At no point in the history of the world has the interest on money been so low as it is now.“ Colorado Senator Henry M. Teller’s comment entered the congressional minutes on January 12, 1895. This was 19 years before the Federal Reserve was created. Were interest rates 122 years ago really the lowest in world history? The chart -giving 5.000 years of interest rates history- shows the justice in Teller’s argument, if you direct your attention to 1895. Short-term U.S. interest rates had indeed never been lower in all of history up to that point. They would only sink lower on two subsequent occasions, during the depression in the 1930s and in the aftermath of the Great Financial Crisis which lingers on to this day. The most interesting fact is that, with the exception of these two episodes, long-term interest rates have trended lower for the better part of the last 5.000 years.
U.S. interest rates rose steeply during the second half of the 19th century because rapid industrialization and significant technological advances transformed the U.S. economy to one of much faster growth. The second massive spike in interest rates occurred after World War II as the United States came out of the war as „the last man standing“ with intact infrastructure and industrial capacity. This was when the U.S. experienced the strongest economic growth period in its entire history. Interest rates peaked in 1981 and have been on a downward path ever since.
This begs the question whether the post-World War II period of dramatic and exceptional growth was itself the exception. „Investors have often talked about the global economy since the crisis as reflecting a „new normal“ of slow growth and low inflation,“ according to New York Times senior economic correspondent Neil Irwin. He concludes that „maybe we have really returned to the old normal.“ Very low rates have often persisted for decades upon decades, pretty much whenever inflation was very low, as it is now. The real aberration looks like the 7.3% average inflation rate experienced in the United States from 1970 to 2007. Bryan Taylor, chief economist of Global Financial Data concludes that „we are returning to normal, and it has just taken time for people to realize that.“
Back to the old normal?
It can be argued that periods of sharply rising interest rates are history’s exceptions, as interest rates are a function of strong organic economic growth that leads to a rising demand for capital over time. Therefore, in today’s sub-par growth environment, low rates are not as outrageous as strikes the eye and maybe we are just going back to the old normal.
Today, we have a concoction of low interest rates and ultra-low bond yields across the board coupled with steady economic growth. Under such circumstances, equities look attractive relative to bonds. And indeed, though equity valuations look stretched, when they are adjusted to the current ’lowflation‘ environment, equities are priced at a normal level relative to history.