Jim Grant: “Cycles Begin & End In Excess”

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This week James Grant of the Grant’s Interest Rate Observer joins the weekly commentary.

Buy James Grant Latest Book: Bagehot: The Life and Times of the Greatest Victorian

• Gold now pays better interest at 0 than $13 trillion in negative paying bonds!
• Socialized Risk: Big boys get winnings & tax payer takes all losses
• Bagehot: Central Banks should lend at very high interest rate & only with collateral

James Grant founded Grant’s Interest Rate Observer in 1983 following a stint at Barron’s, where he originated the “Current Yield” column.

His books include works of financial history, finance and biography. They are: “Bernard M. Baruch: The Adventures of a Wall Street Legend” (Simon & Schuster, 1983); “Money of the Mind: Borrowing and Lending from the Civil War to Michael Milken” (Farrar, Straus & Giroux, 1992); “Minding Mr. Market” (Farrar, Straus & Giroux, 1993); “The Trouble with Prosperity” (Times Books, 1996);  “John Adams: Party of One” (Farrar, Straus & Giroux, 2005); “Mr. Market Miscalculates” (Axios Press, 2008); and “Mr. Speaker! The Life and Times of Thomas B. Reed, the Man Who Broke the Filibuster” (Simon & Schuster, 2011).

Jim Grant: “Cycles Begin & End In Excess”
July 23, 2019

“People will do crazy things with credit. Credit is the Achilles heel of finance. People talk about money and the money supply, but it’s not money that gets you into trouble. It’s the promise to pay money. And the promise to pay money, which we call credit, is at the heart, at the root, and the black soul, of every panic in one form or another.”

Jim Grant

Kevin:We have a guest today who actually is worth tracing back his influence. We’ve talked in the past about musicians. Oftentimes when you will hear, especially a jazz musician playing, you’ll hear a little melodic quote, and oftentimes that is after years and years of listening to other people. Jim Grant, our guest today, has influences – he seems to be a sponge that absorbs the most important influences on his subject, which is economics and interest rates.

David:Whether it’s music or a creation on a canvas or in stone, you can look at the history of philosophy and see how there are people who have made a contribution and that has been a subsequent influence on someone else’s life. Jim Grant has been an influence like that for me, and as I read his books, I’m drawn to his bibliographies, because not only am I interested in the way he writes, which is fascinating…

Kevin:It’s how you build your library, actually.

David:Exactly. They’re the basis of his thoughts and I want to know his influences. So as he has influenced me and today our conversation relates to his most recent book on the life of Walter Bagehot – Bagehot: The Life and Times of the Greatest Victorian. He was a man who has been an influencer.

Kevin:And he was influenced. You go back to James Wilson, his father-in-law, being completely influenced by him. And this builds to today. The Economistmagazine has changed quite a bit over the last 150 years.

David:Including from a 3,000 subscriber base to 1.5 million today (laughs).

Kevin:I guess it has changed.

David:There are a few more people who have read it.

Kevin:Jim Grant is a man of great curiosity. As a writer he has commented on the financial markets in Barron’s, Financial Times, and the Wall Street Journal,to name just a few, and of course, his bi-monthly newsletter, the Interest Rate Observer. As an author he has wandered the highways and the byways and the back alleys of economics, politics, and financial market history. I think all of his books are in my library. Some have served as critical educational cornerstones.

The last commentary interview we did with Jim was on his book, The Forgotten Depressionof 1921, published in 2014. Today, we’re gathering to discuss his most recent contribution. It is the definitive biography of a banker, of an essayist, the editor of the Economistmagazine, and I can’t think of a better person to have written Bagehot: The Life and Times of the Greatest Victorian than James Grant.

Welcome, Sir.

Jim:Thank you, David, and thank you for that nice introduction. Glad to be here.

David:I have to begin by asking, what is left to observe in the world of interest rates these days?

