Interest Rates – A Key Indicator of Economic Health

Sep. 23, 2019
David McAlvany

Our regular author for articles on MIAtoday.com, Bob Adelmann, was hit by a car while bicycling last week. He was badly injured, but his prospects for recovery are good. Our prayers are with him as he heals, and I'm sure he would appreciate yours, as well. Until he's able to rejoin us, we will be featuring some excerpts from David McAlvany's podcasts at mcalvanyweeklycommentary.com. David has interviewed some stellar guests on his program, and we invite you to spend some time at his site if you find these excerpts of use.

On August 20, 2019, David interviewed Richard Sylla, coauthor with the late Sidney Homer of A History of Interest Rates. Few people would read such a work if it were seven pages long. This book, at 700 pages, is therefore a valued resource for a select few. That's very unfortunate. Like one's body temperature, interest rates are an indication of health and/or risk. In the authors' words, "free market long-term rates of interest for any industrial nation, properly charted, provide a sort of fever chart of the economic and political health of that nation. Wars and political and economic calamities are recognizable at site on the charts." [Emphasis added.] With that critical function in mind, here is today's excerpt from the interview.

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David: Interest rates are worth observing, I think, in part because of the drama that they indicate all around them. So to be intrigued by them is to be intrigued by indicators, to be intrigued by signs, to be curious about the clues that are a part of the ongoing human story that looks back ancestrally, but also to our heirs – what they will receive from us.

There are two men who capture and convey that intrigue with interest rates in their book, and the title of the book is A History of Interest Rates, now in its 4thedition. Sidney Homer, a Solomon Brothers veteran, is no longer with us. Richard Sylla joins us today as the coauthor of this guide on rates to explore the past of interest rates, the present circumstance, and perhaps the future, as well….

I thought it was interesting that the grand sweep of your book starts with the ancient world – Sumerian, Assyrian, Babylonian, and Egyptian. I thought it was interesting that the credit markets remained under-developed in ancient Egypt. It was an authoritarian state, but by contrast you had very developed credit markets in the Sumerian, Assyrian, and Babylonian cultures. This is where enterprise and free trade were a driving force. Do you have any thoughts on the healthy development of credit markets in particular political contexts?

Richard: I think the development of credit markets, of course, is one of the reasons why there is a long-term trend toward lower interest rates. The financial development in the modern era – I could think back to the medieval and Renaissance Italians who invented modern banking, to the Dutch Republic of the 17th and 18th centuries when the full range of modern financial institutions and markets developed. The Dutch had a government debt market, they had a Bank of Amsterdam as sort of a central bank. They had an equity market, you could buy stock in the Dutch East India Company, Dutch West India Company. So the Dutch had companies and banks and, in particular, well-developed securities markets, so the Republic could borrow money. It actually won its independence from Spain by being able to borrow more money than Spain could, at lower rates than Spain could.

And then you see the same thing. Basically, the English adopted Dutch finance at the end of the 17thand early 18th centuries. The United States under Alexander Hamilton duplicated these institutions. And then you see Japan, when it modernized in the 1870s and 1880s, looking at the rest of the world and then founding the Bank of Japan in 1881. They had a government debt market in the 1870s, and also the banking system. And so civilizations do develop better ways of financing entrepreneurship and financing governments. And I think, if you look back into ancient history, the Greeks and the Romans improved on the Babylonians, in particular.


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If you remember, The History of Interest Rates studies the full range of interest rates that existed at any time, but the real goal of the book was to say what the lowest rates were that you would observe in any civilization. The Romans actually got down at the time of Augustus to where people could borrow money at 4%, so that Roman civilization developed pretty good financial markets. Then, as I say, the modern civilizations, from the Italians of the Renaissance to the Dutch, to the English, to the Americans, and the Japanese.

And in the 20thcentury, of course, in our own time we see these markets being extended all over the world to emerging markets and the independent states of the old communist countries. We're seeing a lot of spread of modern financial technologies throughout the world. The Egyptians, apparently, did not adopt these technologies to the same extent that the Greeks and the Romans, and maybe the Babylonians, did. Not everybody is equally developed financially….

David: You mentioned a moment ago the issue of quality in the top of the structure in terms of risk. The best quality is sovereign debt. Quality is one aspect of a debt instrument. At one point in time there was no such thing as sovereign debt. There was the merchant, there was an enterprise, and that was considered the best quality credit. Now sovereign debt is at the top of the heap. Could that ever change, where commercial paper is of higher quality than sovereign paper?

Richard: Oh yes. Go back to medieval and early modern Europe. There were countries, with kings, usually, and the records show that merchants who had a kind of mercantile code of honor and fair dealing could borrow at lower rates than the kings could because the kings often defaulted on their debts. So it is very clear that a country, or a king, had to pay a higher rate of interest than merchants who trusted each other charged each other. So, certainly, sovereign debt has only become the safest of assets in the modern era and I think that relates a little bit to changes in the monetary system, too.

You know, money used to be based on gold and silver. Today it is something that governments create with the stroke of a pen, unrelated to the amount of gold and silver they have in reserve, and that makes the modern sovereign debt – take a country like the United States. It borrows 22 trillion dollars, and that is what the national debt is now, and people buy and hold that because it's a promise of the government to pay you in dollars and the government that created the debt has the ability to create the dollars to pay that debt. We could talk about what those dollars might be worth and the markets think about that, but they don't seem to be that worried about it of late.

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