[History of Investing Chapter 15] The History of Interest Rates: Why the 'Price of Money' Drives Stock Prices and the Economy
Recently, the word “interest rate” has been appearing more frequently in the news in Japan as well.
Rate hikes.
Mortgage interest rates.
Bank deposit interest rates.
Government bond yields.
Yen appreciation and depreciation.
Stock prices.
At first glance, these seem like separate topics.
However, they are all connected.
At the center of it all is
interest rates
.
When I first started investing, I didn’t think very deeply about interest rates.
Will stock prices go up?
How much is the dividend?
Will the company grow?
My eyes were inevitably drawn to these things.
However, as I studied investing and the economy,
I eventually arrived at the realization that
“money itself has a price.”
This time, I would like to look at the history of investing from the perspective of
“interest rates.”
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What exactly is an interest rate?
You borrow 1 million yen.
You pay back 1.01 million yen one year later.
This 10,000 yen is the interest.
As an interest rate, that is 1% per year.
It is very simple.
Then,
why, even though you borrowed 1 million yen,
do you have to pay back 1.01 million yen?
One reason is that
“present money” and “future money” do not have the same value.
If you lend 1 million yen to someone,
the lender cannot use that 1 million yen for a certain period.
They cannot invest it.
They cannot use it for shopping.
Furthermore,
there is also the risk that it won’t be paid back.
Therefore,
interest is generated as “compensation for letting someone use your money for a certain period.”
Thinking of it this way, an interest rate can also be called
the price for borrowing money.
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The history of interest rates is very old.
The mechanism of interest
was not created by modern banks.
Its history dates back to ancient civilizations.
In ancient Mesopotamia,
interest existed not only for silver,
but also for the lending and borrowing of grain and other goods.
In other words, long before the monetary economy took its current form, humanity
already had the concept of “lending what you have now and having more returned in the future.”
And as the economy developed,
interest rates became deeply involved in commerce and state administration.
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Why did religion view interest as a problem?
The history of interest rates has
an interesting side.
For a long time,
the act of charging interest itself was often viewed as morally or religiously problematic.
In the Christian world,
as well as in the Islamic world,
various debates have taken place regarding interest.
Why is that?
For one thing,
there was the question, “Is it right to generate money from money?”
I think this is still an interesting question today.
You work.
You make products.
You provide services.
In these cases, it is easy to understand that you have created value.
However,
money increases just by lending it.
What is this?
The topic I wrote about previously, “capital generates money,” is
actually a problem that humans have been thinking about for thousands of years.
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17th Century—The Emergence of Central Banks
As the economy grows,
society can no longer be supported by lending and borrowing between individuals alone.
The state also comes to require enormous amounts of money.
Wars.
Roads.
Ports.
Public works.
Thus, financial markets developed,
and the existence of central banks was born.
A representative example is
the Bank of England, established in 1694.
It supplied funds to the government,
and played a major role in the development of the government bond market and the financial system.
From here,
“interest rates” became not just lending and borrowing between individuals, but an important mechanism that drives the national economy itself.
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Why does lowering interest rates improve the economy?
This leads to modern monetary policy.
For example, suppose a company
wants to build a new factory.
It needs 10 billion yen.
If the interest rate is 1%,
it is easy to make the decision to borrow funds and invest.
But what if the interest rate is 10%?
Unless they can generate a fairly high profit,
they cannot pay back the debt.
Then the company might think,
“Let’s hold off on investing for now.”
Housing is the same.
If mortgage interest rates are low,
it becomes easier to buy a house.
If they become high,
the monthly repayment amount increases.
In other words, when interest rates are lowered,
it becomes easier for companies and individuals to borrow money.
Money moves.
Capital investment increases.
Home purchases increase.
Consumption increases.
It works in the direction of stimulating the economy.
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Conversely, why do central banks raise interest rates?
So,
are lower interest rates always better?
That is not the case.
If you make it too easy to borrow money,
a large amount of money flows into the economy.
Demand increases.
Companies raise prices.
