THE CASE FOR POSITIVE INTEREST
An Austrian rebuttal of Summers et al, in four parts
THE TIME IS OUT OF JOINT
Over the years, any number of psychological experiments have been conducted in order to validate – or at least to give a veneer of academic corroboration to – a truth already well established by practical experience; namely, that we humans must continually struggle to overcome our basic animal instinct to seek instant gratification of our wants.
Seen from a different perspective, it is just this capacity for forward thinking that underpins, even defines, our very humanity. As such, the idea that the phenomenon represents a major facet of our behaviour much should not be in any way controversial.
In order for us to deny ourselves the pleasure of the moment, we generally need some form of reward – or at least the prospect of one – in return for our abstinence. The reward can, of course, be the negative one of not being punished and it can clearly also take spiritual rather than purely material form.
It hardly needs to be said that that last motivation – essentially the promise that we shall have cake for tea if we are good little boys and girls in the meanwhile – is by far the most prevalent one in everyday operation.
If we start from this simple, human premise and if we concentrate on how the real-world individual is likely to act rather than rushing to lose him in a faceless mass of abstract mathematical symbolism, one very important corollary soon follows; viz., that the widely perceived and highly persistent requirement for a measure of compensation to be given for undergoing the psychic discomfort of deferring the satisfaction of our wants and desires is the fundamental source – the ontological root, we might say- of the phenomenon of interest.
In that last paragraph, an Austrian would easily recognise that we are arguing for what he would call ‘methodological individualism’ and that such a focus on how we individuals actually conduct ourselves in everyday life is entailed in the study of that purposeful Acting-with-a-capital-A that Mises called ‘praxeology’. He would also readily identify with the concept that interest is a matter of subjective, individual time preference – one which would be expressed even in the absence of a medium of exchange or a market for loans thereof.
As financial market participants, it is a hard fact that we would nevertheless do well to acknowledge that the interest rates we spend so much time analysing, predicting, and comparing are not in any way primary. Even when not being reduced to absurdity by the unrestrained monetary quacks who people our latter-day central banks, we should hold onto the idea that they are just the shadows of a deeper truth being cast on that electronic wall of Plato’s cave which is our Bloomberg screen.
Rather, market interest rates are a close reflection of the marginal degree of time preference being expressed in their dealings by the relevant population of Acting Men. Or at least that is what they best approximate when the market is being left to function as it should.
That such a degree of happy concordance is in practice more of a rare occurrence than we could wish is thanks both to the rickety stage construction of our flawed institutions and to the uncomprehending folly of the political actors who strut and fret upon it.
This recurring disparity between the ideal and the observed is the primum mobile in our long, sorry history of booms and busts, for such cycles of mass delusion and disabusement are principally brought about when falsified market rates of interest lead successively more people to act as if the world were a richer, less time-constrained place than it really is. Only later, in the ensuing crash, is the true horror revealed that those under the spell of the delusion have all the while been making it poorer and more urgent than it ever need have been.
Ironically, it is the case that the now poorer folk, with fewer spare resources available to be devoted to schemes for improving their future lot, must be closer to a bare subsistence than they were before. Hence their time preference must have RISEN along with their degree of precarity. Underlying, natural interest rates, then, must have gone UP, not down much as it does for those poor souls who deliver themselves, in their hour of desperation, to the pitiless clutches of the loan shark.
This inference tells us that knee-jerk policy moves to suppress firstly short-term, official and then, by contagion, all other market rates of interest can only work to maintain the debilitating incoherence between past and future which the boom introduced, if with a different range of outcomes to those observed when it was at its height.
And to be clear here, to say this is not unfailingly to endorse a stony-faced, Old Testament rejection of all aid for the ‘sinners’ amid the crisis, nor does it lead us to propose that emergency interventions aimed solely – in the classic, costly, tough love, Bagehotian style – at preventing the tug and swirl of the fast-receding monetary floodwaters from undermining the foundations of even the most sound of our buildings should always be foregone.
What it does do, however, is insist both that any such emergency aid is restricted solely to preventing the spread of the blaze and that those saved from the flames should entertain no doubts as to whether they will then be presented with a substantial firemen’s bill. It should be made categorically plain that it is no part of the duties of the rescue team to help those who have been playing with matches to keep themselves warm amid the embers of their delinquency, much less to aid them in rekindling a new conflagration on the site of the old.
In direct contravention of the guiding tenets of dear old Walter’s much cited (if, in fact, reluctantly adopted) approach, current practice is to lend cheaply, for lengthy periods of time, most especially to those possessing NO semblance of sound collateral whatsoever. Thus it is the case that many firms which are realistically in need of a mercifully swift liquidation are instead ‘evergreened’ and placed in that ‘twixt Heaven and Hell, run-them-for-cash category populated by what we now refer to as ‘Zombies’.
Once that happens, the latest manifestation of an incompatible market rate of interest is not now to be seen in an insupportable ‘lengthening’ of the productive architecture – i.e., in entrepreneurs engaging in long-amortization, often highly speculative activities which presuppose an excessive flow of capital, not just to such activities themselves, but also into all manner of other, hazily-conceived, but nevertheless essential, complementary undertakings. Rather, too low rates now result in the inhibition of that over-extended structure’s contraction back to a healthier, more sustainable span, as well as in the retardation of its rearrangement into a more coherent, mutually supportive set of interlinkages.