Jim:There is very little to see, the rates being so low. It is hard to make out negative rates. They simply don’t show up on the horizon. But what interest rates lack in visibility they certainly make up for in drama and in possibility. In 4,000 years of recorded interest rate history we have never before see substantially negative bond yields. By nominal, I mean not adjusted for inflation, just plain old below zero yields on securities longer than, say, a 90-day treasury bill. So we are living in, really, for better or worse, very interesting times in the credit markets.

David:As a financial market historian, you have the opportunity to observe cycles and common elements from one timeframe to another, and you have said that in the physical sciences, progress is cumulative, and we stand on the shoulders of giants. In economics, you have said that the most ostensibly rigorous of these social sciences, progress, and error, too, are cyclical. We keep stepping on the same rakes. Why Walter Bagehot? And why now?

Jim:Well, Bagehot is an appealing figure for me because he did what I do. He did it very differently, and, I dare say, much better. But he was in the financial journalism trades. He ran the Economist. I should tell people, to anchor this in history, he was born in 1826 and he died in 1877, only 51 years old. He edited the Economist, having married the founder’s daughter, but he would have gotten that job on pure merit, so fine a journalist and author was he.

He wrote something called Lombard Street, which is a kind of handbook of central banking practice and dogma, that is still, at least, cited. I’m not sure how widely it is read, but it is still discussed and cited to this day. Bern Bernanke, in his own memoir of the great recession, cited Bagehot more frequently than any other living economist. So Bagehot is with us.

When I was just getting starting at Barron’s I had come to New York for the Baltimore Sun. I was getting started in financial journalism in a serious way. I would go to the New York public library and sit down on Saturday and call up the then still available bound, dusty volumes of the Economistin the physical hard copy form and read them. You could always tell Bagehot’s work because of how his style just scintillated and just sparkled, so I’ve been a fan for years, indeed decades, and I thought it was just high time. I wasn’t getting any younger.

David:We look back at the 19^thcentury, and financial market panics are not uncommon. The common element between them, then and now, perhaps through all time, has been the expansion of credit. Bagehot was in a household that was keenly aware of the history of problems, panics – financial market panics, and what it took to operate in the context of a financial market like that. 1825 was a little early for Walter, as you mentioned, 1826 is when he was born.

But his professional career spanned 1839, 1847, 1857, and 1866, years in that 19^thcentury, where he got some experience, both as a banker and as the writer/editor of the Economist. Can you set the stage for his life by taking us back a little further? 1797 – Bank of England suspends gold convertibility. What did that set in motion that would end up influencing his role in the British financial system?

Jim:1797 was the year, as you say, David, in which the paper pound came to supplant the gold pound. You could up until then exchange your pounds for gold at the fixed and statutory rate – I have forgotten now what it exactly was, but it was inviolable. And all at once, with a threat, perhaps an overblown threat, but still with a threat of a French invasion, the government of Pitt the Younger suspended gold convertibility. So the paper pound was born, and with that birth came also the beginning of a monetary controversy that lasted, certainly, until the restoration of convertibility in the early 1820s.

But in a fundamental way, it is still with us today. What is the nature of money? What is money? And who says so? Those great questions came to the fore during this long suspension of gold convertibility. So in 1797, if you didn’t like the paper pound, you could not present yourself at the Bank of England with notes and get the equivalent in gold. You had to make do with the paper, and you had to depend on the management of the bank to maintain the purchasing power of those paper pounds. There were intermittent demands for the restoration of convertibility throughout that 20-odd year period. It was supposed to have been temporary, and it lasted, instead, a full generation.

And when the time came, finally, to revert to a monetary system of convertibility, there was a great debate as to what rate of conversion the British authorities should adopt. Should they go back to the one that was in force in 1997 just before the inflation that necessarily followed the suspension? Or should they set the conversion rate at a somewhat arduous and easier, or cheaper, level to give a break to the people who had borrowed money and inflated paper pounds? I’m probably getting a little bit too deep in the weeds here, but the controversy between lenders and borrowers, between the advocates of inflation and hard money – these debates have recurred at intervals over 200+ years and there seems no end to them even today.

