Claims about real rates of return

With recourse to archival, printed primary, and secondary sources, this paper reconstructs global real interest rates on an annual basis going back to the 14th century, covering 78% of advanced economy GDP over time. I show that across successive monetary and fiscal regimes, and a variety of asset classes, real interest rates have not been “stable”, and that since the major monetary upheavals of the late middle ages, a trend decline between 0.6-1.8bps p.a. has prevailed. A consistent increase in real negative-yielding rates in advanced economies over the same horizon is identified, despite important temporary reversals such as the 17th Century Crisis. Against their long-term context, 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. I also posit that the return data here reflects a substantial share of “nonhuman wealth” over time: the resulting R-G series derived from this data show a downward trend over the same timeframe: suggestions about the “virtual stability” of capital returns, and the policy implications advanced by Piketty (2014) are in consequence equally unsubstantiated by the historical record.

That is from a new paper by Paul Schmelzing, via the excellent Kevin Lewis.

Comments

Thank god! All that capital accumulation over the centuries, wars aside, must have some effect on rates of return. :-)

If rates truly compounded the world would be owned by the pope.

> a trend decline between 0.6-1.8bps p.a. has prevailed. A consistent increase in real negative-yielding rates in advanced economies over the same horizon is identified

I'm only a part time bush economist (reserve orange peeler really)... I'm hoping someone can explain what this means in less jargon - thanks

Umm...pretty much the same here....but I think bps = basis points, which are like 0.01% each....

So the Cliff Notes version is real rates declined ~ 1% per century over the last 600 years?

I think that's the idea, yes.

...and therefore Piketty is wrong.

" Aggregating such evidence, and constructing plausible long-run R-G series over the last 700 years, suggests that real returns on nonhuman wealth are equally downward trending over time. They are by no means “virtually stable”, a cornerstone of Piketty’s (2014) framework. "

I think this might be an over-reach. Falling discount rates should drive higher valuations on equity (as future profits are worth far more with the lower discount rate), so I THINK (not sure!) that this is consistent with significant capital gains for equity holders over the time period in question, which MIGHT be consistent with wealth for the capital-owning class rising faster than GDP. At a minimum, more work is required to square this with observed rates of long term growth in equity markets, which are quite consistent with the R>G hypothesis.

I think it's more like 3.6% to 10.8% over 600 years

Your numbers are spot-on.

One issue is: Looking back over 600 years is too long a time horizon. It's like comparing the hot air balloon that crossed the English Channel in January 1785 with a supersonic, USAF F-35.

We are living in interesting times. Today, the prime (primo short-term commercial loan) rate is 4.75%, while the 30 year fixed-rate home loan rate is around 3.75%. In June 2019, the 30 year UST was traded at 2.65%, with a real rate of about 0.65%. At one point in 1981, the 30 year UST was 15% with a real rate of 9%. And, some of us [sigh] didn't buy it.

The Fed did not exist 600 years ago. Fifty years ago (before Humphrey-Hawkins), the Fed wasn't empowered to interfere/intervene with/in market interest rates. Twenty years ago, no one could have imagined the Fed (July 2017) indirectly owning 18% of US single-family loans and 24% of publicly traded UST securities.

I'd be interested is seeing some genius tell us how to avoid the next financial catastrophe.

I'd be interested is seeing some genius tell us how to avoid the next financial catastrophe.
---
I am not a genius but I kidnapped a Russian mathematician, he is locked in my basement, he said:
We avoid the catastrophe by making it the regularly expected catastrophe. As an expected catastrophe we short it a bit and it is less volatile. That is the current plan, to have a catastrophe with half the volatility of a Nixon Shock. And it is not like the wold ended with the Nixon Shock.

You keep referring to the "Nixon Shock."

Sometimes to the FDR sock, sometimes to the First Bank of the US Shocks, sometimes the Greenback era Shock. There is a shock in it for all generations. These shocks make up for the fallacy that capital is stationary.

The cylce is: Shock, then 'This time is different' then back to step one.

If the historical comparison is the rate of return on productive capital, this would make sense, but it isn't and therefore doesn't. There were no capital markets in the 14th century; indeed, capital markets as we know them today did not exist when Karl Marx was writing his crtique. To Marx, owners of capital had two choices: invest in productive capital or consume it. Ray Dalio would be lost to history if he had lived before today's capital markets. What's concerning is the rate of return to productive capital, for a falling rate of return to productive capital discourages investment in productive capital, such investment being the fuel for productivity and economic growth. What the data tell us is that investment in productive capital has been flat or falling, even following the Trump tax cut that was promoted on the promise that it would unleash vast sums in investment in productive capital (investment in productive capital has actually fallen since the tax cut). While owners of capital today have many more options than in the time of Marx, there is the parallel of consumption, in the great mansions of the industrialists of his day and the great mansions of the Ray Dalios of today. To a certain school of economics, investment is investment. But it isn't. Ray Dalio defends his type of investment as an efficient allocation of a scarce resource, namely capital. Does speculation on currency gyrations (or stocks or other intangibles that trade in capital markets) have the same effect on productivity and economic growth as investment in productive capital (plant, machinery, etc.)?

I read the article a bit. The research claims to have extracted the informal market from tax, death, and other municipal records.

Interesting.

A few other papers have shown long-term unlevered returns on equity capital to be quite stable (and well above real GDP growth) in the modern period. I suppose the way you'd square this data with that insight is that falling real rates drive up the valuation of equity (i.e. $1 of profit at a lower discount rate is worth far more to the equity holder), creating capital gains for equity holders.

