envisaged a world in which money was issued by private banks that competed with each other to get their money accepted by the public. Good money would drive out the bad, he predicted. Any bank that offered too little interest would lose clients. ([Location 7235](https://readwise.io/to_kindle?action=open&asin=B09NS1CZ7W&location=7235)) - Central banks are developing digital currencies to compete with free-wheeling cryptos. The central bank digital currencies might be used to acquire government bonds that would provide them with asset-backing. If their issuance was limited to no more than the economy’s trend growth rate, this money would be as good as gold.16 A digital Gold Standard would have some of the advantages, and fewer of the disadvantages, of the classical Gold Standard. One advantage is that central bankers would no longer be able to pursue an active monetary policy. The cost of borrowing would more accurately reflect the supply of and demand for actual savings. Guided by the market’s invisible hand, the rate of interest would find its natural level. ([Location 7242](https://readwise.io/to_kindle?action=open&asin=B09NS1CZ7W&location=7242)) - Tags: [[blue]]