A renowned financial historian, journalist, and investment strategist, Edward Chancellor is a distinguished voice of caution in an often-exuberant financial world. His work delves into the history of financial speculation, the critical role of interest rates, and the cyclical nature of markets. Chancellor's insights, drawn from centuries of market behavior, offer invaluable lessons for investors and policymakers alike.
On Interest Rates: The Price of Time
At the heart of Chancellor's analysis is the fundamental role of interest rates as the "price of time." He argues that manipulating this price has profound and often detrimental consequences.
- On the essence of interest: "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."[1]
- The function of interest: "Interest exists because capital is scarce, man is mortal, and time is valuable."[2]
- Capitalism's dependence on interest: "Capitalism cannot function without interest. The invention of interest was the most important innovation in the history of finance as it allows people to transact across time by borrowing and lending, valuing assets, investing, putting a price on risk, and so forth."[3]
- The danger of low rates: "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."[4][5][6]
- Distorting the economic signal: "It is important that interest rates provide an accurate signal to economic agents. Yet, throughout history, this signal has nearly always been corrupted by government regulations."[2]
- The Everything Bubble: Ultra-low interest rates have resulted in an "everything bubble" in asset prices and extreme wealth inequality.[7]
- The impact on savers: Even households with relatively low incomes have savings, and they have lost hundreds of billions of dollars in interest income after 2008.[3]
- The illusion of wealth: "When the system then all starts falling to pieces you get inflation rising interest rates. and the asset prices come down you say actually hang on say i wasn’t as rich as i thought i was." (Money Talks with Liam Halligan, GB News, July 13, 2022)
- A historical perspective: The cultural level of a nation is mirrored by its rate of interest, with very low rates often being the calm before the storm.[6]
- The origin of interest: The concept of interest in its modern sense likely arose from productive loans, such as loans of seeds and animals that would yield an increase.[4]
On Financial Speculation and Bubbles
Chancellor is a keen student of financial manias throughout history, warning that while the objects of speculation change, the human behavior driving them remains constant.
- The nature of speculation: "Credit was the Siamese twin of speculation; they were born at the same time and exhibited the same nature; inextricably linked, they could never be totally separated."[8]
- The illusion of a new era: A common feature of speculative manias is the belief that "this time it's different," but history shows this is rarely the case.[8]
- The fuel for bubbles: "These really are the craziest financial markets, as far as I can see in my reading of history, that have ever been witnessed.”[9]
- The psychology of bubbles: During speculative manias, inexperienced investors enter the market, and a "hive-mind" disregards evidence that contradicts the prevailing narrative.[8]
- The aftermath of bubbles: "A mighty bubble of wealth is blown before our eyes, as empty, as transient, as contradictory to the laws of solid material, as confuted by every circumstance of actual condition, as any other bubble which man or child ever blew before.”[8]
- Spotting a bubble: Periods of speculative euphoria, wasted investments, and a surge in initial public offerings (IPOs) are all signs of a potential bubble.[10]
- The role of debt: Speculators often use debt to enhance their returns, amplifying both gains and losses.[10]
- The inevitability of busts: It's an inevitable feature of a capitalist or market-based system that you'd have these periods of boom and bust.[4]
- Historical repetition: Those who do not understand history are doomed to repeat it, a truth particularly relevant in financial markets.[3]
- The challenge of each crisis: Each successive financial crisis tends to be larger and more difficult to analyze than the one before it.
On the Capital Cycle and Investment Strategy
Chancellor, as the editor of "Capital Account," champions the capital cycle approach to investing, which focuses on the supply side of an industry rather than just demand.