Small technical note but could any of this be actually caused by shifts in average duration of debt? I might have missed it but didn't see any real discussion in the paper of duration. I have no idea what the trend would be there (or if you could even parse it out of the very old data), but it's plausible to me that average durations have risen as the legal regimes have gotten more stable....

...or fallen, in the last sentence above, as capital market liquidity has risen. Either plausible. Should be more careful typing things about interest rates before the second coffee.

The author of the study misses a major point made by Piketty in his book, which is the condition for his prognosis: that governments and central banks (presumably advised by leading economists) will adopt appropriate counter-cyclical policies that will avert the great gyrations of the past (booms and busts) that resulted in averages that don't reflect the reality of the economic instability and crises that existed. Piketty's compliment to his fellow economists has been overlooked by almost all other economists, who have focused instead on Piketty's prediction of rising inequality. Are economists too insecure to question the wisdom of economists (i.e., their ability to avert economic crises)? I'm not an economist, so I have questioned Piketty's premise many times in comments because it doesn't reflect on me and my profession.

I always think of all those financial brokers who claim a 5-8% long term growth trend on stocks, and how for decades they couldn't answer on performance since 1998.

I don't understand what you are saying.

The DJIA was 14,400 in Dec 1998 it is 27,700 in Dec 2019.

That's a 6.1% rate of return.

You forgot dividends. 8% total return since Dec 1998.

+1, you are correct

The claim by many asset managers is that equities would have real rates of return of 7% forever. Last 20 years real CAGR of S&P with dividends 4.4%. Thus the sorry state of public pensions.

Those asset managers and their heirs didn't answer for the mistakes going back to 1300, says the author.

Frankly, you'll probably get your money easier from the stock market - Microsoft is never going to call you to fix their toilet or force you to go to court in order to collect your dividend. Again, I like real estate fine now with the artificial stock prices caused by low interest rates, but let's just be honest about the return. Articles about getting 60% returns on your money are why so many investors find themselves desperate to unload their "money pits" despite their 30% down payment.

If the historical comparison is the rate of return on productive capital, this would make sense, but it isn't and therefore doesn't. There were no capital markets in the 14th century; indeed, capital markets as we know them today did not exist when Karl Marx was writing his crtique. To Marx, owners of capital had two choices: invest in productive capital or consume it. Ray Dalio would be lost to history if he had lived before today's capital markets. What's concerning is the rate of return to productive capital, for a falling rate of return to productive capital discourages investment in productive capital, such investment being the fuel for productivity and economic growth. What the data tell us is that investment in productive capital has been flat or falling, even following the Trump tax cut that was promoted on the promise that it would unleash vast sums in investment in productive capital (investment in productive capital has actually fallen since the tax cut). While owners of capital today have many more options than in the time of Marx, there is the parallel of consumption, in the great mansions of the industrialists of his day and the great mansions of the Ray Dalios of today. To a certain school of economics, investment is investment. But it isn't. Ray Dalio defends his type of investment as an efficient allocation of a scarce resource, namely capital. Does speculation on currency gyrations (or stocks or other intangibles that trade in capital markets)

Before everyone starts talking about interest rates as a function of available return on capital, what consideration have we given to the idea that interest rates fall as people live longer (time preference!) and market liquidity vastly improves?

real interest rates going down would lead to more inflation. These interest rates being negative would have a negative effect on savings.

Could rising savings rates actually cause lower interest rates (more demand for yield-bearing assets should drive up their price)?

If individuals are saving to a specific goal (say, funding a retirement), could lower rates just mean needing to save more? Depending on longevity assumptions, inflation, risk-taking behavior, etc.

In particular, as longevity extends and countries get richer, and thus need for savings rises at the same time as capacity to save also rises, could secular demand for savings shift the demand curve, creating both falling rates and rising savings?

Mindful of Cowen's second law, I recall someone writing about Jane Austen's writing making reference to 5% annuities. I presume in the 18th century, prices were presumed to be pretty stable, so that's definitely a hefty real rate of return compared to what has been available in my lifetime (controlling for risk).

"I presume in the 18th century, prices were presumed to be pretty stable, so that's definitely a hefty real rate of return compared to what has been available in my lifetime (controlling for risk)."

There was a significant amount of risk involved in British annuities at the time. The American revolution, The French revolution. The Napoleonic wars. Furthermore, inflation was running around 2% during that period.

I can't get past the paywall, but here is an article from the Economist about personal finance in Jane Austen.

https://www.economist.com/special-report/2005/12/20/percents-and-sensibility

In the Forsyte Saga, set in the early 20th C., the characters tend to be living off of consols at three or four percent.

Capital flows, is the point. It is a congested flow the structure of which changes asynchronous to bond term structure. The two never mach and a market making error should be accumulating and serialized. It is not sterialized, it is carried forward by he fiction of compounding.

It is the inherent error in money and prices when term length is introduced. The 'Time to completion' is hidden information, the borrower attempts to fleece the lender on that.

It is like Einstein, discovering tame is compressed or lengthened. Your currency banker, at its root, should run an asynchronous, adjustable interest rate, it simply set a current interest swap when deposits and loans are observed to generate a market making risk greater than a stated bound. The monetary errors are always may current and the accumulate within bound. Timeless, do not bet the 'Time to completion'.

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