Odd Lots - Episode 5: 6,000 Years of Interest Rates

Episode Date: December 7, 2015

(Bloomberg) -- What better way to prepare for what may be the first U.S. rate hike in almost a decade than to tour 6,000 years of interest-rate history? This week, Joe and Tracy speak with NYU Stern finance professor Richard Sylla, co-author of A History of U.S. Interest Rates. We start in Babylonia, where Hammurabi codified the relationship between debtors and creditors, and end with zero percent interest rates in the U.S. in the 21st century. Along the way, we journey to the Roman city that pledged its public colonnades as collateral, learn why medieval French princes had such terrible credit histories and figure out why today's negative interest rates in parts of Europe really are a historical oddity. In other words, Odd Lots read a 700-page book on interest rates so you don't have to. (No, really, you should read it. It's a great book).See omnystudio.com/listener for privacy information.

Thanks for listening to Odd Lots. Follow the show on Amazon Music for more future episodes or just ask, Alexa, play the Odd Lots podcast on Amazon Music. The Odd Lots podcast is brought to you by ExxonMobil. Energy lives here. Welcome to Odd Lots. It is Monday, December 7th. I'm Tracy Alloway, executive editor of Bloomberg Markets. And I'm Joe Wisenthall, managing editor of Bloomberg Markets. Hey, hey, Joe. Yeah. What's this? That is a book. Yes, but specifically it is a 700-page book on the history of interest rates.

Have you read the entire thing? I actually did, and I have to tell you, it is a scintillating read that encapsulates everything from Mesopotamian interest rates in 3,000 BC to medieval attitudes towards usury, hyperinflation in Argentina in the 1980s. It's actually a pretty famous book in financial circles, and it was first written by Sydney Homer back in 1963. Now, unfortunately, Homer has passed away since then, but I am very excited to say that the guest we have on today is Richard Silla, who's the co-author on the fourth edition of this book and also a professor of economics and financial markets at NYU Stern. So we are

about to embark on a rollicking 6,000-year tour of the history of interest rates. So two quick think. They had interest rates back then in Mesopotamia. Like, this is not a totally modern invention. Oh, Joe. You're going to learn so much. And studying interest rates could theoretically be pretty exciting right now because we may be on the verge of our first rate hike in several years. Yes. So what better way to prepare for that historic event than to go back in time and learn about Dutch interest rates in the 18th century? Let's do it. I'm excited. Professor Silla, thank you so much for joining us. Pleasure to be here. I have to ask, so when Sydney Homer first published this book in the early 1960s. That was a time when interest rates were not exactly the

hot topic matter that they are now. Why do you think he wanted to look at them? Well, Sidney Homer was a kind of a cultured fellow Harvard grad who had a career on Wall Street. And I think because he was highly educated and he thought more than most people do about their jobs. And he wanted to know, he was in the bond markets and he wanted to know, you know, what was the origin of them? And for example, he'd heard about the Dutch finance as being important. Well, exactly what was Dutch finance. And so he embarked on this history of collecting interest rates as much as he could from, you know, all the recorded history up to that time and decided to put it into one book called The History of Interest Rates. Now, the book starts in ancient times and it starts with

Things like Babylonian kings setting the maximum rates of interest on loans of grain. How in the world did Homer go about collecting the data for this book? Well, if you're talking about Babylonia, there is a great source there, which many people have heard of, but they probably don't think it has interest rates in it. It's the code of Hamirabi. It was sort of a great code that came. I think it was about 1800 BC or something like that. So it's about 4,000 years ago.

And in the code of Hamarabi, it sort of specifies that if you lend somebody money, the maximum rate you can charge them as 20%. If you lend somebody grain, apparently people lent grain as well as money, the maximum rate was 33 and a third percent. So how did they how did Hamurabi derive these figures? Was it a sort of finger in the wind? 20 percent seemed like the right amount? Or was it something more reflective of the economy where there was a basis in reality? Well, I suspect that since Hamerabi was saying this is the most you can charge, that there were a lot of lending practices both for money and grain. And sometimes people tried to charge more than 20 or 33 and a third percent. And Hamerabi thought that was unreasonable. And so he sort of put a ceiling on what could be charged.

And I think it was probably sort of customary rates at that time. One of the things I love so much about the book is all the types of collateral that it outlays. So for instance, there's a king of Jerusalem. Baldwin the second who famously pledges his beard for re-hypification. And there's an ancient Greek city that pledged its public colonnades. So when the city defaulted, the citizens couldn't walk down the colonnades anymore, which just seems absolutely absurd to us nowadays. But there's a long history of various types of collateral being used.

