Episode 5: 6,000 Years of Interest Rates

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 and three thousand BC two medieval attitudes towards usury hyper inflation in Argentina in the nineteen eighties. It's actually a pretty famous book in financial circles, and it was first written by Sydney Homer back in nineteen sixty three. Now, unfortunately Homer has passed

away since then. But I'm 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 n y U Stern. So we are about to embark on a rollicking six thousand 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 eighteenth century. Let's do it. I'm excited, Professor Silla,

thank you so much for joining us. Pleasure to be here. Um. I have to ask, so, when Sydney Homer first published this book in the early nineteen sixties, 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, Son, 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 uh, he thought, you know more than most people do about their jobs, and he wanted to know you know, he was in the bond markets, and he wanted to know, uh, you know, what was the origin of them. And for example, he had heard about the Dutch Dutch finances 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 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, he if you're talking about BABYLONEI, uh, 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 Hammurabi. It was sort of a great code that came I think it was about eight hundred BC or something like that, so

it's about four thousand years ago. And in the Code of Hammurabi it's sort of specifies that if you lend somebody money, the maximum rate you can charge them as if you lend somebody grain. Apparently people lent grain as well as money, the maximum rate was thirty three and a third percent. So how did they How did Hammurabi derive these figures? Was it a sort of finger in the wind tent seemed like the right amount, or was it something more reflective of the economy where there was

there was a basis in reality. Well, I suspect that if since Hammurabi 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 a twenty or thirty three and a third percent, and Hammurabi thought that was unreasonable, and so he sort of put a ceiling on 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 hypothication. And there's an ancient Greek city that um pledged its public colonnades, so when the city defaulted, the citizens couldn't walk down the colonades 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, you know, 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 these the colonnade. I mean that's a 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 to fight

a war. Nowadays, when we think about in rates, we think about, you know, there's 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

this 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 we're 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 Servant School at n y U 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 and four thousand years of 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 usurally and what constitutes a fair rate of interest. Can you maybe talk a little bit about that, well, usury.

You know that 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 Greek's 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 the interest. And uh, that was

a view. I think that 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. You know, 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 to say the interest rate should not be higher than so many 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 was that felt right on lending money, that felt like a limit that um I wouldn'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 just so that people couldn't exploit other people. I think that 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 the 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 needs. Well, we know that the 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 is, you know, 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 even medieval and 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, um, I think Hammurabi set the maximum rate in something like thirty. 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 when we first detect interest rates in those civilizations,

they're pretty high. And then as they develop and reached 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 That Declined and Followed 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. Doesn't happen in the modern world

as well. Right on that basis, I guess with zero percent interest in the US, we're at the peak. That's an interesting observation. Are we at the high point of our civilization? Because interest rates are so low right now? I mean that when you study this book, it sort of makes you wonder whether you know 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 started to imagine we're at the high point right now.

And in the early days of when people started studying interest rates, what they've 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 I don't think it's a big surprise, because you know, before these recent very low interest rates, the lowest rates that we talked about in in our country the United States were kind of at the end of the nineteen thirties and nineteen forty where you rates were not in early one, 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 US economic history, and so I was very interested in seeing the development of our own markets. Uh. I think rates of six and seven 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 US history that occurs more often than another, I would say about six 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 seventeen nineties. His main security when he restructured the US debt in seventeen was a six percent six percent one paid interest quarterly at at a six percent rate,

and it sold that about 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, uh, 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 six percent is a normal rate, or even that tent was reached in the nineteen eighties 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 you know about the low rates. But I'm in seventy five years old now, so I was born in nineteen forty and I started by nineteen sixty or so. I'm keeping track of all these things. And by as you mentioned, by night one, interest rates would

gone through the roof. There the government was borrowing at fourteen fifteen percent, and mortgage rates were eighteen percent, and treasury bills, i think, or prime rates at banks reached. But of course we had a lot of inflation and then so we sometimes we need to talk about real interest rates versus nominal interest rates. One of the things that it 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 US we've had declining rates for several decades. Yet almost every year when Wall Street analysts are pulled, 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 US interest rate history and go back at least since the middle to you know, the last part of the nineteenth century, one thing we establishes that interest rates trend for maybe twenty or thirty years. They trended down in the late nineteenth century, than they turned around at the end of the nineteenth century and trend it up to about nineteen twenty. Then they trended down to

nineteen forty five or forty six. Then they trended up to one those very extremely higher rates we were talking about, and from those peaks in one we got gradually back to more normal rates. And now we've gotten to these extremely low rates. So we've there are these twenty thirty year trends. If we go back to eighty one. I guess it's thirty four 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 Odd Lots podcast, brought to you by ex On Mobile Energy lives here. So I have to ask the book ends in two thousand five, 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, and because the book keeps selling every year, it's sort of a minor evergreen book and not not you know, I'm not getting rich off of this book, but I get a little

check every year. And uh so the book keeps on selling and the way, of course the publishers wants to keep on selling it as to you know, updated, But I said, it's I think it's a little too early because we are just you know, maybe reaching this bottom and interest rates, and I would like to have some perspective of two or three years, let's say, of normalizing interest rates is, 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 along back into history, you mentioned the Code of Hammurabi as being one source of interest rates. What are some other

surprising places one find interest rate data recorded? Well, the Middle Ages, you know, had public debt markets in the Italian city states, for example, and so their interest rates there on public bonds, and 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 that in the modern world, usually the lowest interest rates are on government debts because the governments are you know, 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 front, well in France and England and you know other places that Spain, it was a famous example. I mean, the kings would often default, you know, they would borrow the money and they wouldn't pay it back. You know, they had that in those days, something called the divine right of kings, and it seemed to be one of the divine rights of the 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 as good. Yeah, it's a good life. Yeah. Well, the Italians, you know, the Italian bankers and twelve d lent money to the King of England. He didn't pay them back. So many of these early banks failed when

when they didn't get their money paid back. King Philip the Second of Spain UH in the sixteenth century borrowed money for all kinds of wars and uh 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 this credit. We call him a serial defaulter. He could keep on borrowing because eventually he would pay them act and I think the bankers charged him enough interests so that they came out hold.

And so now we think that if a sovereign word a default, then you would then see a huge wave of default throughout the private sector of the economy at the same time, just as 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 businessman. 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 seven hundred 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 difference realizations, and remember we're looking at the lowest interest rates, that there is an association between how well a so 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 to see that when the societies or the 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 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 m y U 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, I love that discussion. One thing I 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 talking about before, but often hundreds and

thousands of years. Yeah. Although I did hear a lot of things in that discussion that makes me wonder if it's different this time, which is, of course, this idea that we have interest rates in thirty years 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 europe 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 Wisenthal at The Stalwart on Twitter. Thanks so much for joining us, and please tune in next week for another episode of Odd Lots. Joe and I are very proud of our new podcast, Odd Lots, but we are also very proud of Bloomberg's. They're growing suite of original podcast all designed to help you navigate the complexities of business,

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