David:So we have a change in the monetary system, perhaps something that was similar to the 1968-1971 period here in the United States in terms of suspension of convertibility. Let’s go back to the 1820s. In the modern era, today, we have a response to falling rates, we have a bull market in everything. Is it a stretch to connect the declining rates of the 1820s and the speculation that followed in unusual assets, leading up to the crisis in 1825, almost a similar echo, 1840s, and the panic that followed later in that decade? Can we surmise anything from falling rates, bull markets that then ensue, and corrections that almost seem to be the next domino?

Jim:One of Bagehot’s many aphorisms is especially relevant today. He said, alluding to the national symbol of Britain, that John Bull can stand many things, but he can’t stand 2% – he meant positive 2%. But what he meant was that very low rates tempt people to reach for yield, to take risks they would not ordinarily think prudent. And the accumulation of those choices, of that risk-taking, leads to – now I’m kind of putting into my words what I think Bagehot would have meant by the process – the persistence of very low rates leads to greater and greater attempts to capture yields through reaching for credit risk.

And lo and behold, one day somebody forgets to bid, and somebody wants cash, and that little flicker of flame is enough to light the fuse that finally ends up in a great big explosion we call a panic. But very low rates have, since the dawn of modern financial capitalism, been the prelude to, and perhaps the cause of, financial difficulties that take the form of panics and bank runs, and generally, a sudden demand for the thing that seemed in such abundance, namely cash.

David:It is, again, cycles. Cycles, as a financial market historian, are things that keep popping up. Pole, Thornton and Company is an establishment that you mentioned in the prologue – and this is kind of an echo from the Victorian period into our own – we have interest rates, low rates, causing a migration to longer maturities, lesser credit quality, the demise of a firm. And so, in the Victorian era we witnessed something that was absolutely amazing – the telegraph, the railroad systems, the expansion massively transformed, and they were fueled by easy money – low rates, accommodative policies, if you will. Which comes first? The innovation and the transformative idea, or ample credit allowing for experimentation and risk-taking?

Jim:Yes, David (laughs). I think that innovation and the excitement that innovation invariably induces in people comes first. I am now searching, not immediately fruitfully, for examples of innovation that occurred at times of very high interest rates. We certainly have had those times. Innovation didn’t stop, but the combination of a big idea like the railroad and very low rates is a very, very happy alignment of the stars, happy in the sense that the innovation proceeds and speculation, in its train, follows.

Invariably speculation goes too far, whether it is in the Internet boom of the late 1990s, or whether it was the case in the railroads in the 1830s and 1840s when people would be building parallel lines and the stock prices of both competing railroads would go up even though people knew in their heart of hearts, or I guess in the mind of minds, that only one of those lines would prove to be successful.

So many of these stories, so many of these features of cycles, seem timeless. The names of the firms change, of course, the nature of technological progress changes, but the storyline more or less remains the same.

David:So we have legislation, then as now, that plays a role, and I’m curious what role it is. You have the Peel’s Acts, which changed the landscape for entrepreneurs, and it also seems to have changed how the Bank of England operated. They started again considering longer maturities, unsecured loans, and very eclectic collateral. What role does legislation play in either taming or exaggerating animal spirits?

Jim:Let’s look at our own time. Back in the period of 2003, 2004, 2005, and 2006, you found not only immense leverage building in residential real estate, which became, of course, notorious, and at length, infamous, but you also found it building up on Wall Street. We ran a piece at Grant’sin 2006 after looking at Morgan Stanley, just relating the fact that the period-end leverage at its ratio of assets to equity was in excess of 30 times, and that was, as I said, at a statement date, and who knows how much higher between statement dates, but the headline of the piece was “Over the Cliff with Morgan Stanley.” But I don’t think there was any particular legislation that was responsible for that. People, I think, have tried to identify changes in the SEC regulations that might have explained it.