Yes, I think there are many, many different kinds of collateral. But the traditional main assets were precious metals and land. But I think many other things could be used as collateral, particularly for smaller loans. Of course, you're citing the colonnade. I mean, that's sort of a public convenience. And it's interesting that they would pledge that. They must have needed to borrow a lot of money, perhaps the fight of war. Nowadays, when we think about interest rates, we think about, you know, the risk-free rate.

And rates often sort of move up and down across the economy with each other. They trend in the same direction. in the very early days when you first have this data of rates and borrowing and lending, how much of the lending was sort of idiosyncratic, just a judgment of the credit risk of the borrower, and how much was the sort of general economic trend at the time? Well, in our book, I think we're talking about mostly about general economic trends, because, and I should point this out at the start of our conversation,

the book was meant to say, what were the lowest interest rates that were prevailing at these various times? in history and various civilizations and, you know, what was there a pattern to the movement of the rates? But we all know it's, the world then was just like the world today. There are some basic benchmark interest rates or risk-free returns we talk about in finance at the Stern School at NYU. And other more risky loans are priced off of this sort of basic rate. But the thing we're trying to do mostly in the book, especially when you go far back into civilization, is to say what were the lowest rates people could borrow at at various times in 4,000 years of history?

history. Now, I mean, you're talking about the lowest possible rates. That was actually a huge, huge debate, both in ancient times, medieval times, and going up, I mean, I guess it continues today. And that's the debate over usury and what constitutes a fair rate of interest. Can you maybe talk a little bit about that? Well, usury, you know, we've had a lot of usury laws in history, and many people trace it back to Aristotle, you know, a very great philosopher, obviously, one of the greatest ever. But he had a curious idea. that I think the translation of the Greeks, money is barren. You know, since money is barren, money doesn't by itself have any productivity.

Therefore, interest rate should be zero. When you lend something to somebody, you should not charge them interest. And that was a view, I think, that it was not widespread, but it was a philosophical view. Then it was picked up by St. Thomas Aquinas in the Middle Ages. And it became part of Catholic teaching that you should not charge people interest. he got it from Aristotle and it became sort of Catholic teaching. So we come right down to the modern world where we have interest rate ceilings and not that interest rate should be zero. I think that went out a long time ago, but the modern equivalent of it is say the interest rate should not

be higher than so many percent. And when those when those usury caps were put in place by various rulers, again sort of going back to my first question, was that just something that felt right 20% on lending money that felt like a limit that shouldn't be breached? I would think that, you know, the usury ceilings were sort of based on what was normal lending rates at a certain time and maybe set around that level a little bit higher, just so that people couldn't exploit other people. I think the reason behind it was sometimes loans were for what we call consumption loans. There might have been a drought and the crops failed.

And one idea behind the usury law was that when the crops fail, you shouldn't take advantage of a person who's having a hard time getting enough to eat by charging them interest. Are there early examples of what we would call payday lenders at some point, basically institutions specifically designed to take advantage of extraordinarily high levels of interest rates from people in desperate need? Well, we know that in medieval Europe, especially like in Italy, there were things like pawn shops. And I think probably there were some equivalence of that in the

ancient world as well. Because, I mean, it's a normal human need, I guess, to have some credit at sometimes. And, you know, I think all of these ancient societies and especially, you know, medieval in the modern societies have catered to this. The thing that strikes me the most about attitudes towards what constitutes a high interest rate or not is just how much it changes throughout time. So for instance, I think Hammerabi set the maximum rate at something like 33%. But then we also have a Babylonian temple that was loaning silver at six and a quarter percent. And that was seen as such a low rate that it was almost a charitable deed for people. I mean, what do you think about changing attitudes towards the level of interest rates? Well, I think, you know, I think one of the patterns we

found in the book is that there's sort of a, you know, most of these ancient civilizations like Babylonia, Greece, and Rome, there's sort of a U-shaped pattern that when we first detect interest rates in those civilizations, they're pretty high. And then as they develop and reach their peaks, you know, like say Rome and the age of Augustus, the interest rates moved down to a very low level. And then, for example, when the Roman Empire was declining and falling, as Edward Gibbon titled his book, The Decline and Fall of the Roman Empire, you begin to see the rates go up again. And this pattern, we saw it in Babylonia, we saw it in Greece, we see it in Rome, does it happen in the modern world as well. Right. On that basis, I guess with zero percent interest in the U.S., we're at the peak of our empire.

