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Note: The Bookrat email is a spin-off from Anthony Pompliano's Pomp Letter. You will receive all future book summaries here, while still receiving Pomp's finance, economics, and bitcoin commentary on The Pomp Letter. Our goal is to separate the two types of content to make it easier to consume.
I read one book per week. Last week’s book was The Price of Time by Edward Chancellor. Highly recommend reading it. If you are interested in the individual highlights that I made in the physical book, you can read those here. Hope you enjoy these notes every Wednesday morning.
Stanley Druckenmiller recently said this is the most important book he has read in a long time. The idea of interest has been around for centuries, yet people continue to debate whether it should exist, what a proper interest rate is, and how interest can impact an economy or society. Edward Chancellor gives us a historical analysis of interest, which is followed by a compelling argument against the ultra-low interest rate environment of recent years. Reading this book is likely to convince you of a massive asset bubble in financial markets.
💡 Idea #1 — Interest is the price of time. This is not immediately obvious unless you can unpack why interest rates and time are so intertwined. Chancellor writes:
"The earliest allusion to time having value has been attributed to a fragment of the Greek orator Antiphon (480-411 BC) which states that “the most costly outlay is time.” Five centuries later, Seneca the Younger reminds his friend Lucillius that time is precious because man is mortal and his days are numbered: “embrace every hour,” he advises,”the stronger hold you have on today, the less will be your dependence on tomorrow.”"But you don't have to go back to 400 BC to understand this concept. You can see it in your daily life. Money today has a different value than money in the future.
"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."Due to this insight, you can think of interest as the price of time.
Interest has been described in many ways over the years—it’s often referred to as “the price of money.” But Thomas Wilson knew better. Interest, he said, is the price of time. There is no better definition.People who have patience and a low time preference should be rewarded.
"Given that life is nasty, brutish and often short, some reward for delaying immediate pleasures makes sense. It may also be the case that humans are congenitally short-sighted and under-estimate their future wants."💡 Idea #2 — Central bankers invented the idea of inflation targets, but it may be one of the most destructive things they have done. Chancellor writes:
"The use of targets is associated with a variety of adverse outcomes, including short-termism, the diversion of resources into bureaucracy, risk aversion, unjustified rewards, and the undermining of institutional culture."This reinforces the idea of Goodhart's Law.
“When a measure becomes a target, it ceases to be a good measure.” — Goodhart’s LawEven Paul Volcker thought the 2% inflation target made no sense.
“I puzzle at the rationale. A 2% 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.” — Paul VolckerIt is dangerous for us to turn a blind eye to the destruction caused by central bank policies. Chanceller explains:
"The pursuit of inflation targets resembled a massive real-time Milgram experiment, with the world’s citizenry as guinea pigs. Obsessed with their targets, technocrat central bankers were blinded to, or at least encouraged to downplay, any adverse results of their policies. Through thick and thin, central bankers would cling to the sacrosanct target. Their credibility depended on it. 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."💡 Idea #3 — Low interest rates drive ridiculous boom and bust cycles. These cycles are a net negative in the long-run and they reinforce bad behavior in the market. When rates are low, people are incentivized to take on more debt, which may be the exact opposite of what they should be doing. Chancellor writes:
"Financial imbalances—a polite term for credit booms and speculative manias—tend to form during periods of low interest rates and low inflation, he [Claudio Borio] noted." "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.”" "Borio asked, “if the origin of the problem was too much debt, how can a policy that encourages the private and public sectors to accumulate more debt be part of the solution?”"Financial markets are one of the places in society where a perceived solution can actually be the impetus for a larger problem. Quantitative easing has proven to be a perfect example:
"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."💡 Idea #4 — It is important for the health of an economy to have market downturns. These drawdown in asset prices, and the simultaneous drop in borrowing demand, help eliminate bad companies. Chancellor explains this phenomenon:
"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.”"Creative destruction gives way to new, improved products, services, and companies. We must tear down the old, inefficient things in order to build the better solutions.
