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🔑 Key Takeaways

  1. Debt jubilees have been historically used for large debt forgiveness but today, financial repression or inflation can be utilized by keeping interest rates below inflation, thereby sneaking into the early stages of ongoing debt jubilee.
  2. Debt Jubilee can lead to a quicker recovery than quantitative easing and low interest rates. Efficient economies charge a price on time, but regulators struggle to find fair levels of interest on loans.
  3. Age affects borrowing willingness and John Law's belief in increased money supply and paper currency led to the formation of central banks.
  4. Beware of manipulating the money supply and inflating asset prices to avoid disastrous consequences such as those experienced by the Mississippi Company. Realize profits during asset price booms and monitor commodity and food prices to mitigate the impact of inflation on the cost of living.
  5. Law's success in implementing low interest rates laid the foundation for modern central banking, but his failed scheme serves as a cautionary reminder that monetary policy alone cannot cure the complex problems of a struggling economy.
  6. Low interest rates can lead to foolish risks and lending crises. The 2% tipping point is the threshold at which people take these risks. However, recent research suggests it may actually be 3%. Be cautious and weigh risk and return during low interest rate periods.
  7. While lowering interest rates may appear to benefit the economy by boosting borrowing and reducing unemployment, it can also lead to risk buildup that may be challenging to identify. The absence of a natural rate of interest can indicate that the policy rate is set too low, reflected in dangerous events occurring in the financial system.
  8. Low interest rates can result in zombie companies and hinder creative destruction, leading to low productivity and wages. It is crucial to consider the impact of financial policies on the economy to avoid a vicious cycle.
  9. Interest rates put a price on time, making it the most important economic variable. We need to understand its role in history and society to avoid errors and financial market crashes.

📝 Podcast Summary

The Age-Old Role of Interest Rates and Debt Jubilees.

Interest rates have been around since ancient times, with Mesopotamians recording loans on clay tablets. Interest has played a crucial role in societies throughout time and has caused boom and bust cycles. Debt jubilees, or official forgiveness of debt by rulers, have been used historically to level large amounts of debt and start anew. Today, debt jubilees occur through financial repression or inflation, by keeping interest rates below inflation. Therefore, we are already in the early stages of an ongoing debt jubilee. While forgiving all debt may make headlines, we have found another sneaky way of doing it without explicitly saying so.

Debt Jubilee vs. Quantitative Easing

The case of Iceland after the 2008 crisis shows that a debt Jubilee, or a sort of default, can lead to a quicker recovery than quantitative easing and low interest rates. Time is considered man's most precious possession, and interest rates are a way of putting a price on how we spend our time. Income smoothing is the concept of borrowing and repaying debts over time to even out income growth. Efficient economies are driven by a charge on time, as seen with the medieval practice of demurrage charges on slow ships. Regulators are still trying to solve for fair levels of interest on loans despite attempts at regulation throughout history.

People's time preference and John Law's economic ideas that shaped banking

People's time preference or degree of impatience affects their willingness to borrow and pay interest. Younger people are often more impatient and eager to borrow, while older people who don't expect their income to grow are less keen to borrow. A famous figure in economic history, John Law, developed an interest in economics and proposed a land bank, as well as the idea that money is just a yardstick of value. He believed that replacing currency backed by precious metals with paper currency and increasing the money supply would lead to economic prosperity. He started a private bank in France, which grew to become an extensive holding company acquiring various assets, including the Louisiana Company. Law's private bank eventually became a central bank or a national bank, called the Bon Royale.

Lessons from John Law's Mississippi Bubble

John Law's Mississippi Bubble was an extraordinary achievement, but it fell apart due to inflation. Law's decision to withdraw currency from circulation and deflate it proved to be his downfall. This teaches us that manipulating the money supply in a bid to prop up asset prices can lead to disastrous results. It is important to beware of bubbles, especially when stocks trade at valuations that are abnormally high relative to historical norms, as occurred with the Mississippi Company. Inflation can also take a toll on people's cost of living, which highlights the need to monitor commodity and food prices. Realization of profits during asset price booms is an important consideration since wealth is numerical in nature and may lack real substance.

John Law, the Father of Modern Central Banking

John Law, the first fiat money central banker, was a low interest rate advocate and succeeded in his aim of bringing down interest rates through monetary policy. Law provided the framework for modern central banking, making him relevant in today's times. However, Law's scheme, designed to alleviate the French nobles, ended in a resounding failure leading to a toxic mixture of deflation, unemployment, and soaring government debt. The collapse of Lehman Brothers in 2008 can be compared to the French economy after the death of Louis XIV. Both had a huge mountain of debt, bad debt deflation, depression and a hope that waving a monetary wand can cure the problem.

The Dangers of Low Interest Rates and the 2% Tipping Point

Low interest rates encourage people to take more risks, which increases the likelihood of speculative manias and lending crises. The 2% tipping point, coined by John Fullerton and popularized by Walter Bagehot, refers to the threshold at which people will take foolish risks to make up for income losses. However, recent research suggests that the threshold may actually be 3% yield. The key function of interest is that it is the price of anxiety or the price of risk. Policies that encourage people to use money to dispel economic problems can ultimately lead to currency depreciation and collapse in value. It's important to carefully weigh risk and return when making investment decisions, especially during periods of low interest rates.

The Dangers of Lowering Interest Rates

Lowering interest rates to encourage borrowing may bring an end to deflation and lower unemployment, but it also encourages a buildup of risk in the system, which may be hard to identify. The concept of a 'natural rate of interest' has a thorny history, but modern monetary policy makers use it to determine whether policy rates are too low or too high. Edward Chancellor argues that aside from inflation and deflation, other things like asset price inflation and credit booms show that the policy rate has been set too low. Hence, the absence of the natural rate, indicated by dangerous things happening in the financial system, reveals the presence of a policy rate that is too low.

The Vicious Cycle of Low Interest Rates and Low Productivity

Low interest rates can lead to misallocation of capital which can result in the formation of zombie companies and hinder creative destruction in the economy. Lack of creative destruction then has an impact on productivity which feeds through to low wages. Low productivity, in turn, feeds back into low-interest rates. The academic economist nowadays tends just to have an abstract view of the economy, which is far away from the reality one can observe. There are constant feedbacks between finance, policies and the financial system and the economy. Therefore, it is essential to consider the impact of financial and monetary policy on the economy to avoid the vicious cycle of low productivity and low-interest rates.

The Importance of Interest Rates in Our Lives and the Economy

The interest rate is central to all of human life and capitalist system, as it puts a price on time. Without applying a discount rate, an interest rate, you cannot have a price, resulting in infinite prices. Interest is the most important economic variable, and we have lost sight of what it does and the richness of its functions. The universality of interest is what my friend Jim Grant calls 'the cause interest, the universal price.' The errors of our way are being recognized as inflation rises, interest rates increase, and financial markets crack. The Price of Time is a book that explores the significance of the interest rate throughout history and its critical role in today's society.