A History of Interest Rates is the seminal work when it comes to trying to understand (find the principles) that guide interest rates. This is interesting (HA!) because early financial independence(*) relies on being a rentier for almost a century, which is actually quite a long run. This is especially important given the problems humanity faces. Extrapolating 20th century numbers based on exponential population growth and exponential energy consumption is stupid—in other words, if you think you can pick an investment type today and keep it for the next 70 years, you probably got another thing coming. On the other hand you might get lucky.
(*) I am getting more and more tempted to refer to ERE as FIE instead since that is technically more correct; RE being a subset of FI.
What it really important is not so much what kind of investments/investment type to pick as I expect this will change a couple of times over the 21st century but what kind of interest rates one can expect.
(This is discussed in more detail in the book.)
So far I drawn the following conclusions.
- Lending has existed for thousands of years. You will find contracts dating back to 3000BC.
- Historical interest rates are really high or conversely, the typical interest rates we have seen in the 19th and 20th century are really low!
- Interest rates are inversely related to the cultural complexity.
- Practically the only time when interest rates have been nonexistent (due to usury laws) was during the dark ages. When a society is substantially crippled, trade breaks down and when trade breaks down, lending breaks down. What could be considered “consumer lending” to people in need is now done as a favor between people who stick together.
- Once society reaches a certain level of complexity, projects like ship building and war can only be financed through the combined investment of many people. In this case, brokers and similar financial services start to appear. Typical commercial rates are 8%. Typical consumer rates are 20% or more.
- In bronze age societies between total break down and complex societies, interest rates are 50% or more(!). Typically counted in seed or cattle.
- The government rate is not always the safest. Sometimes commercial loans and townships have had better credit.
- The interest rate at the peak of the Roman Empire was around 5%. This rate was not reachieved for the next thousand years.
- Interest rates can be set by the scarcity of money.
- If population crashes, the real estate market goes down with it. The same happens in case of war. Historically this happened during the plague and the hundred year war. The former crashed the population by 1/3—a similar crash today would barely bring the population down to a sustainable level—and the latter sent two kingdoms bankrupt—something that several nations are playing with today: Greece, UK, …
- If the complexity of society goes down, commercial lending goes down. This is to be expected since doing business is a “derived activity” that profits on “indirect activity” (artisans) or “direct activity” (farmers and miners). The modern institutions rely on equity financing and corporate bonds, that is, the stock market. Judging by trade patterns of Roman “high tech” pottery, this can happen in about a century. Kings of latter times had less quality than middle class consumers had during the peak of the empire.
Something to ponder, eh?
We can draw a couple of conclusions. Most importantly, unless a complete collapse is expected (and some do expect this, I don’t), there will still be a rentier class. (Historically, townships have acquired money in exchange for lifetime annuities … yeah, you could be the next Squire of Podunk Hollow” or you could buy a commission as a colonel in the army.). Most like they wealthy will be relatively richer than they are today. Indeed, the wealthy will inherit the earth.
The worst case is actually business as usual which is why we currently aim for 3-4% withdrawal rates rather than 10%.. The middle class is relatively rich (even though it has gotten relatively poorer since the 1970s, perhaps as an indication that society is slowly collapsing) which means that interest rates are very low. If they rise, naturally those with assets will be much better off. That would be the financially independent people. I thus see Monte Carlo simulations as lower limits to the worst case scenario. Overall, I expect agile and diligent individuals to come out on top of things. On another note, the most important asset management priority of the 21st century will not be growth of principal but protection.
Originally posted 2010-04-23 02:35:33.