A few years before Böhm Bawerk's observation, Walter Bagehot, a 19th-century editor of The Economist, offered an observation of his own. What did Bagehot observe: “John Bull can stand many things, but he cannot stand 2%,” which reflected savers' distaste for ground-scraping interest rates on savings. Homer and Sylla go on to tell us that during Böhm Bawerk’s and Bagehot’s stay on earth prime long-term credits were priced to yield 2.5% to 3.5%.
John Bull (or John Doe for those on the west side of the Atlantic) should have been satisfied with 2.5% 125 years ago. The second half of the 19th century was marked by chronic deflation. Robert Higgs, senior fellow in political economy at the Independent Institute, found that from 1866 to 1897, a period of secular deflation, was perhaps the greatest era ever for US economic growth compared to any era of similar length. Real GDP grew by more than 4% on average annually. But how can that be? Today’s average mainstream economist, upon hearing “deflation,” reflexively conjures a world rant with cries of misery and privation.
How times change. When Böhm Bawerk speaks of interest rates, he really speaks of time preference. The lower the time preference in a society, that is, the higher the ability to defer gratification, the higher the ability to produce wealth over time, because capital accumulation correlates positively with the ability to defer consumption. The lower the interest rate, the lower the time preference.
Yes, everything produced is produced to contribute to, or to be, final consumption, but first you have to produce. To delay gratification and produce is a very adult thing. The more willing you are to delay gratification to invest, the lower the cost of capital for people who want to produce. A lot of low-price capital conflated with a a lot of entrepreneurial ingenuity will lead to a sweet time of it if you'll let. Each year there will be more to consume. In this regard, Böhm Bawerk is right.
Bagehot is also right: A rational John Bull would demand compensation for delaying consumption. This is human nature. If the choice is an equal quantity of a good today or a year from today, today wins. Interest rates in an unhampered market can be nothing but positive. (They can be low, but they must be positive.) In an unhampered market, the real rate of interest is reflected in the interest rate on loanable funds, a component of the intertemporal market of interest rates determined by the aggregated time preference of a society.
Today's rationality differs from rationality in Bagehot’s day. The Wall Street Journal reports that $13 trillion of global debt offer a negative yield. The Journal goes on to say that Lithuania’s 10-year government debt yields 0.5%; the yield on Taiwan’s 10-year bonds has fallen to about 0.7% from 1% this year alone.
Should Böhm Bawerk rejoice? Has the world embraced intelligence and moral rectitude to a degree unseen in human history?
Hardly. We live in a world Böhm Bawerk would likely find dystopian – a world of perpetual government manipulation of prices and a world of unrelenting inflation. (By inflation, I refer to the relentless increase in the money supply. The general price level and asset prices may or may not rise, but they will be higher than they would without money inflation.)
Interest rates are a price, and never has a price been more manipulated by government intervention. The continual creation of bank reserves via Federal Reserve open market operations ensures the continual expansion of bank credit, which drives the loan rate below the natural rate determined in an unhampered market. In Böhm Bawerk’s day, interest rates were allowed to float to a level dictated by aggregated preferences. The rate was set on the margin in a market more legitimate than the one we see today. In a legitimate market, the rate always floats positively. (James Grant, publisher of Grant’s Interest Rate Observer, asked Richard Sylla if negative interest rates prevailed at any other time in history. The answer was “no.”)
Low interest rates, reflected lower-time preference in Böhm Bawerk’s world of stable commodity-backed money, rising productivity, and chronic, though anticipated, price deflation.
Thanks to the introduction of cost-free (to produce) fiat money in 1971, everything has accelerated. Inflation rules. Profligacy, in turn, has taken precedence over frugality. Debt is priced cheaply and is used profusely.
It’s no longer rational to save money over time to buy a home or to fund an education; better to trundle into debt, rejoice in the immediacy, and to repay the debt in devalued money. Hurry up and spend before consumer-price inflation diminishes the value of monetary savings. Hurry up and invest before asset prices trend higher and yields – already nonexistent on savings – are bid even lower.
Businesses pile on the debt to leverage their investments, which brings greater returns than savings in cash or equity-financed investments. Corporations accumulate unprecedented amounts of long-term debt to fund present dividends and share buybacks.
But debt, no matter how inexpensively priced, always elevates financial risk.
In today’s brave new world, interest rates are lower than in Böhm Bawerk’s relatively quaint world, though time preference, I argue, is higher. One can only speculate what Böhm Bawerk would associate with low interests today. I suspect that if Böhm Bawerk were to observe the current zeitgeist that “intelligent” and “rectitude” are words unlikely to spring to mind.
As for Bagehot, I suspect that he would change his tune: John Bull can stand many things, and sub-2% is apparently one of them, because John Bull really has no choice but to stand sub-2%..