What will happen when interest rates eventually start to rise again?
AT THE END of 1989, an American in London received a call from a friend back home. The caller had watched the fall of the Berlin Wall and the toppling of Nicolae Ceausescu in Romania with growing dismay. He was at the end of a four-year course in Russian Studies at an elite university with hefty tuition fees. He had learned all the Kremlinology a would-be cold warrior could need—but not that the cold war might suddenly end. “I just took a $60,000 bath,” he said.
It is hard to be truly confident about the future path of real interest rates. The reasons for their decades-long decline are not well understood or agreed upon. One school stresses an increased desire for saving. Demographic change is part of this story. As a large chunk of the rich world’s population approaches the end of their working lives, they seek to set aside more of their income for retirement. The integration of high-saving China into the world economy is another strut.
In the absence of rising inflation it seems reasonable to expect that the era of low interest rates will last. If yields on the safest government bonds remain low, the expected returns on other assets—the earnings yield on equities, say, or the rental yield on property—should stay in line. The result would be that all assets will continue to look expensive relative to their long-run averages.
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