The Book of Ecclesiastes in 935BC declared ‘there is no new thing
under the sun’, however, just how true is this of interest rates? While modern technology is a great driver of cost reduction, products and services less influenced by technology are remarkably cost comparative through time.
For instance, morality aside, in ancient Roman times a farm labouring slave would cost in the region of $40-50 000 in today’s money, while a free worker would cost about the same for a year of work, but the farm owner would have to pay for food and other needs of the slave and would risk that the slave could die. Thus the decision to buy a slave or hire a free man was line-ball economically. A top gladiator could be bought for up to $250,000 in today’s money, adding to the prestige of the owner and perhaps giving him or her an inside running on gambling opportunities. Analysed from scratching’s on the inside wall of a Pompeii pub, beer cost about $10-$15 a cup in today’s money and a cup of good quality wine about $10-$20. Not too dissimilar to the cost of drinks today in a Perth city hotel, remembering of course that Pompeii was something of a luxury location for the Roman well to do.
Fast forward to the 1600s and each spice sailing ship would carry on their dangerous year-long journey approximately $5-$6 million in spices in today’s money. Which gives some insight into why the trade was worth the risk. So from a historical context perspective, are current interest rates really as out of the ordinary as many say? Returning to ancient Rome, Constantine The Great held interest rates at 4 – 8%, with bankers allowed to charge interest rates of 8% and private citizens limited to charging a 6% top rate.
Interestingly, these interest rates were not far out of alignment with rates thousands of years earlier in ancient Egypt according to Bank of England statistics.
Short term and long term interest rates back to 3000BC
Looking at more modern times, current Variable mortgage rates in Australia are more in line with those seen in the 1950s and 1960s [as the chart below demonstrates].
Australian historic average standard variable mortgage rates
The concern for Australia, is less that interest rates are unusually low and more that the historic household debt-to-income level is currently very high. This makes households vulnerable to a slowdown in the economy that could lift unemployment and thus create difficulty in servicing debt.
Additionally, a continued pullback in house prices increases the risk that homeowners could face negative equity, especially given many home loans in 2017 were made as interest-only loans and may need to be reset to principal and interest in 2020 and 2021. Coincidentally this would coincide with the longer-range period of recessions post interest rate inversions which is currently occurring in the US.
A key problem for global central banks is that much of economic growth in modern economies is dependent on continually rising credit demand, which in turn creates additional demand for goods and services. Slow credit demand, and goods, services and the price of assets can also decline. However, perpetually increasing debt is not possible unless GDP and incomes are both rising in real terms.
Thus for Australia and much of the world economy, the problem is less where interest rates are positioned and more the level of debt relative to serviceability, that makes the system vulnerable. It is for this reason, combined with risks in the Over the Counter Derivatives market [beyond the scope of this article] that is causing investors to currently place significant funds in negatively yielding government bonds.
Bloomberg estimates that US$13 trillion of Bonds are currently showing negative yields, if inflation is taken into account this number jumps to US$25 trillion. That means that investors are actually willing to pay to buy certain government Bonds and lose real purchasing power, meaning that these investors are expecting asset values and interest rates to fall in future and are willing to pay for the security of certain government debt instruments, rather than invest the money in
Only time will tell if their investment decision is correct.