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What Does the World Economy Have in Common with a Wheel of Cheese?
It’s all about Banks, Interest, and Bad Debt. Reviewing Edward Chancellor’s ‘The Price of Time’
Consider an Italian cheesemaker, specifically someone who makes “the king of cheeses,” Parmigiano-Reggiano. Parmesan cheese develops its bold, unique flavor over months of aging: eighteen months on the young side, thirty-six on the mature end. But that means cheesemakers wait up to three years to get paid for their work. Meanwhile, they’ve got to buy groceries. What to do?
Local bank Credito Emiliano offers a solution by providing loans against the mature value of the cheese. Cheesemakers give Credito Emiliano wheels of the young stuff, which the bank stores as collateral against the loan until the cheese can be sold at full value. To hedge against spoilage and market fluctuations, the bank loans only 70–80 percent of the projected value and charges 3–5 percent interest for the lost use of their own capital while cheesemakers spend it on dinner or invest it in their businesses.
As curious as such arrangements might sound, these cheesemakers stand in close proximity to the origins of finance itself. We just have to roll back the calendar about five thousand years when loans were common but money had yet to be invented.
The Origins of Finance
The story of finance starts with loans of animals and grain. The idea is simple enough: If someone borrowed livestock or seed, they returned the principle (the animal or equivalent seed) along with a cut of the increase (the interest on the loan). The practice echoes in the very words people have used for interest.
“Across the ancient world the etymologies of interest derive from the offspring of livestock,” explains financial journalist Edward Chancellor in his book, The Price of Time.
The Sumerian word for interest, mas, signifies a kid goat (or lamb). The ancient Egyptian equivalent ms means to give birth. In ancient Greek interest is tokos, a calf. Among the several Hebrew words for interest are marbit and tarbit, meaning to increase and multiply. The Latin for interest, foenus, connotes fertility, and for money, pecunia, is derived from pecus, a flock. Our word capital comes from caput, a head of cattle.
One way to think of interest is rent paid on money borrowed. But Chancellor argues, as his title suggests, it’s more accurately construed as the price of time. “The waiting is,” as Tom Petty sang, “the hardest part.” How much would you pay for use of that cow now, not later? Interest is the price we pay to cut the line. And how far you want to cut affects the invoice. Just compare a fifteen-year home mortgage to a thirty-year.
The longer we want to use resources we don’t own ourselves, the more we pay for the privilege. So, if interest is fundamentally about time, the next question is how we should price it. That question drives pretty much all the drama in Chancellor’s long and riveting history.
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Faulty Pricing and Misinformation
Three to five percent for Parmesan is relatively low. Historically, interest rates have been much higher. Babylonians charged 20 percent for loans of silver and 33.3 percent for barley. At the Delian Temple of Apollo borrowers from the fifth to second centuries before Christ could expect to pay 10 percent. Whether a tithe or a full third, we’re talking about a substantial portion. No surprise the ancient Hebrews employed an additional term for usury: neschek, to bite.
But the bite’s not all bad.
Prices represent information. Buyers and sellers use this information to make strategic and—hopefully—productive decisions. As the price of time goes up, people think twice (and more) about the bill. Likewise, the scrutiny drops in tandem with the rate. Lower costs means investors and speculators can evade risks that higher costs might impose.
As the price of time, the rate of interest rations the available supply of investment capital. Right up until it doesn’t. Bankers can, as Chancellor shows, lower the rate of interest to accelerate a plodding economy or turn a sinking one around. And in dire circumstances—during, say, the Great Recession—few people will argue with the tactic. But by artificially suppressing rates, bankers flood the economy with misinformation. The price of time doesn’t yield the intelligence it used to; instead, it winks and hints that things look better than they are.
Just consider the housing bubble that triggered the Great Recession. Easy money meant underwriters sold—and people took on—more debt than they could afford. Imagine that big Italian bank of Parmesan cheese with shelf after shelf of spoiled product. Debtors defaulted and there was little value in the collateral to recoup the losses.
Risks supposedly evaded by low rates have a funny way of biting more than the higher rates might. Chancellor traces a series of bubbles and blowouts prompted by both the availability of easy money and the need to secure higher returns for investment than banks could then offer with suppressed interest rates. A few examples:
France’s Mississippi Bubble of 1719, which gave us the word millionaire amid all its fevered speculation but which ultimately collapsed.
Britain’s Crisis of 1825 in which low interest rates drew money out of savings and into investment speculation for higher returns; the banks nearly crashed and the returns failed to materialize.
The Overend Gurney collapse of 1866 where a bank that traded in short-term lending locked too much of its capital in long-term investments and was unable to serve its own customers.
In these and other episodes, low interest rates made investors impatient for higher returns, which fueled greater speculation in riskier ventures. Simultaneously, lower interest rates made borrowing money to speculate attractive to those that couldn’t otherwise afford it.
Low interest rates sent waves of bad information through the economy, which was soon propped up with more wishes than wealth.
But Now We’re Smarter, Right?
The trouble with all these dates—1719, 1825, 1866—is that the distance might lead us to think we’re beyond those kind of mistakes. Surely, we’re smarter these days. Chancellor says no.
In response to the market crash of 1987 and the savings and loan crisis of the late eighties and early nineties, for instance, the U.S. Federal Reserve kept interest rates low to free up capital and revive the economy. But while the low rates addressed the symptoms, they also helped fuel asset-price bubbles, especially in housing.
In 2002 Fed chairman Alan Greenspan told a congressional committee that low rates had spurred home sales and construction. “Mortgage markets,” he added, “have also been a powerful stabilizing force . . . by facilitating the extraction of some of the equity that homeowners have built up.” But unintended consequences followed. Four years later, Greenspan admitted certain sectors of the housing market appeared “frothy,” that is, both more active and less substantial than warranted.
Cheap home debt allowed Americans to spend and invest more money, but the number and excitement of those loans masked their shoddy quality. The shelves were full of bad cheese. The Great Recession resulted when the bubble burst in 2008.
And what drove the recovery? More cheap debt. The Fed’s low rate kept the economy going and bailouts prevented a collapse, but it didn’t solve the underlying problems. Arguably, it exacerbated them. We traded a housing bubble, says Chancellor, for an “everything bubble.”
One strength of Chancellor’s history is his wide engagement with the theory and theorists behind economic policies and their evaluation. Austrian economist Joseph Schumpeter rises to the fore more than once. Schumpeter is famous for the phrase “creative destruction,” which describes capitalism’s tendency to find productive investments while flushing out the bad.
The unintended consequence of bailouts and cheap money was to stifle the creative destruction dynamic. Instead of flushing the bad investments, these policies helped them persist. Chancellor refers to them as “zombies.” But sticking with the Parmesan example, we can think of these defaulted loans, lousy investments, and failed companies as spoiled cheese. Instead of getting rid of it, we decided to hold onto it and pretend it’s still good.
Such a system is not a free market, says Chancellor. Instead, the financial sector has socialized their risks and engineered the trade for their benefit. Rising inequality, which critics blame on the free market, is one of the consequences.
There’s much to learn in The Price of Time that might help bankers and policymakers chart a better course, but it’s not an encouraging story. While reading, I was often reminded of a line from Dorothy Sayers’ 1942 essay, “Why Work,”
A society in which consumption has to be artificially stimulated in order to keep production going is a society founded on trash and waste, and such a society is a house built upon sand.
I was also reminded of Milton Friedman’s frequently cited adage, “There ain’t no such thing as a free lunch.” We’ve been living in a world of low interest rates and cheap money for decades now. We’re reasonably wary of the bite we’ll feel from increased rates. But avoiding the bite might be even worse.
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