Why We’ll Never See “Normal” Interest Rates Again
These are historic times. In recent weeks, interest rates have plunged into record-low territory.
Uncle Sam has never been able to borrow money so cheaply. In fact, it’s never been cheaper across the planet.
The idea has us worried.
But it’s not new.
Interest rates have been on a downward trend for nearly as long as they’ve been in existence.
It’s a trend investors need to understand. It helps explain why the idea of going back to “normal” rates in our lifetimes is downright preposterous.
Think of interest as a huge, rocky mountain. Only this mountain is eroding faster than anything in the natural world.
With each passing storm, the rains wash away more and more of it.
It was during the Neolithic age (about 5000 B.C.) when man first got serious about interest. Our mountain was mighty and strong. Interest rates were a noble and highly respected idea.
But the primitive man wasn’t borrowing money to buy a boat or run his city. No, he simply borrowed seeds. And interest rates were high - often half the harvest.
But the key here is that early man borrowed assets that naturally created more wealth. One seed would turn into many more. The debtor simply gave a portion of his harvest to the lender.
And so it went for many years. Grain was the leading currency for centuries. But somewhere around 3000 B.C., copper became a store of wealth. And with it, interest could be paid in a share of the harvest - or in metallic money.
As the trend toward what we would now call traditional money grew, the penalties for not being able to pay your interest got quite serious. You could go to jail, become a slave, lose your home or even lose your wife.
Folks were serious about debt. And interest rates were high, but falling. A loan of barley repaid in copper could cost 33% per year.
It was here that our mountain began eroding.
Fast-forward a bit and we see the Greeks expanded the credit system. In 600 B.C., they paid rates of around 16% in a quickly modernizing monetary system. By 100 B.C., though, a typical loan came with a rate of just 8%.
And then things got interesting...
Just about the time Rome was reaching its peak as an empire, interest rates became the center of quite a debate. The government did something that would eventually become synonymous with the state... it borrowed money. And in an ironic bout of foreshadowing, the bankruptcy system was created at nearly the same time.
For a short time, perhaps to save the government a few slivers of gold, interest was flat-out outlawed.
Through it all, though, rates averaged between 5% and 12%.
The erosion continued.
The surging power of the church was perhaps the most powerful early force on interest rates. Somewhere around 300 A.D., the idea of usury pushed interest rates to fresh lows.
The church made it clear that charging high interest rates (it viewed it as taking advantage of the poor) was a sin. In several historic instances, usury was touted as worse than murder.
Needless to say, rates at the time were low... if they were charged at all.
And so it went for several thousand years. But as global exploration began to outweigh the pull of the church, interest rates began to rise. After all, if you’re investing a big chunk of change in a high-risk journey across an unknown sea, you want a big reward.
A typical 15th-century loan came with a rate of 10% or more.
But the trend didn’t last.
Rates fell once again in the 1700s as England found itself in one costly battle after the other. As William III took on France, he found the need to borrow from his citizens. He paid about 8%. But more importantly, throughout this period of heavy borrowing, the Bank of England was created.
The erosion-inducing realm of central banking was upon us.
The bank and the growing power of its brethren across Europe pushed rates to fresh lows throughout the 18th and 19th centuries. Borrowers of the day could expect to pay little more than 3% for a short-term, high-quality loan.
The same was true in the quickly expanding United States. Westward-looking railroads were paying interest rates just shy of 3% as we welcomed the 20th century.
Throughout the century’s minor and major crises, rates remained consistent. Not until the financial turmoil of the 1970s did the benchmark Fed discount rate rise above 4.6%...
The same benchmark rate that stands at 0.25% today.
The biggest disruption to the millennia-long downtrend in interest rates - and perhaps the reason so many folks feel rates must return to “normal” - came during the Reagan administration as the Fed fought the “Great Inflation.” At their peak, rates rose to an incredible 20%.
They’ve fallen ever since.
Despite the short-term blip some 35 years ago, the historic trend has been toward falling interest rates...
From over 30% to 12%... to 8%... and, now, below zero.
Our mountain is nearly gone.
To believe we’re somehow going to reverse this centuries-old trend within our lifetimes is preposterous.
Interest rates have been falling for millennia. With the exception of a few fits and starts, they’ll keep falling. It’s especially true that negative interest rates have become a new normal.
If your investing strategy relies on rising rates... think again.
History is not on your side.
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