THE PRICE OF TIME

It's often remarked that there are two simple subjects that can readily trip up even the brightest minds: probability and interest. For some reason, neither is something that people grasp intuitively because…well, maybe people just aren't native probabilistic or financial thinkers in that sense.

Of the two, many authors have already written at length about probability. But interest? Not so much. It's for this reason that Edward Chancellor's The Price of Time: The Real Story of Interest stands out. Here's a book that is squarely about interest (in the financial sense of the word).

Conceptually, it might be said that the book is divided into two parts. The first goes over the concept of interest and how our understanding of it has evolved through human history. "Interest exists because loans are productive, and even when not productive still have value," Chancellor writes. "It exists because those in possession of capital need to be induced to lend, and because lending is a risky business. It exists because production takes place over time and human beings are naturally impatient."

Thus, it's plain to see where the book derives its title: from a financial standpoint interest is no more and no less than the price of money and therefore also the price of time, because there is an intertemporal dimension to consider wherever the the exchange of money is concerned.

It's such a straightforward point that it's fascinating how society has grappled with the propriety of interest since Babylonian times. Or to put it differently, when is charging interest reasonable as opposed to usury? Outside conservative viewpoints that equate the two, it seems there's some intuitive understanding that only unreasonably high interest rates constitute usury and should therefore be verboten. (Curiously, the British empire seemed to have skirted this issue with a royal decree that it's only usury if the Crown says it is, which is certainly one way to look at things.)

Today, of course, that interest is charged in financial transactions is accepted and expected practice. This brings readers to the second part of The Price of Time, where Chancellor describes the economic consequences of getting interest rates wrong.

The main argument of this part of the book is simply that bad things happen when we price money to cheaply. Consider: if the interest rate is the cost of capital, then there should be a natural rate of interest in every economy. Yet Central Banks try to influence that natural rate by setting nominal rates of interest, which in turn affect the money supply, and therefore inflation/prices, and therefore employment. In theory, when faced with the prospect of an economic downturn or financial crises, Central Banks can cushion the impact by making credit more accessible through lower interest rates. However, in practice Central Banks consistently set interest rates too low, which precipitates and aggravates the very crises that they strive to avoid—or so Chancellor's argument goes.

It's something that will be very familiar to anyone who's read The Big Short (or watched the film adaptation). Depending on your perspective, it's all a matter of regulatory capture or misaligned incentives (or both). Take the United States as an example. A regime of low interest rates regime throughout the 1990s led to price stability and easy access to credit, but also to the real estate bubble that eventually gave rise to the 2008 financial crisis. Thereafter, while it's true economic stimulus (as well as a government bailout) averted outright disaster, the gains from these were still concentrated among those with access to larger financial markets at the expense of ordinary citizens. Today, something analogous is also playing out in China—with the outcome yet to be written.

Certainly, there's a lot to unpack in this part of the book. For the uninitiated, Chancellor's presentation may be "Exhibit A" as to why there aren't more books about the subject: there are a lot of complex concepts to follow, plenty of policy decisions to deconstruct and their consequences to analyze, and it all comes at a rapid clip. No doubt, it's heavy stuff. But the patient will be rewarded with a discussion that will change the way they view how markets work (or don't), not to mention the far-reaching consequences of monetary policy.