Monday, August 01, 2022

Lowest interest rates in 5,000 years but low investments by advanced countries

The Sumerian civilisation lived in southern Mesopotamia, situated within the Tigris–Euphrates river system (in modern Iraq.) They settled in the area at about 4,000 BC and first used interest related to barley and silver. It was used for valuing cattle for example. In the Sumerian period from 3000 - 1900 BC, the rate of interest on barley was usually 33-1/3% and 20% on silverSumer was the site of the earliest known civilisation, and it had a record of innovation: The Wheel; Sail; Writing; Corbeled Arch/True Arch; Irrigation and Farming Implements; Cities; Maps; Mathematics; Time and Clocks; Astronomy and Astrology and Medicinal Drugs and Surgery.

The Babylonian period stretched from 1900-732 BC and the Sumerian interest rate system was mainly copied.

King Hammurabi (circa 1810- c 1750 BC) ruled the city-state of Babylon and eventually, the Babylonian Empire covered most of Mesopotamia. The Code of Hammurabi had about 150 rules on financial and economic issues (see below).

In 2015 Andy Haldane, then chief economist at the Bank of England and his staff researched interest rates back to antiquity: Check Chart 5 here with sources.

The Bank of England was founded in 1694 and it lent £1.2mn to the English government at a rate of 8%. The record highest rate was 17% in November 1979.

The Federal Reserve was founded in 1913 and its record federal funds rate was a 19-20% range in December 1981.

In September 1992, the Riksbank — the Swedish central bank — raised the interest rate to 500% to defend the krona. This defence failed and the krona exchange rate was floated.

Falling interest rates

Long-term rates typically reflect bonds sold by governments.

In 1990 the Group of Seven (G7) industrialised nations accounted for 66% of global GDP (gross domestic product). It is about 45% now.

The informal group meets annually and the European Union (EU) has participated in the G7 since 1981 as a “non-enumerated” member.

In 1990 and 2000 (in parenthuses) among G7 countries, Japan's long term rate was at 7% (2%); US 8% (6%); Germany 9% (5%); France 10% (5%); Canada 11% (6%); UK 12% (5%); Italy 13% (5%).

In the early 1990s, Italy's long-term interest rate of 13% resulted in 12% of GDP going to debt servicing while the public debt was 112% of GDP. In 2007 the debt servicing rate had fallen to 4.5% while the public debt was at 104% of GDP. In 2021 the debt servicing was at 3% while the public debt had jumped to 153% of GDP.

In 2021 the long-term average rate was also about 3%.

Economists at the Federal Reserve Bank of Chicago noted in 2021: "both an increased desire to save on the part of economies in East Asia and in the Middle East and North Africa, as well as a relative dearth of investment demand worldwide." They added, "we concluded that the ability of the GSG (Global Saving Glut) hypothesis to explain the fall in long-term real rates between 2002 and 2006 is probably significantly greater than its ability to account for the further fall in rates from the Great Recession onward."

The Great Recession of 2007-2019 resulted in central banks in most advanced countries engaging in quantitative easing (QE) as a monetary policy strategy. This depressed rates further and when the pandemic hit, negative interest rates appeared.

Beyond the well-off in the decade, in addition to poor levels of investment, consumer demand was hit by low wage rises.

Demographics whether it's the decline in fertility or the increase in longevity, have also contributed to the decline in rates.

The modern corporate world also is divided into frontier firms and laggards.

Digital Era — Poor productivity and rising economic inequality

The decline in taxes on the rich has boosted inequality while these tax cuts do not have any significant effect on economic growth or unemployment.

The economic consequences of major tax cuts for the rich

Historic low-interest rates did not trigger a rise in investments

Annie Lowrey who writes on politics and economic policy for The Atlantic in June wrote in 'America Wasted Its Chance to Push the Economy Forward,' "We have wasted $2trn on tax cuts for the rich. We have made some improvements to the infrastructure, but mostly we have delayed and procrastinated. Meanwhile, a catastrophic housing shortage has developed, driving up the price of everything else. Our cities have collapsed and roads have warped. The climate crisis has intensified as we stick to the fossil fuels that are drying up families and destroying the planet."

"About 46,000 of the 617,000 across the country are structurally impaired. And we face similar problems with our power grid, our airports, our water and wastewater systems, our roads, our highways, and our mass transit systems ... New York City created 908,000 jobs but only 206,000 homes from 2009 to 2019. As a result, the cost of a home in Brooklyn or Manhattan has doubled. During the same period, San Francisco added more than 200,000 jobs but only 31,000 homes. As a result, rents have doubled."

Martin Sandbu, the Financial Times's European Economics Commentator, in July wrote that from 1970-1989 the share of GDP devoted to investment by six of the G7 countries averaged from 22.6% for the US to 24.8% for Germany. Japan was at 35%.

Of the G7, only Canada has sustained this level of investment at 22.5%. Martin Sandbu says that 1970-89 investment levels were matched on four occasions: the US in the boom years of 2000 and 2005-06, and France in 2021.

France and the US have invested almost 2 percentage points of GDP less this century than they did in the 1970s and 1980s; Germany and Italy were about 4.5 points less; the UK and Japan 6 and 10 percentage points less respectively. "These are enormous numbers."

