As core inflation rates remain low in advanced economies, many have hopped on the “secular stagflation” narrative, but one historian warns that something far different is happening.
In a report published on the Bank of England’s staff blog, Harvard University’s Paul Schmelzing notes that the world is actually in its ninth “real rate depression,” and 7 century’s worth of data shows that when the turnaround in rates comes, it could happen suddenly.
According to Schmelzing, those who point to a period of permanently lower equilibrium real interest rates are lacking long-term context and fails to consider the deeper historical rate trends. To get a more accurate picture, Schmelzing tracked the risk-free rate since 1311 by identifying the dominant asset for each period—beginning with sovereign rates in the Italian city states in the 14th and 15th centuries, and moving to long-term rates in Spain, then the Province of Holland, the U.K., Germany, and now finally, the U.S.
The all-time real rate average of all periods is 4.78%, and the 200-year real rate average stands at 2.6%. Considering this, the current market environment remains severely depressed. However, looking closer at the data reveals that real rates have been on a downward trend for nearly 500 years, and in that time, there have been nine periods of secular decline followed by sharp reversals.
The period we’re in now, since the early 1980s, is the second-longest on record, and only the years surrounding the discovery of America outstrip the current cycle by length. However, the period most analogous period to today’s “secular stagflation” is the global “Long Depression” of the 1880s and 1890s which was marked by low productivity growth, deflationary price dynamics, and the rise of global populism and protectionism.
So what ended this Long Depression? Productivity bottomed out in 1892-3 just prior to the discovery of gold at the Klondike and the associated monetary expansion. Wage inflation gained traction in 1885, leading the recovery in general inflation. And U.S. equities bounced back from 15-year lows with the election of William McKinley in November of 1896.
“In other words, there is strong evidence suggesting that the last “secular stagnation cycle” started fading relatively autonomously after just over two decades following the key financial shock, not requiring the aid of decisive fiscal or monetary stimulus.”
But be forewarned, the data also shows most reversals of real-rate stagnation periods have been rapid and non-linear. According to Schmelzing’s research, within 24-months after hitting their troughs in the cycle, rates gained 315 basis points on average, with two occasions showing appreciations of more than 600 basis points.
“Looking at past cyclical patterns, the evidence suggests that when rate cycles turn, real rates can relatively swiftly accelerate.”