But let’s double back to Bagehot’s time. One of the attempts at making capitalism a better system, at making enterprise a better system, was legislation to create limited liability, so no longer would you have to form a partnership in which the partners were fully at risk of all the debts of the firm. You could distribute risk, and you could do this without an act of parliament. That was a well-intended piece of legislation, and it facilitated not so much what the author, the eminent great future Prime Minister, William Gladstone, intended to create, but rather it seemed to incite a lot of sketchy actors creating a lot of kind of fake corporate structures. So I’m not so sure about the effect of legislation in the short run.

One final thought on this is that, in the day, way back when in the 1820s and 1830s in England, banking institutions were, just about invariably, except for the Bank of England, itself, partnerships. And the partners were liable, as the phrase went, for the debts of the firm down to their “last shilling and last acre.” And you would have thought that that responsibility, that the Sword of Damocles of utter financial ruin would have enforced a most rigorous and conscientious attention to risk management on the part of these bankers. But there were still panics. And so the laws were relaxed, and limited liability banking was introduced.

You asked a very good question about 15 minutes ago, and I am dancing around it.

David:Well, let me take this to a personal place, and it’s also a speculative place. As a father of grown men, you can now reflect on the lessons that are sometimes caught, and other times deliberately taught. Can you speculate on what the family conversations, the dinner table discussions, might have been that influenced Bagehot? You have Vincent Stuckey, perhaps an influencer, Walter’s own father who is a partner at Stuckey’s bank, and what did he know just by osmosis that set him in motion?

Jim:A lot of the lore of banking, and of risk management as we now call it, I’m sure young Walter imbibed in family counsel at the dinner table. His father was a very dutiful, kind of second or third in command at the family bank, which was called the Stuckey’s Banking Company, so they certainly talked about banking problems. Young Walter was a little bit too young to have felt the family tension that must have occurred around the time of the panic of 1825, only being just newborn, but subsequent booms and busts were, to him, living things. And he came up, did Walter, in a family institution that was immensely successful and resourceful and profitable.

So his line, as a young man, his view on banking was that of being a privileged member of a family that had wrought great things, in the always somewhat hazardous business of borrowing short and lending long, and managing credit risk.

The Stuckey’s Banking Company earned, consistently, rates of return on stockholders’ equity, the partners’ capital, in excess of 40%. Amazing. Today we think that a money center bank is doing well if it can earn in excess of 10%. 15% was certainly common enough before the crisis, but it is much less common now. So 40%, and never really a serious credit issue. There were certainly some bumps in the road, but Walter had, as I said, I guess a kind of unusual experience in banking in that the institution was so successful for so long.

One of the ironies of the subsequent career of Stuckey’s, it became, through a succession of mergers, a particle of the monstrosity called the Royal Bank of Scotland, which made the greatest failure in the history of British banking during the troubles of 2008. Vincent Stuckey, Walter’s uncle – not quite the founder, but certainly the founding genius in this institution – always had been wont to say that bankers are mortal, but banks should live in perpetuity. And if any bank seemed destined for that fate, it was Stuckey’s, but finally, alas, it wound up in the lap of the British government, which would have been a mortification beyond reckoning for the Stuckey family and the Bagehots.

David:Well, perhaps what Royal Bank of Scotland missed was some of those historical footnotes that did matter. Stuckey’s Bank was trimming the sails of its operations in 1853 and avoiding pro-cyclical management. RBS didn’t exactly do anything to alter the course. In fact, they kind of layered on risk. How do we borrow that conservatism, trimming the sails, and infuse it into today’s banking system? We talked a little bit about limited liability, current management structures – what could we learn and put into real application?