That's an interesting observation. Are we at the high point of our civilization because interest rates are so low right now? I mean, when you study this book, it sort of makes you wonder whether we are at some high point of civilization. I would say with all that's going on in the world, that isn't so nice. It's hard to imagine we're at the high point right now. Yeah, in the early days of when people started studying interest rates, would they have been surprised by the fact that we've had basically very mediocre economy and a lot of economic deterioration, incredible amounts of debt, and yet interest rates have continued to grind lower throughout all this time?

Well, I don't think it's a big surprise because, you know, before these recent very low interest rates, the lowest rates that we talk about in our country of the United States were kind of at the end of the 1930s and 1940, where rates were not in early 1941 interest rates were not all that much higher than they are now. I mean, I think Treasury bills got down to a quarter percent or something like that. But that was right before Pearl Harbor, and then when the war came, you know, things went up a little bit. What was your favorite section of the book? Well, I'm a specialist on U.S. economic history, and so I was very interested in seeing the development of our own markets.

I think rates of 6 and 7 percent were very common in colonial America and the early United States. And, you know, if somebody asked me what is the typical interest rate in U.S. history that recurs more often than another, I would say about 6 percent. And I've seen a lot of that in my lifetime, and it goes back to the Alexander Hamilton, who set up our financial system in the 1790s. His main security when he restructured the U.S. debt in 179091 was a 6% bond. A 6% bond paid interest quarterly at the 6% rate, and it sold that about, you know, at various times. It varied, of course, but, you know, it got up to par very quickly.

So for someone like me who only entered the workforce, well, relatively recently, I suppose, I've been living with very, very low interest rates for a long time, and it kind of shocks me to hear that 6% is a normal rate or even that 20% was reached in the 1980s under Fed Chair Paul Volker. Well, that's, you know, I would say that the highest rates in American history and the lowest rates have occurred in my lifetime. You know about the low rates, but I'm 75 years old now. So I was born in 1940, and I started by 1960 or so. I'm keeping track of all these things.

And as you mentioned, by 1980, 81, interest rates would go. through the roof. The government was borrowing at 14, 15%, and mortgage rates were 18%. And Treasury bills, I think, are prime rates that banks reach 20%. But of course, we had a lot of inflation then. So sometimes we need to talk about real interest rates versus nominal interest rates. One of the things that really fascinates me, and it's a phenomenon, obviously, that's been going on for a while, is the perennial overestimation of where interest rates will go. So we've basically, in the U.S., we've had declining rates for several decades, yet almost every year when Wall Street analysts are polled, they always think interest rates are going to turn around, and this will be the

year that rates go higher. Looking back historically, are there any similar phenomenon where basically we saw a trend go on for an extremely long time without some kind of mean reversion surprising a lot of people in the process? Well, I would say if you study U.S. interest rate history and go back at least since the middle to the last part of the 19th century. One thing we establish is that interest rates trend for maybe 20 or 30 years. They trended down in the late 19th century. Then they turned around at the end of the 19th century and trended up to about 1920. Then they trended down to 1945 or 46.

Then they trended up to 1981. Those are very extremely high rates we were talking about. And from those peaks in 1981, we got gradually back to more normal rates, and now we've gotten to these extremely low rates. So there are these 20, 30-year trends. If we go back to 1981, I guess it's 34 years that rates have trended down. And that's kind of at the high end of the trend. And so we're talking about the Fed possibly raising rates soon and normalizing rates. So maybe the trend is about over.

All right. We're going to be back in one minute after a word from our sponsors. You're listening to the Oddlots podcast, brought to you by ExxonMobil. Energy lives here. So I have to ask, the book ends in 2005. That was the fourth edition. Would you ever do a fifth edition? And if so, what would you put in it?

Well, I was asked recently by the publisher, John Wiley, whether I would be interested in putting out a fifth edition. Because the book keeps selling every year, it's sort of a minor, evergreen book. I'm not getting rich off of this book, but I get a little check every year. And so the book keeps on selling, and the way, of course, the publishers wants to keep on selling it is to update it. But I said I think it's a little too early because we are just, you know, maybe reaching this bottom in interest rates. And I would like to have some perspective of two or three years, let's say, of normalizing interest rates, which is what the Fed is sort of promising, you know, to get some perspective on this period. we've been through, which is kind of unique in the annals of history. So I think it's a little bit

too early to revise the book. Going back long back into history, you mentioned the code of Hamarabi as being one source of interest rates. What are some other surprising places one finds interest rate data recorded? Well, the Middle Ages, you know, had public debt markets in the Italian city states, for example. And so there are interest rates there on public bonds, And there were also bankers who lent money to kings, usually for fighting wars. And one of the interesting things I found was that the bankers would charge the kings and other politicians a much higher rate than they charged the merchants that they dealt with. The merchants had much better credit than the heads of state did. In the modern world, usually the lowest interest rates are on government debts because the governments have taxing powers and can print money.

and so you sort of feel safe holding a government bond. But there was a reverse of that in the medieval world. The merchants had good credit. They were honorable businessmen, and the kings had terrible credit. This is actually one of my favorite parts in the book. There was a reason for that, right? Especially in France. Well, in France and England and other places, Spain was a famous example.