Asset prices rise.
And,
inflation can become strong.
Therefore, central banks
raise interest rates.
They make the cost of borrowing money higher.
Companies hold back on investment a little.
Individuals also hold back on housing and consumption.
They cool down economic activity a little.
In other words, central banks
use interest rates like an accelerator and a brake.
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1929—The Great Depression and Interest Rates
1929.
The American stock market crashes.
It is the Great Depression.
Bank failures.
Corporate bankruptcies.
Unemployment.
The global economy entered a serious recession.
From the experience of this era,
the role that central banks should play during financial crises began to be studied all over the world.
If the financial system stops,
companies cannot borrow money.
If companies cannot borrow money,
investment and employment also decrease.
And the entire economy shrinks.
The financial market and the real economy
were inseparable.
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1970s—This Time, the Fight Against Inflation
During the Great Depression,
“how to support the economy”
was a major issue.
However, when the 1970s arrived,
the opposite problem occurred.
Inflation.
Against the backdrop of the oil shocks and other factors,
high inflation continued in the United States.
And in 1979,
Paul Volcker took office as FRB Chairman.
Volcker implemented very strict monetary tightening to curb inflation.
Interest rates rose significantly.
A heavy burden was placed on the economy.
Unemployment rates also rose.
Even so,
he prioritized curbing inflation.
Looking at this era,
one can clearly understand the meaning of central banks raising interest rates.
To stabilize prices, it is sometimes necessary to cool down the economy.
Interest rate policy
always involves difficult decisions.
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1980s—Japan Moves Toward Low Interest Rates
In Japan, too, interest rates moved the economy significantly.
1985.
The Plaza Accord.
After that, rapid yen appreciation progressed.
To support the economy, the Bank of Japan
lowered the official discount rate.
Due to low interest rates,
it became easier to borrow money.
Companies and individuals raised funds.
Large amounts of money flowed into stocks and real estate.
And in the late 1980s,
Japan headed toward a bubble economy.
At the end of 1989, the Nikkei Stock Average
recorded its all-time high at the time of 38,915 yen.
Real estate prices also soared.
“Land prices will not go down.”
An atmosphere even emerged that suggested this.
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What happens to a bubble when interest rates are raised?
However,
if asset prices keep rising,
you cannot leave it alone forever.
The Bank of Japan shifted to monetary tightening.
It raised interest rates.
Then,
the cost of debt increased.
Real estate investment became difficult.
It became harder for funds to enter the stock market.
And the bubble burst.
Of course,
the bursting of the bubble cannot be explained by interest rates alone.
However,
it was an era in which Japan itself experienced the magnitude of the impact that interest rates have on asset prices.
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1990s—Japan Enters a “World Without Interest Rates”
After the bubble burst,
the Japanese economy entered a long stagnation.
Companies reduced their debt.
Consumption was weak.
Prices did not rise either.
Banks had money.
But companies did not actively borrow money.
So the Bank of Japan
kept lowering interest rates.
And in 1999,
the Bank of Japan
introduced a zero interest rate policy.
This was a very unique policy even from a global perspective.
Even after lowering interest rates to almost zero,
the Japanese economy did not grow strongly.
From here, Japan
entered a long “ultra-low interest rate era.”
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2016—Finally, Negative Interest Rates
And in 2016,
the Bank of Japan
introduced a negative interest rate policy.
Just hearing the name,
you might think, “If I deposit 1 million yen in a bank, will it decrease?”
In reality,
it did not directly apply negative interest rates to all general deposits.
It was a mechanism that applied negative interest rates to a portion of the current account deposits that financial institutions hold at the Bank of Japan.
The goal was
to create an environment where it is better for banks to lend to companies and individuals than to keep money at the Bank of Japan.
That is how much
Japan was trying to get money to flow into the economy.
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“It doesn’t increase even if you deposit it in a bank” became the norm.
For us Japanese,
this era lasted for a very long time.
Even if you put 1 million yen in a savings account,
there is almost no interest.