Jim:Safety was a competitive attribute up until the institution of deposit insurance, and too big to fail, and the so-called put that central bankers are meant to be offering the market. They deny it, but nonetheless, that is an idea in the market. So central banks today in the developed world, without quite intending to, have taken away safety as a competitive edge that you could claim. There was a bank in New York City that was finally absorbed in what has now become J.P. Morgan Chase, that was called Chemical Bank. I’ve forgotten when the merger was, but it was quite a while ago.

Chemical Bank was known in the day, in Bagehot’s time, as Old Bullion, because in – I think it was 1857 – Chemical Bank had continued to pay out gold to its clamoring depositors, even as every other bank in the city of New York suspended convertibility. And Old Bullion, Chemical, traded on that moniker until at least the early 20^thcentury. You could still see these old ads if you went through newspapers of the 1920s for Chemical bragging about its record in the panic of 1857.

The bragging had an economic rationale, and that was telling people that this is an institution that thinks first and foremost about the sanctity of its depositors’ money. Today, if you go around looking for a new bank, if you move or something like that, the bank you are likely to choose is the one that has the ATM nearest your house, and you will not bother to look at the balance sheet because that bank is insured or in some cases it is much too big to be considered a failure. So that’s what happened.

David:You mentioned the profitability of Stuckey’s, and this is fascinating because on the one hand Bagehot loves the gold standard, but he loathes the idea of gold as a reserve asset in the commercial banking world that he was a part of. Can you jab at that a little bit?

Jim:Yes, it’s a great paradox of Stuckey’s Bank. My really, really invaluable researcher in this is Harrison Wood. When Harrison went to Edinburgh and went to the RBS records, RBS, be what it might have been, the archives are fabulous and the archivists are wonderfully welcoming, but when Harrison went to check this out I said, “Aha! We are going to see a balance sheet that shows a great big chunk of gold because the Stuckey’s people were famously conservative and successful.”

But on the contrary, what the balance sheet showed was that they held almost no bullion. And there were complaints in the financial media, the financial press during the 1830s, 1840s and 1850s, the gold standard in London was being run with precious little gold, and one of the complainants said that gold was becoming like the mahogany veneer on furniture in London drawing rooms, it was just so thin. And why is this? Well, gold, as wonderful as it is to touch, and as pretty as it is to behold, yields nothing.

Now today, gold yielding nothing – it actually out-yields 13 trillion dollars or so worth of bonds, so it is kind of a high-yielding asset. But when yields were invariably positive, a yield of zero held no charm. So profit-seeking bankers did what profit-seeking bankers do, and that is, they wanted to hold earning assets. And every ounce of gold on the balance sheet was foregone income. But they did believe that someone ought to hold gold. There ought to be a gold standard. Very few people conceived of a purely paper currency, certainly in the unhappy aftermath of 1797 to 1820, whenever it was. People were bound to the system of what we call a gold standard.

But who was going to hold the inert money? And that someone, Bagehot prescribed, was the Bank of England. Now, Bagehot was a fine, wonderful paradox, for kind of tickling the reader by saying one thing and then inviting the reader to consider the alternative. He was a very playful writer. So Bagehot would say, “In the perfect world, each bank would hold its own reserve, but this is not a perfect world. And furthermore, we are used to having the Bank of England hold, so therefore let the Bank of England explicitly own responsibility for holding this,” and he didn’t say this, but its ROE, return on equity, would go down, and ours would remain as elevated as it is.

So some of us in 21^stcentury America deplore the kind of socialization of natural risk. By that I mean that in the boom the big shots get the dividends, and in the bust the taxpayers own the downside. That is the socialization of risk. And so this idea didn’t come from nowhere. To a degree, the bankers who wanted to slough off responsibility for holding the gold reserve onto the government, onto the government’s bank, the Bank of England, those people, too, were interested in a little bit of financial socialism, and Bagehot was a spokesman for that group.

David:Speaking of socialism, and really kind of the opposite end of it, because on the one hand, while he sponsors a bit of financial socialism, he is a free trade advocate. He is a free market guy through and through. Bagehot wrote as a free trade advocate, as his father-in-law did as the founder of the Economist. His father-in-law was a hat maker.

