"500 Years of Interest Rates: The Lesson"
by Brian Maher
"Wednesday we hauled forth evidence that long-term interest rates have trended persistently downward 500 years running. And the Himalayan rates of the mid-to-late 20th century? These may be history’s great exception, a brief but violent spasm… like a fleeting burst of blood pressure… or a volley of cannons. Here again, the graphic evidence:
Harvard economics professor Paul Schmelzing, in summary: "Despite temporary stabilizations such as the periods 1550–1640, 1820–1850 or in fact 1950–1980 -- global real rates have shown a persistent downward trend over the past five centuries… since the major monetary upheavals of the late middle ages, a trend decline between 0.6–1.6 basis points per annum has prevailed… Against their long-term context, currently depressed sovereign real rates are in fact converging ‘back to historical trend’..."
Furthermore: Rates have held this downward course “irrespective of particular monetary and fiscal responses.” That is, despite the monkeyings of governments and their central banks. Can you therefore expect the downward journey of interest rates to maintain present headings?
We have further ransacked the historical data… rooted around for clues… and plucked out worrisome findings. Worrisome, that is, if you track your time in years and decades — not centuries. Details to follow. Let us first examine another historical oddity, worrisome in its own way — the present stock market...
Tech Trounced: Markets are sensing inflationary pressures, and the Federal Reserve’s willingness to let them build. Technology shares led the U.S. stock market lower on Friday as a spike in bond yields fueled concern about equity valuations and prompted investors to sell growth-focused high flyers. But let us resume our study of time… and money. For light, we once again resort to the good Professor Schmelzing. The arc of interest rates bends lower with time, he has established. But as he has also established: "No line bends true across five centuries." Even the long downturning arc has its squiggles and twists, its crooks and its kinks, each bent by the great forges of history. To these, we now turn…
“Real Rate Depression Cycles”: Across seven centuries, Schmelzing identifies nine “real rate depression cycles.” These cycles feature a secular decline of real interest rates, followed by reversals — often sudden and violent reversals. The first eight rate depression cycles tell scintillating and often murderous tales…These cycles rotated upon such high dramas as the Black Death of the mid-14th century… the Thirty Years’ War of the 17th century… and the Second World War of the 20th century. The world is presently ensnared within history’s ninth real rate depression cycle. This cycle began in the mid-1980s.
Schmelzing’s researches reveal the real rate for the entire 700-year span runs to an average 4.78%. The real rate for the past 200 years - meantime - averages 2.6%. It is here where our tale gathers pace… and acquires point…
A Thing of Historic Grandeur: Schmelzing’s research shovels up this revelation: This present cycle is a thing of historical grandeur - in endurance - and intensity. Of the 700 years, only one cycle experienced a greater endurance. That cycle was in the 15th century. And only one previous cycle - also in that age - exceeded the current cycle’s intensity. By almost any measure… today’s rate depression cycle is stupendous, a thing for the ages. The sharp plunge to the right gives the flavor of it:
Beware “Reversion to Mean”: “Relative to both historical benchmarks,” concludes this fellow, “the current market environment thus remains severely depressed.” That is, real rates remain severely depressed relative to historical benchmarks. If the term “reversion to mean” has anything in it - we believe it does - the world is in for a hard jolt when the mean reverts. When rates do regain their bounce… history shows... they bounce high.
Schmelzing: "The evidence from eight previous “real rate depressions” is that turnarounds from such environments, when they occur, have typically been both quick and sizeable… Most reversals... have been rapid, nonlinear and took place on average after 26 years…
Within 24 months after hitting their troughs in the rate depression cycle, rates gained on average 315 basis points [3.15%], with two reversals showing real rate appreciations of more than 600 basis points [6%] within two years."
If the magnitude of the bounceback approximates the magnitude of the cycle it ends… we can expect a fantastic trampolining of rates. We must consider that rate appreciations of 6% are within reason. The present rate depression cycle runs nigh on 40 years. We must conclude - therefore - that the present rate cycle depression goes on loaned time. What happens once the loan is called in?
Crushing Debt: The stock market and the economic “recovery” presently underway hinge upon ultra-low interest rates. And so we recoil, horrified, at the prospect of a “rapid, nonlinear” rate reversal. Consider alone its impact on America’s ability to finance its skyshooting debt… A drastic rate increase means debt service becomes an impossible burden. The virus has dynamited mighty holes in America’s finances. The nation has taken on $7 trillion of fresh debt within the past year alone.
How would America service a $28 trillion debt - a $28 trillion debt jumping by second, by minute, by hour, by day, by week, by month, by year? Indeed… by decade? Debt service already represents the fastest-growing government outlay. The Committee for a Responsible Federal Budget (no laughter!) estimates interest payments on this debt will total $300 billion this year.
Horrifying Arithmetic: But as the Committee further informs us, at present debt levels: "Each 1% rate increase inflates debt service by roughly $225 billion." Should rates rise 1%… interest payments would balloon to $525 billion… exceeding all Medicaid costs.
What if rates jump 2% or - heaven forfend - higher? The Committee: If rates were 2% higher, interest costs would total $750 billion, which is more than the federal governments spends on defense or Medicare. And at 3% higher, interest costs would total $975 billion - almost as much as is spent on Social Security benefits.
We do not expect such a violent lurch in rates within the year. But assume the present rate depression cycle reverses spin next year or the year following. Assume further that real rates leap to 6% within two years of the reversal. Recall, rates streaked to 6% or higher after two previous rate reversals.
Debt levels - meantime - could well exceed $30 trillion within the next two years. What is the cost to service a $30 trillion debt… at 6% the year? We haven’t the stomach to run the arithmetic. But we hazard the figure is plenty handsome. Debt service would nearly swamp the entire budget. But what might bring down the curtain on the current cycle?
The Mischievous Gods: Most previous rate depression cycles swung with death, destruction, howls, shrieks and sobs. Examples, again, include the Black Plague, the Thirty Years War and World War II. Perhaps a similar calamity will reverse the present cycle. Or some other unforeseen blow. The mischievous gods hold many tricks up their shirtsleeves.
Of course, we can find no reason in law or equity why the second-longest, second-most intense rate depression cycle in history… cannot become the longest, most intense real rate depression cycle in history. The cycle could run years yet, we must allow. It could also reverse Sunday morning. The Lord only knows - and He is silent."
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