Therefore,
the phrase “there is no point in depositing money in a bank” became common.
And,
from savings to investment.
NISA.
Asset formation.
These trends became stronger.
However,
it is interesting to think about this here.
It can also be considered that the “world where deposit interest rates are almost zero,” which we thought was normal, was actually special historically.
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2022 onwards—The World Returns to Rate Hikes
After the COVID-19 pandemic,
inflation progressed rapidly around the world.
Supply chain disruptions.
Energy prices.
Large-scale fiscal and monetary policies.
Various factors overlap.
In the United States,
the FRB implemented rapid rate hikes.
The policy interest rate, which was near zero, rose significantly.
Why?
It is the same as in the 1970s.
It is to curb inflation.
Here too,
interest rates were used as a brake on the economy.
History is not exactly the same.
However,
similar structures appear again and again.
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Japan also begins to return to a “world with interest rates”
And in Japan, too,
the long-lasting ultra-low interest rate policy has shifted.
In 2024,
the Bank of Japan ended its negative interest rate policy.
Since then, the policy interest rate has been raised in stages.
Then,
bank deposit interest rates.
Mortgages.
Government bond yields.
Corporate borrowing costs.
The impact appears in various places.
For a long time,
for Japanese people who have lived in a world where “interest rates are almost zero,”
this is a major change.
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Why does rising interest rates affect stock prices?
This is important as an investor.
For example,
suppose you cannot get almost any return from highly safe assets.
Bank deposits 0.001%.
Government bonds also have almost no yield.
Then,
more people think, “Let’s invest in stocks even if it means taking some risk.”
However,
what if you can now get a certain yield even from highly safe assets?
If you are going to invest in stocks,
if you cannot expect a return higher than that, there is little point in taking the risk.
This is one of the reasons why interest rates and stock prices are deeply related.
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Interest rates also affect corporate value itself
Another important thing is
corporate value.
One way to think about the value of a stock is
to discount the cash flow that a company will generate in the future to its present value.
If interest rates are low,
profits in the distant future also have relatively large value.
However, when interest rates become high,
the present value of future profits becomes smaller.
Therefore,
growth companies that currently have little profit
and are expected to have huge profits 10 or 20 years from now
may be more susceptible to the impact of rising interest rates.
This is one of the reasons why technology stocks and interest rates are often talked about together.
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Interest rates determine the “hurdle for investment”
I studied interest rates and
started to have one easy way of thinking.
For example,
a world where you can only get 0% without taking almost any risk.
In that case, an investment where you can expect 5% might look attractive.
However,
in a world where you can get 3% from highly safe assets,
if you take a big risk and can only expect 5%, the story changes.
In other words, interest rates
also become a standard for thinking about “where is it worth taking a risk.”
This also connects to the topic I wrote about previously,
“comparing bank interest rates and investment returns.”
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Interest rates also connect to foreign exchange
Furthermore,
interest rates are also related to foreign exchange.
For example,
interest rates in the US are higher than in Japan.
Then,
there may be a movement to shift funds to dollar assets in search of higher yields.
Sell yen.
Buy dollars.
This becomes a factor in the direction of yen depreciation.
Conversely,
if Japanese interest rates rise
and the interest rate gap with the US narrows,
it may also affect foreign exchange.
Of course, foreign exchange
is not determined by interest rates alone.
Trade.
Economy.
Politics.
Market psychology.
There are various factors.
However,
the interest rate gap is one of the very important factors when looking at foreign exchange.
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Interest rates also connect to housing prices
For example,
suppose you buy a 50 million yen house.
Even if the housing price is the same,
is the mortgage interest rate 1%,
or 4%?
The total repayment amount changes significantly.
In other words,
if interest rates are low,
more people can purchase even at higher housing prices.
Conversely, if interest rates rise,
more people cannot buy at the same price.
Therefore,
interest rates are significantly related not only to stocks,
but also to real estate prices.
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In the end, interest rates are connected to the entire society
Looking at this far,
you can see that interest rates are not just bank numbers.
