Interest Rates Over Seven Centuries, 1273-2017

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SimpleGift
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Interest Rates Over Seven Centuries, 1273-2017

Post by SimpleGift » Tue Oct 31, 2017 1:18 am

This post reports on a recent paper from the Bank of England, which has assembled a continuous set of interest rates over seven centuries, from the year 1273 to 2017 (charts below).

Their data set begins with private debt instruments in Venice, Italy, which started trading freely on secondary markets starting in the 1270s. It then picks up interest rates from the bond markets in Genoa, Spain and Amsterdam to 1700, then the U.K. bond market from 1700 to 1900, and finally the U.S. and German bond markets to 2017. This first chart shows the data sources and the nominal interest rate over the full period:
Much more interesting is the real global interest rate (inflation-adjusted) over the 700-year period, shown in this second chart:
Clearly, the multi-century trend has been toward lower real interest rates — from 9.4% in the 1400s, to 3.4% in the 1800s, to 1.24% in the 2000s. This is consistent with the generally declining societal risk over the centuries, as economies and financial markets worldwide became more stable and less uncertain. As eloquently discussed in William Bernstein's 2001 article, stability and prosperity have historically implied higher asset prices and lower interest rates.

Any thoughts on this research?
Last edited by SimpleGift on Tue Oct 31, 2017 1:47 am, edited 1 time in total.
Cordially, Todd

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CaliJim
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Re: Interest Rates Over Seven Centuries, 1273-2017

Post by CaliJim » Tue Oct 31, 2017 1:45 am

Good stuff. Interesting and very tempting to spin stories to explain the data. My intuition is to agree with Bernstein somewhat.

However, my personal struggle is with the little wiggles that don't show very well on the long long long term graphs.

Have real interest rates hit the bottom of a short term cycle and are they now on the way back up? Is it safe to extend my avg bond duration or not. I don't know! Stay the course!!

However - I think it is SAFE to assume that real returns (both for bonds and equity) will be low in the foreseeable future, and folks these days must either amass a huge fortune to achieve financial independence, or plan on working longer than they might want.

Another thought: technological disruption, political and social instability, or other black swans are an ever present immediate possibility.
Last edited by CaliJim on Tue Oct 31, 2017 1:49 am, edited 2 times in total.
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TD2626
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Re: Interest Rates Over Seven Centuries, 1273-2017

Post by TD2626 » Tue Oct 31, 2017 1:48 am

Simplegift wrote:
Tue Oct 31, 2017 1:18 am
Clearly, the multi-century trend has been toward lower real interest rates — from 9.4% in the 1400s, to 3.4% in the 1800s, to 1.24% in the 2000s. This is consistent with the generally declining societal risk over the centuries, as economies and financial markets worldwide became more stable and less uncertain. As eloquently discussed in William Bernstein's 2001 article, stability and prosperity have historically implied higher asset prices, lower interest rates, and lower asset returns.
Very impressive to have this much data. A great post!

I do worry that societal risk levels will decline, and that therefore, interest rates and investor returns will decline. In the 1800s, investing in stocks was very, very, very risky. Now, with the SEC and FINRA regulating things, it is merely very risky. Similarly, with more stable societies, and better evaluation of credit risks, it is likely that interest rates may remain lower than they were in the 1400s. I invest without worrying about marauding hordes of heavy cavalry confiscating my assets.

I feel that the risks involved in setting up a factory or business are timeless. They are the same kinds of risks faced in the 1400s as are faced today. The risk that the founder will not succeed in their plans. The risk that anticipated profits won't materialize. The risk of unexpected occurrences (like natural disasters) negatively impacting the firm. Investing in bonds or stocks of growing enterprises is thus effectively the same, whether investing in the 1600s, 1800s, or the 2200s. There is more regulation and protection today, so it's possible that there's a less risk - less reward phenomenon.

Investors, though, are all human and humanity hasn't changed. People are subject to the same emotional and behavioral biases and shortcomings that they always have been - technology and modernity doesn't change that. People want shiny show-off luxuries now - not tomorrow - and are happy to pay high interest rates to keep up with their neighbors. It doesn't matter if this involves having a better mule than their neighbor or a better car.

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Re: Interest Rates Over Seven Centuries, 1273-2017

Post by daveydoo » Tue Oct 31, 2017 1:54 am

Simplegift wrote:
Tue Oct 31, 2017 1:18 am
... as economies and financial markets worldwide became more stable and less uncertain...
I think his explanation kinda sounds like the chauvinism of the present. The rich always assume that they are living in stable times; that's why market crashes are so disrupting. And, for the record, it didn't feel very stable in 2009.

