5,000 Years of Interest Rates
“At no point in the history of the world has the interest on money been so low as it is now.”
Here the good Sen. Henry M. Teller of Colorado hits it square.
For 10 years plus, the Federal Reserve has waged a nearly ceaseless warfare upon interest rates.
Savers have staggered under the onslaughts. But the timeless laws of economics will not be forever put to rout.
We suspect they will one day prevail, and mightily. Interest rates will then revert to historical averages.
When they do, today’s crushing debt loads will come down in a heap. They will fall directly on the heads of governments and businesses alike.
This fear haunts our days… and poisons our nights.
Let us check the date on the senator’s declaration…
Kind heaven, can it be?
Our agents inform us Sen. Teller’s statement entered the congressional minutes on Jan. 12… 1895.
1895 — some 19 years before the Federal Reserve drew its first ghoulish breath!
Were the late 19th century’s interest rates the lowest in world history?
Here at The Daily Reckoning, we are entertained infinitely by the dazzling present.
Its five-minute fads, its 15-minute fames, its popinjay actors strutting vainly across temporary stages…
All amuse us vastly and grandly.
They amuse us, that is — but they do not fascinate us.
It is the long view that draws us in — the view of the soaring eagle high overhead, the view from the mountaintop.
So today we rise above the daily churn, canvass history’s broad sweep… and report strange findings.
Quite possibly scandalous findings. Scandalous?
That is, we will investigate the theory that falling interest rates the historical norm… rather than the exception.
And are central banks powerless to direct them?
The Lowest Rates in 5,000 Years
The chart below gives 5,000 years of interest rate history. It shows the justice in Sen. Teller’s argument.
Direct your attention to anno Domini 1895. Rates had never been lower. Not in all of recorded history:
Rates would sink lower only on two subsequent occasions — the dark, depressed days of the early 1930s — and the present day, dark and depressed in its own way.
The Arc of the Universe Bends Toward Low Interest Rates
Paul Schmelzing professes economics at Harvard. He is also a visiting scholar at the Bank of England. And he has conducted a strict inquiry into interest rates throughout history.
Many take the soaring interest rates of the later 20th century as their guide, he begins:
The discussion of longer-term trends in real rates is often confined to the second half of the 20th century, identifying the high inflation period of the 1970s and early 1980s as an inflection point triggering a multidecade fall in real rates. And indeed, in most economists’ eyes, considering interest rate dynamics over the 20th century horizon — or even over the last 150 years — the reversal during the last quarter of the 1900s at first appears decisive…
Here the good professor refers to “real rates.”
The real interest rate is the nominal rate minus inflation. Thus it penetrates the monetary illusion. It exposes inflation’s false tricks — and the frauds who put them out.
In one word… it clarifies.
And the chart reveals another capital fact…
The Long View
Revisit the chart above. Now take an eraser in hand. Run it across the violent lurch of the mid-to-late 20th century. You will then come upon this arresting discovery:
Long-term interest rates have trended downward five centuries running. It is this, the long view, that Schmelzing takes:
Despite temporary stabilizations such as the period between 1550–1640, 1820–1850 or in fact 1950–1980 — global real rates have shown a persistent downward trend over the past five centuries…
This downward trend has persisted throughout the historical gold, silver, mixed bullion and fiat monetary regimes… and long preceded the emergence of modern central banks.
What is more, today’s low rates represent a mere “catch-up period” to historical trends:
This suggests that deeply entrenched trends are at work — the recent years are a mere “catch-up period”…
In this sense, the decline of real returns across a variety of different asset classes since the 1980s in fact represents merely a return to long-term historical trends. All of this suggests that the “secular stagnation” narrative, to the extent that it posits an aberration of longer-term dynamics over recent decades, appears fully misleading.
Is it true? Is the nearly vertical interest rate regime of the mid-to late 20th century a historical one-off… a chance peak rising sheer from an endless downslope?
What explains it?
Interest Rate Spikes, Explained
Galloping economic growth explains it, says analyst Lance Roberts of Real Investment Advice.
He argues that periods of sharply rising interest rates are history’s lovely exceptions.
Interest rates are a function of strong, organic, economic growth that leads to a rising demand for capital over time.
In this view, rates soared at the dawn of the 20th century. It was, after all, a time of rapid industrialization and dizzying technological advance.
Likewise, the massive post-World War II rate spike owes directly to the economic expansion then taking wing. Roberts:
There have been two previous periods in history that have had the necessary ingredients to support rising interest rates. The first was during the turn of the previous century as the country became more accessible via railroads and automobiles, production ramped up for World War I and America began the shift from an agricultural to industrial economy.
The second period occurred post-World War II as America became the “last man standing”… It was here that America found its strongest run of economic growth in its history as the “boys of war” returned home to start rebuilding the countries that they had just destroyed.
Let the record show that rates peaked in 1981. Let it further show that rates have declined steadily ever since.
And so we wonder…
Was the post-World War II period of dramatic and exceptional growth… itself the exception?
The Return to Normal
Let us widen our investigation by summoning additional observers. For example, New York Times senior economic correspondent Neil Irwin:
Investors have often talked about the global economy since the crisis as reflecting a “new normal” of slow growth and low inflation. But just maybe, we have really returned to the old normal.
Very low rates have often persisted for decades upon decades, pretty much whenever inflation is quiescent, as it is now… The real aberration looks like the 7.3% average experienced in the United States from 1970–2007.
That is precisely the case Schmelzing argues.
Now consider the testimony of a certain Bryan Taylor. He is chief economist at Global Financial Data:
“We’re returning to normal, and it’s just taken time for people to realize that.”
Just so. We must nonetheless file a vigorous caveat…
A Pursuit of the Wind
Drawing true connections between historical eras can be a snare, a chasing after geese, a pursuit of the wind.
Success requires a sharpshooter’s eye… a surgeon’s hand… and an owl’s wisdom.
The aforesaid Schmelzing knew the risks before setting out. But he believes he has emerged from the maze, clutching the elusive grail of truth.
Today’s low rates are not the exceptions, he concludes in reminder. They represent a course correction, a return to the long, proper path.
How long will this downward trend continue, professor Schmelzing?
The Look Ahead
Whatever the precise dominant driver — simply extrapolating such long-term historical trends suggests that negative real rates will not just soon constitute a “new normal” — they will continue to fall constantly. By the late 2020s, global short-term real rates will have reached permanently negative territory. By the second half of this century, global long-term real rates will have followed…
But can the Federal Reserve throw its false weights upon the scales… and send rates tipping the other way?
With regards to policy, very low real rates can be expected to become a permanent and protracted monetary policy problem…
The long-term historical data suggests that, whatever the ultimate driver, or combination of drivers, the forces responsible have been indifferent to monetary or political regimes; they have kept exercising their pull on interest rate levels irrespective of the existence of central banks… or permanently higher public expenditures. They persisted in what amounted to early modern patrician plutocracies, as well as in modern democratic environments…
We have argued previously that central banks wield far less influence than commonly supposed. Here we are validated.
But we are unconvinced rates are headed inexorably and unerringly down.
Tomorrow, another possible lesson — a warning — from the book of interest rates.
Managing editor, The Daily Reckoning