Jim:Oh, James Wilson was one of the purest exponents of the doctrine of laissez-faire. He came out once in the pages of the Economistagainst public health laws. He said, “Everyone ought to take care of his own damn sewer.” (laughs) He was not one for compromise.

David:Well, they’re writing at the same time that Marx and Engels are, and they are in print advocating for a system that favors capital, where obviously Marx and Engels were favoring labor. Lombard Streetis a Bagehot calling card. You mentioned his book earlier.

Jim:May I say one thing? Wilson, I think, would blanch a little bit at this word capitalism. It wasn’t as if Marx and Engels favored people, and James Wilson favored money, which is a way of saying the same thing. Wilson favored enterprise, and he thought that with his own eyes he could see the world improving with respect to wealth, of course, but also the quality of civilization he saw in the Crystal Palace Exhibition of 1851 in which the world sent its inventions and its new products to be displayed and ogled by visitors to the Crystal Palace in London, he saw in this one of the signal triumphs of human ingenuity and the advance of the human race.

So he was a great optimist and a great believer in what we call capitalism and what we perhaps more descriptively ought to call enterprise. But he believed that the system he favored would redound to much greater benefit for the workers than anything that Marx and Engels proposed that would directly advantage those same people. Anyway, that’s the end of my speech.

David:No, but let’s build on that because people versus money is the way that it is contrasted. If money is a measure of capital, and capital is a means of wealth creation, now we’re to your point on enterprise. How do you think Bagehot might respond to the 21^stcentury viewpoints of capital redistribution as they percolate up again in the modern political spheres?

Jim:I don’t know. You know, Bagehot was an establishmentarian, and just as you said there, he espoused views that would today be considered rather quaint. He believed that only gold and silver were money, that everything else was a credit instrument. He believed, as you say, in free trade. He did not believe that railroads, for example, ought necessarily to be owned by the people who built them. He kind of toyed with the idea of nationalizing the railroads. But he was a man of his times and he poured a little bit of scorn on ideologues of his day, people who were zealous for one cause or another. He smiled at some of his father-in-law’s enthusiasms.

So if we imagine Bagehot standing around today, say, taking a seat at the Council on Foreign Relations, I imagine he would be no gold-standard guy, but rather a Ph.D. standard guy. I think he would favor the experts and favor the system of central banking we have, because after all, he believed in what was. He might, in fact, fit in rather well on the pages of the Economist.

David:(laughs) In its current edition, not written by James Wilson.

Jim:Yes. He was adaptive and I think he ornamented his times. I think he did his times a great service by living in them, but he was of his times, and I think he was the kind of adaptive person who would not waste his precious heartbeats on tilting at windmills, although I say as a fellow who actually makes his living at tilting at windmills, that it is a living, but Bagehot, I think, has the personality that would have him right smack dab in the middle of the establishment. I kind of think he would be a very happy camper on the Federal Reserve Board, I’m sorry to say. I hope this won’t put people off reading the book (laughs).

David:No, I think they should read the book, because here is an important element. Again, we go back and forth between then and now. August of 1857, the Ohio Life and Trust Company fails in, obviously, Ohio, the United States. News of the failure was in London in early September, and you have the panic of 1857 in motion. Talk to us about the interconnectivity of finance because if transatlantic problems were not contained in the 19^thcentury, how much more so in this age of globalized and interconnected markets of the 21^st?

Jim:Yes. There is always a question of which is the first truly international panic, and you could make a case that it was the one of 1819, six years before Bagehot was born. In any case, certainly, the 1857 one was an example of a transatlantic problem and not only today when one tritely observes that communication is instantaneous, but emotions, too, are instantaneously conveyed from person to person and from network to network.