- The core of the capital cycle: "It is better to invest in a mature industry where competition is declining than in a growing industry where competition is expanding."[11]
- The determinant of shareholder returns: "The most important determinant of share price performance is management's ability to allocate resources efficiently."[11]
- Profitability and competition: "Profitability is determined primarily by the competitive environment or the supply side, rather than by revenue growth trends."[11]
- The long-term view: "Over the long run, share prices are determined by cash flows, which are themselves primarily influenced by the competitive environment of an industry.”[12]
- Beyond quarterly earnings: "Over the long run, it is a company's return on capital, not changes in quarterly earnings, which primarily determines the direction of its share price."[12]
- The red flag of increasing capacity: "When shares are priced on the assumption that existing returns are likely to be maintained or even improved, then a rapid increase in industry capacity should serve as a red light.”[12]
- The cure for poor returns: "One of the primary cures for poor returns is consolidation, which is either driven by mergers and acquisition activity or by firms leaving the industry."[12]
- The contrarian approach: The capital cycle framework helps investors to be "contrarian and right" by identifying areas where capital is scarce and future returns are likely to rise. (The Value Perspective Podcast, Schroders, November 25, 2024)
- The importance of capital allocation: How managers understand the capital cycle and allocate capital is critical for long-term corporate success.[13]
- Avoiding the bubble: The capital cycle helps investors avoid bubbles and sectors where excess capital is flowing, which tends to depress returns. (The Value Perspective Podcast, Schroders, September 17, 2024)
Learnings on the Broader Economy and Society
Chancellor's analysis extends beyond financial markets to the wider implications of monetary policy on society.
- The rise of "zombie" firms: Ultra-low interest rates have kept unprofitable "zombie" companies alive, leading to overcapacity and a misallocation of capital.[14]
- Stifled productivity: The survival of zombie firms has hindered new business formation, innovation, and overall productivity growth.[14]
- Financialization over productive investment: "The Promoter's Profit" describes how financialization, fueled by easy money, crowds out investment in the real economy.[14]
- The erosion of savings and pensions: The era of low interest rates has eroded the value of savings and contributed to a looming pension crisis.[14]
- Exacerbating inequality: Low interest rates benefit the wealthy who have access to credit, while penalizing savers, thus exacerbating inequality.[4][14]
- The unseen consequences: The focus on the immediate, visible benefits of low interest rates often obscures the long-term, unseen negative consequences.
- The link to populism: Ultra-low rates have likely played a role in the resurgence of populism as ordinary people lose patience with the economic system.[4][5][6]
- The fragility of the system: The prolonged period of easy money has increased financial fragility, creating the conditions for another crisis.[3]
- The limits of central banking: There is no way that financial regulations can be robust when interest rates are extraordinarily low and there are profits to be made from taking on certain types of risk.[9]
- The folly of price stability as the sole goal: The 1920s demonstrated that price stability can mask a credit-fueled bubble.[14]
Additional Insights and Reflections
- On the nature of financial writing: "One of the things I've discovered about writing about finance for nearly 30 years is that it's hardly worth having new ideas, because the conservatism of the world is so great that it's very hard to get them taken up."[4]
- The danger of debt supercycles: We are in the final phase of a "debt supercycle," which, when it bursts, could lead to significant financial repression and social turmoil.
- The mispricing of money: The prolonged mispricing of money through artificially low interest rates has distorted economies and financial markets globally.
- The importance of a historical perspective: A deep understanding of financial history is essential for navigating the recurring patterns of booms and busts.[3]
- The fallibility of central bankers: Central bankers are not infallible and their policies can have severe unintended consequences.
- On the difficulty of forecasting: While history provides valuable lessons, predicting the exact timing and nature of future financial events remains a formidable challenge.
- The human element in finance: Human emotions of greed and fear are constant forces in financial markets, driving speculative excesses and subsequent panics.[10]
- The interconnectedness of the global financial system: Financial crises in one part of the world can quickly spread to others, highlighting the interconnectedness of the modern financial system.
- The need for sound money: The shift from a metallic-based money to a paper-based money has removed a key constraint on credit creation, contributing to greater financial instability.
- A warning for the future: The consequences of the most recent era of easy money are still unfolding, and the "biblical response" that was staved off after 2008 may still be to come.
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