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Re: Interest Rates Over Seven Centuries, 1273-2017

Post by SimpleGift » Tue Oct 31, 2017 3:55 am

^^^ If one accepts the premise that real interest rates reflect the level of risk in a society (ala Mr. Bernstein), it's fairly clear that not only has the global real interest rate declined over the past seven centuries, but it has also become much less volatile. This chart from the Bank of England study in the OP shows the annual real global interest rate since 1273:
It's hard not to conclude that the world has progressively become more economically stable over the last 700 years — likely reflecting the transition from agricultural-dominated economies, to manufacturing economies, to mainly services-dominated economies today. This along with many other stabilizing factors, such as counter-cyclical monetary policies by central banks, protections for unemployed workers, more open and diverse economies, and the like.

Economic risk hasn't disappeared (see the 2008-09 Financial Crisis, as mentioned) — but it certainly appears to have moderated dramatically over the centuries, as a general trend.
Cordially, Todd

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Re: Interest Rates Over Seven Centuries, 1273-2017

Post by SimpleGift » Tue Oct 31, 2017 2:00 pm

TD2626 wrote:
Tue Oct 31, 2017 1:48 am
Investors, though, are all human and humanity hasn't changed. People are subject to the same emotional and behavioral biases and shortcomings that they always have been - technology and modernity doesn't change that.
Good point. But I believe this applies more so to stock investing, where investors seem more subject to extreme bouts of irrational exuberance and pessimism — and as you suggest, this will likely never change.

However, over on the bond side, my sense is that bond investors are a more sober group, and interest rates tend to be set in markets that are less prone to irrationality and extremes. I could be wrong — but if so, this would strengthen the argument that interest rates are a good measure of relative societal and economic risk over long historical periods.
Cordially, Todd

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Re: Interest Rates Over Seven Centuries, 1273-2017

Post by alex_686 » Tue Oct 31, 2017 2:26 pm

Simplegift wrote:
Tue Oct 31, 2017 2:00 pm
TD2626 wrote:
Tue Oct 31, 2017 1:48 am
Investors, though, are all human and humanity hasn't changed. People are subject to the same emotional and behavioral biases and shortcomings that they always have been - technology and modernity doesn't change that.
Good point. But I believe this applies more so to stock investing, where investors seem more subject to extreme bouts of irrational exuberance and pessimism — and as you suggest, this will likely never change.
I would like to point out that there have been secular changes during this time period. At the start governments really were not governments - they were more like the private enterprise of a family. Most loans were made to the head of state, not to a country. Most people did not use money as we know it. Thus interest bearing loans were more akin to speculative ventures and stock investing.

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TD2626
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Re: Interest Rates Over Seven Centuries, 1273-2017

Post by TD2626 » Tue Oct 31, 2017 2:46 pm

alex_686 wrote:
Tue Oct 31, 2017 2:26 pm
Simplegift wrote:
Tue Oct 31, 2017 2:00 pm
TD2626 wrote:
Tue Oct 31, 2017 1:48 am
Investors, though, are all human and humanity hasn't changed. People are subject to the same emotional and behavioral biases and shortcomings that they always have been - technology and modernity doesn't change that.
Good point. But I believe this applies more so to stock investing, where investors seem more subject to extreme bouts of irrational exuberance and pessimism — and as you suggest, this will likely never change.
I would like to point out that there have been secular changes during this time period. At the start governments really were not governments - they were more like the private enterprise of a family. Most loans were made to the head of state, not to a country. Most people did not use money as we know it. Thus interest bearing loans were more akin to speculative ventures and stock investing.
Good points, all. I wasn't just referring to the exuberance of bubbles when I was pointing out long term constant human emotional preferences and characteristics, expected to be constant, that produce a rationale for interest being demanded. People want consumption instead of in the future and demand an interest rate to compensate them for their delayed gratification. Thus, there'll always be a risk free interest rate (or maybe not... see some foreign developed bonds).

One question is whether this decline is simply decline in return due to decline in risk. Has the risk-adjusted real return of bonds remained constant over long periods?

Also, it's possible that we don't have enough data. Maybe this sort of article might help: http://businessinsider.com/chart-50 ... ory-2016-6

The obvious cautions that data this old is likely to be questionable apply, of course.

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Re: Interest Rates Over Seven Centuries, 1273-2017

Post by daveydoo » Tue Oct 31, 2017 6:32 pm

Simplegift wrote:
Tue Oct 31, 2017 3:55 am
...it's fairly clear that not only has the global real interest rate declined over the past seven centuries, but it has also become much less volatile.
I think you're mistaking old bad data for volatility. These are real returns so how much do we know about the medieval CPI? Where do those inflation numbers come from? Errors are compounded when we're merging two sets of unreliable data. And we're comparing a regional economy early on to a global economy.

