What the Last 700 Years Teaches Us About Low Interest Rates

What the Last 700 Years Teaches Us About Low Interest Rates

Back in August I wrote that the man they called the ‘bond god’ was calling for a rally in the US dollar. His name is Jeff Gundlach. He got that right, as far as we Aussies are concerned anyway.

Our dollar was around 80 cents then, and flirting with going higher. Instead it’s drifted down to 75 cents.

I mention this because another forecast from Gundlach at the time was for interest rates on US Treasuries (government debt) to start going higher.

So far he’s been right about that too. A US 10 year note now yields 2.356%.

This is THE key interest rate figure around the world. It’s the benchmark for everything else, including influencing your mortgage, if you have one.

What happens here is crucial for pricing other assets, like stocks, both here and in the USA.

The US bond market has fooled a lot of commentators for a long time. At one point I thought rates would be much higher than they are now. I stopped saying anything after I got it wrong enough times.

Perhaps I needed to look further back.

That’s what my colleague Brian Maher is going to do for you today.

History suggests Jeff Gundlach might be on to something…


Callum Newman Signature

Callum Newman
Editor, The Daily Reckoning Australia


What The Last 700 Years Teachers
Us About Low Interest Rates

By Brian Mahar,
Managing Editor of The Daily Reckoning US

Recently I presented evidence that interest rates have trended lower for the better part of 500 years.

I also suggested that the high interest rates of the mid-to-late 20th century may be history’s true aberration.

Let me here reintroduce the prosecution’s evidence:

Source: Bank of England
Here, in graphic form, five centuries of generally descending real long-term rates — before a Himalayan spike in the mid-to-late 20th century.

Real interest rates, we should mention, are nominal rates minus inflation.

If nominal rates are 3%, for example, while inflation runs at 1%, the real rate is 2% (3 – 1 = 2).

As Harvard economics professor Paul Schmelzing noted in yesterday’s Reckoning, ‘Real rates have been following a downward path for close to 500 years on a variety of measures.’

But we’ve dug even deeper into the historical data…rooted around for omens…and emerged with disturbing findings.

Details to follow…

Over seven centuries, Schmelzing identifies nine ‘real rate depression cycles.’

These cycles feature a secular decline of real interest rates…followed by reversals.

The first eight cycles tell fantastic tales…

These cycles often pivoted around such events as the Black Death of the mid-14th century…the Thirty Years’ War of the 17th century…World War II.

Source: Bank of England
The world is currently immersed in history’s ninth rate depression cycle, which began in the mid-’80s.

Schmelzing says the closest historical analogy to the present cycle is the worldwide ‘Long Depression’ of the 1880s and ’90s.

This ‘Long Depression’ saw ‘low productivity growth, deflationary price dynamics and the rise of global populism and protectionism.’

Need we list the parallels to today?

It is here where our tale gathers pace…

Schmelzing’s research reveals that the present cycle is the second longest of the entire 700-year record…and the second most intense.

The only cycle to have lasted longer came in the 15th century…

Only one previous cycle — also from the same epoch — exceeded the current cycle in intensity.

By almost any measure…today’s rate depression cycle is a thing of historic grandeur.

The steep downward slope on the extreme right of the chart gives the flavour of its severity:

Source: Bank of America
Schmelzing’s research show that the real rate for the entire 700-year history is 4.78%.

Meantime, the real rate for the past 200 years averages 2.6%.

And so ‘relative to both historical benchmarks,’ says this Schmelzing fellow, ‘the current market environment thus remains severely depressed.’

That is, real rates are well below historical norms.

And if the term ‘reversion to the mean’ has any currency…things could get rather interesting…rather quickly.

Because history shows that when rates do regain their bounce, they do so with malice.

If the world is near the end of the current 34-year rate depression cycle, it could be in for a nasty lesson in mean reversion.


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 to ‘real rate stagnation’ periods have been rapid, nonlinear and took place on average after 26 years.

How rapid? How nonlinear?

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 correction roughly equals the magnitude of the cycle it ends, we can likely expect a real lulu of a reversal.

The current cycle is after all, the second longest on record…and the second most intense.

Since the stock market and economic ‘recovery’ seem to hinge upon ultra-low interest rates, we shudder to think of what a ‘rapid, nonlinear’ rate reversal would mean for either.

Its impact on the West’s ability to finance its debt is another story altogether…but a story for a different day.

Of course…there’s no reason in law or equity why the second-longest, second most intense rate depression cycle in history…can’t become the longest, most intense rate depression cycle in history.

The cycle could run years yet.

Or it could end tomorrow.

But end it will…

Best wishes,

Brian Mahar,
for The Daily Reckoning Australia