The spread of negative interest rates around the world in recent years is worrisome, in part because it raises the specter of strengthening deflationary headwinds for the global economy. Optimists counter that subzero yields are an anomaly that will soon give way to a normalization of rates, which is to say positive yields. Maybe, but the forces of economic history suggest otherwise, according to new research from the Bank of England.
“Currently depressed sovereign real rates are in fact converging ‘back to historical trend’ — a trend that makes narratives about a ‘secular stagnation’ environment entirely misleading, and suggests that — irrespective of particular monetary and fiscal responses — real rates could soon enter permanently negative territory,” writes Paul Schmelzing in “Eight centuries of global real interest rates, R-G, and the ‘suprasecular’ decline, 1311–2018.”
A chart in the paper that summarizes the analysis speaks volumes. You don’t need a Ph.D. in economics to recognize that financial gravity through the centuries has been a one-sided trade in the extreme.
In a herculean task of data assembly, drawing on multiple sources from around the world, Schmelzing documents that the long-run trend for rates shows a clear downside trend. The paper provides a powerful counterpoint to analysts who argue that yields are destined to bounce higher.
To be fair, the short term – which can be measured in decades in the context of Schmelzing’s research – could easily dispense higher yields. But the underlying sweep of macro history reflects a clear bias to the downside.
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A question raised by the research is whether the recency bias that tends to dominate the human condition blinds us to the longer-term forces that appear to be running the show. As Schmelzing observes:
The discussion of longer-term trends in real rates is often confined to the second half of the 20th century, identifying the high inflation period of the 1970s and early 1980s as an inflection point triggering a multi-decade fall in real rates. And indeed, in most economists’ eyes, considering interest rate dynamics over the 20th century horizon – or even over the last 150 years – the reversal during the last quarter of the 1900s at first appears decisive.
But as a longer-run review of the data shows, “global real rates have shown a persistent downward trend over the past five centuries.”
Perhaps the most striking aspect of Schmelzing’s analysis is the evidence that the decline in real rates is persistent through various monetary regimes. Akin to a virulent strain of virus that mutates rapidly as a survival mechanism, the downward slide in rates through time appears immune to any and all policies that governments, central banks and the best laid plans of mice and men can devise.
This downward trend has persisted throughout the historical gold, silver, mixed bullion, and fiat monetary regimes, is visible across various asset classes, and long preceded the emergence of modern central banks. It appears not directly related to growth or demographic drivers, though capital accumulation trends may go some way in explaining the phenomenon.
The most controversial aspect of the paper may be its recommendation for an attitude adjustment to counter the view in recent years that disinflationary/deflationary forces are a phenomenon that are amenable to correcting if only policy makers muster the political will and intellectual capital to grapple with the problem. Measured against the long game of history, however, such plans look like the proverbial Dutch boy sticking his finger in the dike in the hopes of holding off a rising sea.
Whoever posits particular recent savings-investment dislocations in the context of an alleged “secular stagnation” needs to face the likelihood that such “imbalances” may have been a continuous key driver for five centuries.
The slide, in fact, shows no sign of ending simply because zero has come into focus.
Negative long-term real rates have steadily become more frequent since the 14th century, and I show that they affected around 20% of advanced economy GDP over time, a share that has historically risen by 1.2 basis points every year: once more, this suggests that deeply-entrenched trends are at work –the recent years are a mere “catch-up period” in this and a number of related aspects.
Using the centuries-long trend, Schmelzing offers the expected forecast: the rate decline will continue.
The data here suggests that the “historically implied” safe asset provider long-term real rate stands at 1.56% for the year 2018, which would imply that against the backdrop of inflation targets at 2%, nominal advanced economy rates may no longer rise sustainably above 3.5%.
He expects that “whatever the precise dominant driver –simply extrapolating such long-term historical trends suggests that negative real rates will not just soon constitute a ‘new normal’ – they will continue to fall constantly. By the late 2020s, global short-term real rates will have reached permanently negative territory. By the second half of this century, global long-term real rates will have followed.”
The future’s still uncertain, of course, and so every forecast comes with the standard caveats. The challenge in refuting Schmelzing’s outlook is that a contrarian view requires dismissing eight centuries of empirical evidence as the mother of all economic anomalies.
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