700 years of interest rates to predict the future

The bankers of Florence – the inventors of modern finance –imposed a two-figure interest rate in return for their loans. The usurer Shylock, in Shakespeare’s The Merchant of Venice, was happy with 8%, whereas this service charge on debt had fallen to around 4% at the start of World War One, and is now at 0 because savers aren’t getting anything anymore. In fact, the magnitude of the drop in the price of money these last few centuries has been quite spectacular. So, indeed, the nature of the interest demanded by the Medici’s was not of the same order as those imposed nowadays by financial establishments, and this is mainly due to fundamentally different social systems, those being feudalism and capitalism. At the time, the aristocrats’ and clergy’s fortune essentially came from charges, taxes and commitments taken on by the people, and these came mainly in the form of crops, edible livestock, military service and various other tasks.

The fact remains that there is a strong tendency that is undeniable, as a thorough study from Harvard has shown, recounting the evolution of interest rates over the last seven centuries, coming to the conclusion that we will live in a world of widespread negative rates well into the halfway point of this century. This prognostic is greatly consequential – not just in the management of the economy post Covid-19 – but also and above all for the future of capitalism. I have been talking about it and writing about it for many years, following on from Larry Summers who got the idea from Alvin Hansen, by making an obvious observation, being that capitalism as it is currently is no longer a generator of growth.This “secular stagnation” that we are suffering, underpinned by demographic problems, anaemic productivity, and declining education standards, will get significantly worse following the pandemic and will lead to a world of negative rates, most probably before the time predicted by the Harvard study.

The transmission belt for this is the quest for financial security – the famous Anglo-Saxon idea of “flight to quality” – that will be felt even more acutely after the health crisis and the post-coronavirus economic uncertainties, and that will result in a significant decrease in the government bond yields of our democracies with integrated economies because these present a tiny risk of payment default. It is therefore the rush by savers and investors – not only of the third age but also those seeking protection and stability following the unprecedent tumults of the last few months – who will cause an irreparable toppling of our interest rates into unchartered territory, and that will plunge below the 0 rate threshold for good. But so, how can we curb – or at the very least redirect – this capitalism to a bipartite trajectory that would allow both the increase of profits for those who invest in the economy and also the reduction of our debts alongside it?

One visionary – Karl Marx – had theorised this long-term collapse of the rate of return on capital, predicted this inevitable erosion of profits for those who invest in the means of production, and thereby anticipated the growth of the real economy thus becoming insignificant. How do we now persuade the purveyors of capital to take accumulated risks – in other words to redirect a part of their abundant liquidity towards business – when confidence has disappeared ? Today, Marx would tell us to stop obsessing over debt, and would suggest that governments learn to live with levels of public deficits permanently much higher that 100% of GDP, as long as they remain stable.