Finance is, I think, a deeply emotional proposition. I think it is a little bit rich that we should suddenly be discovering this late in the history of economic thought, the concept of behavioral finance. I don’t know what other kind there is. Mechanistic finance? Robot finance? I guess we have robots and we have finance, but so much of what people do with money, it seems to me, is a matter not so much of the head, but of the heart, and of the spleen, and who knows what other body parts?

So if that is the case, and it is the case, how much more contagious must be both extreme moods of euphoria and fear to characterize two extreme cycles of finance? When everyone is liking the adjusted EBITDA earnings report of the latest speculative favorite, that is a very different thing than people reading in the dry pages of the Economistthat such and such a stock appears to be on the upswing. Both news reports could tickle the fancy of a speculator in the heat of a bull market, but the emotional content of a digital media and social medial today overlaid upon the dry recitation of earnings figures or balance sheet figures is a different thing.

So yes, there are no boundaries. The Chairman of the Federal Reserve, I think, rather incautiously, is quoted as saying, and I dare say he regrets profoundly having used this word, but it was used more than once, the idea that things were “contained” in 2007 and 2008. The prospects for containment are ever-dwindling.

David:So there is again an echo from the past. You have 2007 and 2008 and how we addressed those issues, the lifelines that were thrown out. Overend, Gurney was thrown a lifeline in the panic of 1857 and I think maybe one of the things that we learn from that is that assistance is never singular. They went under, they disappeared, they were one of the largest financial institutions of the day, and they disappeared in 1866, in spite of the help they got in 1857.

Jim:Or because of that help. There is a saying on Wall Street, as you know well, Dave, which is, the first loss is the best loss. Overend, Gurney, to give that institution its due, was kind of the J.P. Morgan of its day. Its reputation was spotless, and its prestige was unquestioned, although under the surface of that prestige there was a certain amount of rot. And the rot was evident in 1857. It was evident to a few. It was evident to a few more by the time that it had reached its death throes in 1866, but the Bank of England, perhaps, was kicking itself, and certainly others urged the Bank of England to kick itself, for helping it over the hump ten years earlier.

So Bagehot is, I think, most famous as a financial thinker and writer for having prescribed what a central bank ought to do in times of crisis, and his advice in Lombard Streetwas more or less this. He said, “A central bank ought to lend unstintingly, at a very high rate of interest, against good banking collateral, and of course, to solvent institutions.” So, why at a high rate of interest? That is counter-intuitive, and I’m sure that the central bank, first of all, lent at a very low rate of interest in a crisis, but the idea of lending at a high rate of interest would seem to be almost something from the dark ages.

Well, there is a good reason for it, and it is still, I think, an advisable course of action, certainly one to consider. By lending at a high rate of interest, you ration the credit, because people who don’t need it and who are going to borrow just as a precaution because they were fearful of ever being able to [unclear], they wouldn’t borrow at 10%. It’s too costly. And by lending at a high rate of interest, a central bank would attract capital from overseas, and that capital would re-liquefy in time, the financial system of the country that was stricken by a panic. So that was the reason for a high rate of interest.

But now, of course, there is no need to physically ration credit because central banks materialize it with a few taps of a computer keyboard. Now, either that is, or that is not, an advance in the financial doctrine and practice, but Bagehot espoused those ideas. Lend freely, at a high rate of interest, against good collateral. And we have reduced that to lend freely(laughs).

David:(laughs) I was going say, it’s a modified plan today. Low rates, collateral doesn’t matter. You can establish your own bad bank, and put, as Deutsche Bank has done recently, 70 billion dollars’ worth of garbage into it so that collateral is never an issue.

So, as we come to the end of our conversation, Jim, what kind of public discussion would Bagehot propose today? He liked conversation. He was, at least, with a pen, verbose – very prolific in his writing. What kind of a public discussion would Bagehot propose today, regarding markets, regarding politics, trade and tariffs? Are we back to your observation earlier that he is solidly an establishmentarian? Perhaps he would be in the CFR’s publication, writing that today.