The Economist reported in September 2021 on the poor infrastructure in Germany, the biggest European economy. "Endlessly delayed mega-projects like Berlin’s airport may have made the country a laughing stock, but it is rusting bridges, shaky phone signals and decrepit school toilets that are the staple of daily conversation. Ask anyone in local government what the problem is, and the answer is always people. A report by the Friedrich Ebert Foundation, which is linked to the SPD (Social Democratic Party), finds a huge decrease in municipal staff over 30 years."

In 2021 in advance of the G7 summit, a UK report recommended that the countries should collectively invest about $1trn each year over the decade to ensure their economies recover fully from the COVID-19 pandemic and to make the transition to sustainable, inclusive and resilient growth. Among the priorities for policies and finance identified was to “set a collective goal to raise annual investment by 2% of GDP above pre-pandemic levels for this decade and beyond and improve the quality of investment to support a strong recovery and transformation of growth."

In 2022 G7 leaders announced plans to mobilise $600bn in funding for the developing world in a move seen as a counter to China's Belt and Road plan.

The Organisation for Cooperation and Development (OECD), which represents 31 advanced economies among its 38 members countries, has estimated that about USD$95trn in public and private investments are needed in energy, transport, water and telecommunications infrastructure at the global level between 2016 and 2030 in order to sustain growth. In many OECD countries, however, a significant investment gap remains to be filled. While in emerging and developing countries public investment has started to recover after years of decline, in advanced economies it has steadily declined from 5% of GDP in the 1970s to approximately 3% GDP in 2017 and public investment rates in most of these countries are still significantly below 6-8% of GDP. The impact of megatrends – globalisation, demographic and social changes, climate change, urbanisation, and digitalisation – widens the investment gap."

Gross fixed capital formation: GFCF (formerly gross domestic fixed investment) includes land improvements (fences, ditches, drains, and so on); plant, machinery, and equipment purchases; and the construction of roads, railways, and the like, including schools, offices, hospitals, private residential dwellings, and commercial and industrial buildings.

The OECD says investment by sector includes household, corporate and general government. For governments, this typically means investment in R&D, military weapons systems, transport infrastructure and public buildings such as schools and hospitals.

The 2008 System of National Accounts (SNA) treats all military expenditures on fixed assets as GFCF regardless of the purpose. This indicator is measured as a percentage of total gross fixed capital formation. All OECD countries compile their data according to the 2008 System of National Accounts (SNA).

Households typically are 26% of investments; Corporate is about 60% and General Government is about 14%.

Europe led 2021's share buybacks, with a total of $27.12bn, followed by Japan's $16.36 billion, while US firms have spent about $8bn. Usually, it's the US is in the lead of buying back shares which suggests a lack of worthwhile investments and the big bosses boosting the values of their shares.

McKinsey, a consulting firm, reports that "The top 10% of households in the United States increased their share of capital income to 66% in 2018, from 59% in 1995, and received 30% of their income through the capital income pathway. 

This compares with 26% in Germany and 23% in Japan, where households are less reliant on corporate returns and more reliant on public pensions.

Labour income has also concentrated slightly to higher-income households since 1995.

Housing investment

In June Bloomberg reported on "A world economy already contending with raging inflation, stock-market turmoil and a gruelling war is facing yet another threat: the unravelling of a massive housing boom.

As central banks around the globe rapidly increase interest rates, soaring borrowing costs mean people who were already stretching to buy property are finally reaching their limits. The effects are being seen in countries such as Canada, the US and New Zealand, where once-hot residential real estate markets have suddenly turned cold. 

It’s a sharp reversal from years of surging prices fueled by rock-bottom mortgage rates and government stimulus, along with a pandemic that popularized remote work and sent homebuyers on the hunt for bigger spaces. An analysis by Bloomberg Economics shows that 19 OECD countries have combined price-to-rent and home price-to-income ratios that are higher today than they were ahead of the 2008 financial crisis — an indication that prices have moved out of line with fundamentals."

According to the Encyclopedia Britannica "The Code of Hammurabi, the most complete and perfect extant collection of Babylonian laws, developed during the reign of Hammurabi (1792–1750 BC) of the 1st dynasty of Babylon. It consists of his legal decisions that were collected toward the end of his reign and inscribed on a diorite stela set up in Babylon’s temple of Marduk, the national god of Babylonia. These 282 case laws include economic provisions (prices, tariffs, trade, and commerce), family law (marriage and divorce), as well as criminal law (assault, theft) and civil law (slavery, debt). Penalties varied according to the status of the offenders and the circumstances of the offences."

The principal (and only considerable) source of the Code of Hammurabi is the stela ( a stone or wooden slab) and this one was discovered at Susa (in modern Iran) in 1901 by the French Orientalist Jean-Vincent Scheil and is now is preserved in the Louvre, Paris.

"The Code of Hammurabi is a Babylonian legal text composed c. 1755–1750 BC. It is the longest, best-organised, and best-preserved legal text from the ancient Near East. It is written in the Old Babylonian dialect of Akkadian, purportedly by Hammurabi, sixth king of the First Dynasty of Babylon" — Wikipedia