I mean, the kings would often default. They would borrow the money and they wouldn't pay it back. They had that in those days something called the Divorrect. right of kings, and it seemed to be one of the divine rights of a king was not to repay people that he promised to repay. Right. So you could take out loans and then essentially banish all your bankers if you were a Prince of France or Spain or elsewhere.

Sounds good. Yeah. It's a good life. Yeah. Well, the Italians, you know, the Italian bankers and 11, 12, 1,300 lent money to the King of England. He didn't pay them back, so many of these early banks failed when they didn't get their money paid back.

King Philip II of Spain in the 16th. century, borrowed money for all kinds of wars. And he defaulted, but generally, he defaulted on payment when it was due, but generally he paid it back a little bit later. So he kind of kept his credit. We call him a serial defaulter. He could keep on borrowing because eventually he would pay them back. And I think the bankers charged him enough interest so that they came out whole. And so now we think that if a sovereign were to default, then you would then see a huge wave of default throughout the private sector of the economy at the same time. just for knock-on effects, but it wasn't necessarily the case back then.

No, I think sovereign defaults then were, you know, kind of, they did it quite frequently and the bankers were used to it. But, you know, one way they made up for it to see the businessmen, the merchants, didn't default, so they got a low rate. So you might say the insurance against the default was built into the King's interest rate, which could be two or three times higher than what businessmen could borrow it. So we've been talking about thousands of years' worth of interest rates. If you were to distill all that information, all 700 pages of your book, into one simple pattern or takeaway for listeners of the show, what would it be?

Well, the thing that impressed me about looking at all the different civilizations, and remember we're looking at the lowest interest rates, that there is an association between how well a civilization or a society is doing in the level of its interest rates. And so when you have kind of low interest rates, it probably means that things are pretty well ordered. Now, I wouldn't say that I feel that way about our low interest rates right now because they may be just a phenomenon of the recent financial crisis and what we had to do to fight it. But over the long period of history, you know, Greek interest rates were low in the time of Aristotle and Roman interest rates were low in the time of Augustus. And when you look at the other low interest rate societies, you know, medieval Italy was the most financially advanced and had the lowest rates. Then you get Spain and the Netherlands and then England and then the United States, you know, and you can sort of see that when these societies

or these civilizations were doing well, they had low interest rates. And then eventually, you know, the rates turn up. Now, maybe that takes a long period of time, but we tend to think our American civilization will last forever. But that isn't what you. history seems to indicate. Professor Silla is the co-author of a history of interest rates, fourth edition, and Professor of Economics and Financial Institutions at NYU Stern. He also has a great project tracing the genealogy of financial institutions, which you can look up on the internet, and I highly recommend you do so. Professor Silla, thank you so much. My pleasure. Thank you. So, thus concludes our tour of interest rate history. Joe, would you learn?

I love that discussion. One thing I love that. love about financial history discussions, you see how there are very few new debates in economics or finance. All of these things that we regard as modern or we talk about them as though they're new, not only have they been talked about before, but often hundreds and thousands of years before. Yeah, although I did hear a lot of things in that discussion that make me wonder if it's different this time, which is, of course, this idea that we have interest rates in 30-year cycles and also the idea of negative interest rates. Yeah, and the idea that historically low interest rates were seen as a proxy for the health of the economy. And higher interest rates were seen as bad,

which is funny because right now, everyone's sort of hoping that higher rates signals a new era economic prosperity, and yet we keep sort of getting disappointed and concerned about what it means that rates keep plunging. Yes, indeed. All right. I'm Tracy Alloway. You can follow me at Tracy Alloway on Twitter. And I'm Joe Wai. at the stalwart on Twitter. Thanks so much for joining us, and please tune in next week for another episode of Oddlots. Joe and I are very proud of our new podcast Oddlots, but we are also very proud of Bloomberg's other growing suite of original podcasts, all designed to help you navigate the complexities

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