The Wall Street Waltz: 90 Visual Perspectives, Illustrated Lessons From Financial Cycles and Trends, Revised and Updated Edition

Chart 48

When High Is Low—and Vice Versa

The early 1980s were a time of historically high interest rates and tight money—true or false? Try recalling the period. The prime rate was in the high teens, business activity was sluggish, and unemployment was up. Most folks thought high interest rates were stifling economic activity.

But when you adjust for inflation, interest rates weren't historically high. This chart shows 190 years of interest rates, but it adjusts them to reflect inflation or deflation during each time period. This adjustment results in the interest rates being labeled real. When rates aren't adjusted for inflation, they are often called nominal. This adjusting process allows interest rates to be considered positive or negative numbers.

How can a real interest rate be negative? Suppose the average long-term rate of return on 30-year Treasury notes is 5 percent. If inflation averages 8 percent during the same time period, then in real terms the interest rate is −3 percent. Inflation adjusting reveals a different story than you might imagine. Historically, the real interest rates of the early 1980s (point A) aren't very different from historical averages.

During the 1950–1970 period, real rates weren't volatile. But the chart's brief flatness in that period was short and unique, given a longer perspective. Before the 1950s, real rates tended to move up or down violently—often over 5, 10, or even 20 years (note area around point B).

The real interest rates of the mid-1970s ...