Jim:Yes. Well, Bagehot had a name for his own age, his own enlightened age, the Victorian times, and he called them the Age of Discussion. So he was all for, apart from being a scintillating conversationalist he was meant to be, perhaps, the most interesting guy in London to talk to, but he was on favor of people hashing things out, avoiding precipitous action, avoiding impulse. He was fond of saying such things as, “If people would only do less, think how much better off we would be. If people would not over-trade, if they would take their money and go home, rather than thinking of the next leveraged opportunity, we would all be better off.”

So I think he would be in favor of doing wise things through the councils of wise people. He would, indeed, be at home in the Council on Foreign Relations. And I, myself, am a member of the organization. But Sebastian Mallaby, who is on the staff of the Council, a very good guy and a very talented author, reviewed Bagehot, and he said, “The author of that book (Dave, you’re talking to him now) is the 19^thcentury personified.” He meant me, that I wear a bow tie, and that I call my publication Grant’s Interest Rate Observer, an antique name, and that I am in favor of such absurdities and such anachronisms as gold as money.

He said, I should also add in fairness to him, that he liked the book he had seen a little bit. But I read his review of Bagehot and I thought to myself, “The author of that review is, in fact, Walter Bagehot.” (laughs) So, I will see Walter at the next meeting of the Council on Foreign Relations. I don’t go to many of the meetings, but when I do go, I will see him there. Maybe he will be in the person of Sebastian Mallaby but Walter is that establishmentarian, and he would be in favor of an enlightened governance by enlightened people.

David:We have explored biographical notes and some historical anecdotes today. What do you think we should glean from history to honor the past and perhaps set a better trajectory, Mr. Bagehot? I mean, Jim.

Jim:(laughs) Well, I think that history will make you a less surprised reader of the newspapers. And if you read enough of it, you will avoid the characteristic pitfall of those who read a little. Those who read a little think that you can superimpose the lessons of the past on the present day because you see a pattern and you attempt to exploit that pattern, perhaps, if you are really, really rash with borrowed money – never a good idea, David.

But what you can do if you know enough history is to see that, for example, you can see certain things that are eternally true, and one of those things is that people will do crazy things with credit. Credit is the Achilles heel of finance. People talk about money and the money supply, but it’s not money that gets you into trouble, it is the promise to pay money. And the promise to pay money, which we call credit, is at the heart and the root and the black soul of every panic, in one form or another.

So there is such a thing as the credit cycle, and what we try to do at Grant’s is to trace the dynamics of that cycle. It begins in fear and loathing, and incidentally, Dave, in value – that’s at the bottom – and it proceeds until there ain’t no value, and perhaps there are not 13 trillion, but 23 trillion of securities yielding less than nothing. Who knows? But these cycles begin and end in excess, and, sometimes in excess so great as to appear, on its face, absurd.

But the reader of history will know that just because it seems to you absurd, doesn’t mean you should short it (laughs). I’m trying to adapt that lesson, myself, at the age of 73. You let me know when I succeed, as a very kind reader of Grant’s, David. But history, I think, is a great thing to have under your belt, and to use it wisely is the idea. You can get into a lot of trouble by using it too literally.

David:The reader of Grant’s is, by default, a reader of history, and I think those who are unfamiliar with the Interest Rate Observershould get familiar at grantspub.com. And avail yourself at Amazon of James Grant’s,Bagehot: The Life and Times of the Greatest Victorian. We see these patterns. They are very instructive. They can learn from the past and apply them to the present in some way, borrowing the wisdom of the ages.

Jim, thank you for joining us in our conversation on the Weekly Commentary.

Jim:You are entirely welcome, Dave. You are one fantastic interviewer. You are prepared, you have great questions, and I thank you for that. I do a certain amount of these things over the years and you are really good at what you do, so thank you.

David:Ah, well, I appreciate it.

Jim:That’s the way I see it, David. That’s the way I’m calling it.

David:(laughs) I appreciate it.

Jim:Thank you, David.