Interest rates move.
↓
Bank deposits change.
↓
Mortgages change.
↓
Corporate borrowing costs change.
↓
Capital investment changes.
↓
Corporate profits change.
↓
Stock prices change.
↓
Foreign exchange moves.
↓
Import prices change.
↓
It affects prices.
Everything is connected.
That is why when the central bank
moves the policy interest rate by just 0.25%, investors all over the world pay attention.
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The History of Interest Rates
Let’s briefly summarize the flow.
Ancient Mesopotamia
Lending and borrowing with interest existed
↓
1694
Bank of England established
↓
19th Century
Banks, bond markets, and capital markets expanded
↓
1929
Great Depression
↓
1970s
Global inflation
↓
1979 onwards
Strong monetary tightening by FRB Chairman Volcker
↓
Late 1980s
Japan’s low interest rates and bubble economy
↓
1990s
Bubble burst, long-term stagnation
↓
1999
Zero interest rate policy in Japan
↓
2016
Negative interest rate policy in Japan
↓
2022 onwards
Global inflation and rapid rate hikes
↓
2024
Bank of Japan ends negative interest rate policy
↓
Present
Japan also returns to a “world with interest rates”
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If you are going to invest, don’t just look at stock prices
When I started investing,
I looked at companies.
And as I continued to invest,
I started looking at industries.
Furthermore,
I started looking at the economy.
And,
I started looking at interest rates.
Because,
no matter how wonderful a company is,
that company is operating within the huge environment called the economy.
Fundraising.
Foreign exchange.
Consumption.
Housing.
Capital investment.
Interest rates are related to everything.
Therefore,
not only “will this company grow?”
but also thinking about “at what cost can this company raise money to grow?”
I think this is also one perspective for looking at investment.
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Knowing interest rates is knowing capitalism
Previously,
I wrote an article about financial literacy.
In it, I thought that
financial literacy is not simply being able to invest in stocks.
Banks.
Taxes.
Inflation.
Companies.
Capital.
And interest rates.
Understanding how these are connected.
Looking back at the history of interest rates this time, I feel it again.
If you understand interest rates, you can see the mechanism of capitalism quite well.
People who have money lend it.
People who need money borrow it.
Companies invest.
New value is created.
Profits are generated.
Interest is paid back from those profits.
And capital moves to the next place again.
Interest rates might be
a single “price” attached to this huge flow of capital.
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Japanese people will learn about interest rates once again from now on
For a long time,
we were able to live without being conscious of interest rates.
Even if you deposit in a bank, it doesn’t increase.
Mortgages are very low.
There was no need to think deeply about interest rates.
However,
when the world with interest rates returns,
the situation changes.
Do you deposit?
Do you invest?
Do you buy a house?
Do you take out a loan?
Do you invest in companies?
Do you buy bonds?
For various decisions,
interest rates become important.
Therefore, I think
now is the time for Japanese people to relearn interest rates.
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Money also has a “price”
If you go to a supermarket,
products have prices.
Land also has a price.
Labor also has a price called a salary.
And,
money also has a price.
That is the interest rate.
If interest rates change,
the behavior of people who borrow money changes.
Companies change.
Investors change.
The housing market changes.
Foreign exchange changes.
And,
the entire economy changes.
Having learned the history of investing,
I think again.
Even if you only look at stock prices,
you cannot understand the economy.
Behind those stock prices,
where does the money come from, and at what price is it moving?
By looking that far,
won’t the landscape of investment change a little?
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Next Preview: History of Investing Chapter 16
“The History of Inflation: Why, even though it’s the same 10,000 yen, can you buy less?”
When you think about interest rates,
the next thing that always comes up is inflation.
If you deposit 1 million yen in a bank,
and it is still 1 million yen 10 years later,
is the value of that 1 million yen really the same?
Wars.
Oil crises.
Paper money.
Central banks.
Deflation.
And current price increases.
Next time,
why are “money numbers” and “money value” different?
I would like to think about it from the history of inflation.