Data that look like these suggest that "truth" is in the middle of these implausible swings -- rates whipsawed between 40% and -40% real returns over the span of a handful of years? That does not seem super-likely.

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Re: Interest Rates Over Seven Centuries, 1273-2017

Post by djheini » Tue Oct 31, 2017 6:48 pm

daveydoo wrote:
Tue Oct 31, 2017 1:54 am
Simplegift wrote:
Tue Oct 31, 2017 1:18 am
... as economies and financial markets worldwide became more stable and less uncertain...
I think his explanation kinda sounds like the chauvinism of the present. The rich always assume that they are living in stable times; that's why market crashes are so disrupting. And, for the record, it didn't feel very stable in 2009.
But I think it is indisputable that the world is becoming more interconnected, allowing more options for commerce (and borrowing) which would presumably lead to lower rates. If your only option is what your local moneylender will offer you, then that's what you have to pay. But if you can trade/borrow with thousands of counterparties, then you're almost guaranteed to get a better rate.

alex_686
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Re: Interest Rates Over Seven Centuries, 1273-2017

Post by alex_686 » Tue Oct 31, 2017 7:07 pm

TD2626 wrote:
Tue Oct 31, 2017 2:46 pm
alex_686 wrote:
Tue Oct 31, 2017 2:26 pm
I would like to point out that there have been secular changes during this time period. At the start governments really were not governments - they were more like the private enterprise of a family. Most loans were made to the head of state, not to a country. Most people did not use money as we know it. Thus interest bearing loans were more akin to speculative ventures and stock investing.
Good points, all. I wasn't just referring to the exuberance of bubbles when I was pointing out long term constant human emotional preferences and characteristics, expected to be constant, that produce a rationale for interest being demanded. People want consumption instead of in the future and demand an interest rate to compensate them for their delayed gratification. Thus, there'll always be a risk free interest rate (or maybe not... see some foreign developed bonds).
I think you missed my point, which was that for most of the time the bonds were risky speculative investments - more like speculating in junk bonds of emerging markets. Payment was very not guaranteed. I will point out that many traditional savings schemes have negative returns because what we consider to be traditional low risk savings was way out of reach.

Then factor in that there were often shortages of money - that is gold. If you had hard money you could demand high rates for it. Yeah fiat money.

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Re: Interest Rates Over Seven Centuries, 1273-2017

Post by whodidntante » Tue Oct 31, 2017 8:25 pm

"May you live in interesting times." I guess we are lucky.

protagonist
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Re: Interest Rates Over Seven Centuries, 1273-2017

Post by protagonist » Tue Oct 31, 2017 9:26 pm

daveydoo wrote:
Tue Oct 31, 2017 1:54 am
Simplegift wrote:
Tue Oct 31, 2017 1:18 am
... as economies and financial markets worldwide became more stable and less uncertain...
I think his explanation kinda sounds like the chauvinism of the present. The rich always assume that they are living in stable times; that's why market crashes are so disrupting. And, for the record, it didn't feel very stable in 2009.
That's a good point. Just a quick glance at the two graphs (nominal and real- 7 year moving average) doesn't suggest significantly more stability from 1900 until today than from 1500 through 1900....if anything just the opposite. For one thing, the economy is now global, so if one region crashes the whole world crashes. And there was WW1 and WW2. As weaponry gets more sophisticated wars become potentially more devastating. As technology drives forward new innovations have a potentially greater impact on society. When people speak of stability they are ignoring the fact that black swans are what drive history (and the economy)... and globalization increases their impact.

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Re: Interest Rates Over Seven Centuries, 1273-2017

Post by SimpleGift » Wed Nov 01, 2017 8:21 am

protagonist wrote:
Tue Oct 31, 2017 9:26 pm
When people speak of stability they are ignoring the fact that black swans are what drive history (and the economy)... and globalization increases their impact.
Actually, increased stability and increased tail risk are perhaps not mutually exclusive.

Taking the U.S. economy as an example (where we have decent historical data), the frequency of economic recessions has certainly declined over the past 150 years (in gray, chart below). Prior to 1940, the U.S. economy was in recession over 40% of the time; since 1940, however, it's been in recession about 15% of the time. There's been a clear trend toward increased stability and moderation of the business cycle.
At the same time, there's recent evidence that the severity of economic recessions has increased. The two most recent recessions, starting in 2001 and 2007, have been economic jolts with lasting structural consequences — especially for employment, which has taken much longer than usual to recover (chart below). As you suggest, this may be due to increased globalization of the U.S. economy.
In short, with greater global connectedness, we could be experiencing less frequent, but more severe and consequential economic downturns. And this is before we get to black swans, with the prospect of a global pandemic, an environmental catastrophe, or a nuclear conflict.
Cordially, Todd

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