"Creative destruction—the evolutionary process by which new technologies and business methods displace older, less efficient ways of doing things." "[Arthur] 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.”"We can clearly see creative destruction at play when bad times occur, as long as central bankers don't step in and prevent market cycles from playing out.
"The forces of creative destruction are at their most unremitting during sharp economic downturns. In the panic phase, the cost of borrowing soars. Sales dry up. Bankers call in their loans and become reluctant to supply new credit. Firms must cut costs fast, laying off less productive workers and finding other efficiency improvements. The weakest players fail. Survivors emerge from the trail leaner and fitter, better adapted to the new business conditions. The broad economy benefits from this dose of salts."💡 Idea #5 — Cheap, easy money flows to Wall Street. This is an uncomfortable truth for the investment class. It is easily seen in the promoter's profit. Chancellor writes:
"In an influential book, Finance Capital, published in 1910, Rudolf Hilferding came up with the concept of the “promoter’s profit.”" "The lower the interest rate, the higher the promoter’s profit."Private equity specifically figured out how to make the most money off the cheap capital available. On one hand, this makes them the winners of the game of capitalism. On the other hand, people will scoff at the profits they were able to pull in.
"No set of individuals benefited more from the Fed’s easy money than the buyout barons. None was less deserving."Many of these private equity investors were able to boost profits by simply employing an age-old strategy. The stock buyback became the weapon of choice and stock prices soared.
"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. Since companies with robust earnings growth performed well in the stock market, senior executives earned windfall gains from this simple feat of financial engineering. The promoter’s profit was back."
This has officially become one of my favorite finance books. I don't make that statement lightly. There are some amazing books out there, but Edward Chancellor really nails this one — understanding interest and interest rates will tell you more about financial markets than almost any other data point. If you don't believe me, read the book and then see what you think.
My first big takeaway was how old the debate around interest has been happening for. There is debate around the appropriate interest rate, but also the morality of interest. People from various points in history have argued different things. You could say that interest was ultimately deemed moral because it is continued in use today. You could also argue that the right interest rate is believed to be set by the free market — this one is more debated though. Central bankers would tell you they have a monopoly on setting interest rates, but the market likely would disagree. The funny thing? We still haven't solved that debate after a few centuries.
My second big takeaway was that interest rates ultimately serve as incentives. Lower the interest rate and you incentivize borrowing. Raise the interest rate and you incentivize saving. The central bank can pull the lever in either direction whenever they want. Chancellor wrote: "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." Just as taxes can be wielded for positive or negative outcomes, so can interest rates.
My third big takeaway was how emphatic the author comes out against maximizing shareholder value. This mantra has taken hold across Wall Street, but this book is a warning message against the practice. Chancellor said, "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.”" You know it is serious when Jack Welch is openly admitting mistakes he had previously hung his reputation on.
My final takeaway is that we could be in one large asset bubble. Stanley Druckenmiller, who recommended this book, appears to think so. A critique of this view would be "if everything is in a bubble, then nothing is in a bubble." I will leave you with this paragraph so you can make your own judgement:
"In the decade after Lehman’s bankruptcy a great variety of assets soared to extreme valuations. There were bubbles in industrial commodities and rare-earth elements, in US agricultural land and Chinese garlic bulbs, in fine or not-so-fine art, bubbles in vintage cars and fancy handbags, bubbles in super-city” apartments, bubbles in sovereign bonds, bubbles in Silicon Valley unicorns and cryptocurrencies, and a giant bubble in American stocks. Never before in history had so many asset price bubbles inflated simultaneously. But then, never before in history had interest rates around the world sunk so low."Interest is as old as money. Interest rates matter. And maybe the central bankers should stay out of the way of the free market.
As I mentioned, last week’s book was The Price of Time by Edward Chancellor. Highly recommend reading it. If you are interested in the individual highlights that I made in the physical book, you can read those here. Hope you enjoy these notes every Wednesday morning. Reply to this email with your thoughts, including what you agreed or disagreed with. I will respond to as many emails as I can.
-Pomp
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