Similarly, in a world where credit is easily accessible not just by producers but by all manner of exhaustive end-users – whether private or, most egregiously of all, public sector ones – the artificially lowered rates have as their misguided purpose a stoking of the fires of Keynesian consumption. In so doing, they only serve to militate against the swift replenishment of the capital which has been lost in the Boom by being locked into so many, now unprofitable forms, both physical and organizational.
There may be many specific features at work both in promoting any given Boom and in precipitating its ensuing Bust – on top of which lies an entire bestiary of subsequent responses and tail-chasing interventions – but it should not be hard to recognise here the outlines of an explanation for why this past eight years’ unprecedented efforts to preserve the status quo ante and to frustrate the re-shaping and re-allocation of both human and physical capital have been accompanied by so meagre a recovery, or why debt levels have continued to rise so alarmingly even as capital investment has languished and official measures of productivity have only flattered to deceive.
THE TRADE AND PROFIT OF THE CITY CONSISTETH IN ALL NATIONS
But, we digress. The issue at hand is for us is firstly to achieve a better understanding of the phenomenon of interest and then to examine the frankly illogical nature of much current thinking on the issue. In order to do this, let us step right back to the beginning as a way of providing a solid underpinning for some of the concepts developed above.
In even the simplest of barter economies it is the case that the real price of anything we wish to acquire is the value of whatever it is we next most urgently desire among the things which, having only finite resources and limited time allotted to us, we must give up in order to have it. In other words, at bottom, price equals opportunity cost.
Stepping up to the next level of complexity, we now enter a world where most of our transactions are indirect and largely anonymous, rather than direct and face-to-face. Here we have hit upon the felicitous idea of employing mutually acceptable media of exchange in order to carry out our traffic. (We shall here avoid all discussion of whether this was a largely spontaneous, emergent happening or the fortuitous offshoot of proto-states’ attempts to gather revenue and exercise control of their subjects).
Once liberated from the narrow trust networks which must have prevailed in pre-pecuniary times, the adoption of media of exchange allowed for a great flourishing of commerce and industry. Now, in this new world of multiple potential counterparties, the market process could grade and sort the competing uses to which scarce resources could be put according to the highest valuation placed upon them by those with the means and the will to make their assessment effective, even if these were people of whom one knew nothing more than that they were indeed so furnished.
In such a system, in order to achieve his own aims, the buyer must offer up something to the seller which this latter prizes more than the good he has put up for sale. Ignoring for now the rare cases of physical good-for-good swaps, this offer takes the form either of a final settlement good (viz., money) or a deferred settlement one (credit) which is essentially a pledge to provide a quantity of that same money in the future.
Since, as we have just argued, future goods are generally worth less to us (furnish us with less satisfaction) than present goods, that deferred claim must include some increment to today’s settlement – an addition to which we refer as ‘interest’.
In the interests of avoiding confusion, here we should note that that this contractually agreed increment typically includes a premium by which to account for additional risks we run in postponing the final reckoning, whether one perceived to be due to the deferrer’s own particular circumstances, the general tide of affairs, or to the wider hazards pertaining to a possible variation in the standard of value in terms of which the bargain is concluded.
Note that, if such risk premia are small enough and if we were ever to suppose that the two apples which we demand next month as payment for the enjoyment of one apple today are then expected to be had for a lower overall monetary outlay then their sale might fetch today – it might just be the case – rare to the point of non-existence though such instances have been on the unhampered market – that the arithmetical, pecuniary amount of interest would be a negative numerical quantity.
This would still not alter the deeper truth that the underlying real, natural rate of interest – i.e., the one which remains after excluding such expectations of change in money’s worth and so the one which emanates solely from the workings of societal time preference – would remain incontrovertibly positive. After all, there is a compelling, Aristotelian logic to the proposition that two apples has been, is now, and ever shall be a greater quantum of appleness than one apple, however distributed in time is their delivery.
Though this may seem trivial enough, there is one further implication of what we might call the Law of Jam Today.
As we have seen, the market tends to allocate our limited goods to those willing to pay the most for them. Out of the near infinitude of possible uses to which they could be put by the teeming crowd of would-be buyers, such a price can only be paid by those whose past efforts to produce valued goods have met with sufficient success as to now afford them the greatest means to devote to such a purchase, or else by those whose credible plans to acquire such means in the future will do enable them to issue some kind of acceptable IOU (and membership of the first class is, naturally, the attribute most likely to assure membership to the second).
Given that the production of future saleable goods involves, by definition, the passage of time, for the process to be worthy of the singular expenditure of effort, much less for it to be repeatable, the maximum price which entrepreneurs can rationally pay for the inputs which their production requires (land and labour, process and capital goods) must not exceed today’s equivalent of the proceeds of their eventual sale.
At worst then (and, strictly, after assuming that the entrepreneur’s own subsistence is counted among the cost of labour), the outlay must be equal to the sum of those expected future receipts discounted back to today at the prevailing rate of interest. This simple truth should be enough to dispel the annoyingly persistent theory that interest rates are determined by productivity alone, a shallow half argument which neglects the plain fact that the would-be users of means will naturally pay more for those which they feel will lead to more lucrative ends, an upward assessment leaving us with nothing left over by which to explain the ratio between these two prices, i.e., the interest rate.
This means that producer goods are effectively priced with close regard to (in an ideal setting, exact correspondence with) the net present value of the future net cash flows to which it is assumed they will give rise.
Great Scott, Marty, they are, in effect, today’s material embodiment of tomorrow’s as-yet unformed consumables!