The Interest Rate Cap Was 20% Per Year 3,700 Years Ago and Still Is Today — The Difference Between Interest Rates and Dividend Yields
The difference between “interest rates” and “dividend yields” considered from 5,000 years of history
— The interest rate cap was almost the same 3,700 years ago
We hear about “interest rates” almost every day in the news. Even if we feel like we understand them, explaining them can be surprisingly difficult. In this article, I will try to organize everything as simply as possible, from the origins of interest rates and modern mechanisms to the surprising history of the “interest rate cap” set by law, and the difference between them and dividend yields.
■ What is an interest rate? It is a “rental fee for money”
An interest rate is a rental fee for borrowing money. If you borrow 1 million yen at an annual rate of 3% for one year, you return 1.03 million yen. This 30,000 yen is the rental fee paid by the borrower, and for the lender, it is a “reward for lending money.”
There are three main reasons why interest is charged. These are the “time value” of money, which suggests that money available now is worth more than money in the future; the “compensation for risk,” which covers the danger that the money might not be returned; and “compensation” for the loss of value due to inflation.
■ Interest rates have existed for 5,000 years
Records of interest rates date back to ancient Mesopotamia around 3000 BC. There was already a system in place for lending barley for seeds or silver, to be returned with an added amount after the harvest.
What is interesting is that the word for interest in Sumerian was the same as the word for “kid” or “calf.” It carries the image of the lent item producing offspring and increasing.
Japan also had an ancient system called “Suiko,” where rice was lent in the spring and returned with interest in the autumn. Interest rates have been with humanity ever since we started using money.
■ The interest rate cap is almost the same as it was 3,700 years ago
What is surprising is that the “cap” on interest rates was also established by law a very long time ago. The Code of Hammurabi, dating back to around 1750 BC, already stipulated interest rate caps.
・Code of Hammurabi (c. 1750 BC): 20% per year for silver loans, 33⅓% per year for grain
・Ancient Rome: 12% per year (1% per month) was long considered the standard cap
・Modern Japan (Interest Rate Restriction Act): 20% per year for principal under 100,000 yen, 18% for 100,000 to under 1 million yen, and 15% for 1 million yen or more
The line that “money lending is generally capped at 20% per year” has remained almost the same across approximately 3,700 years. It is believed that the higher cap for grain reflected the increase in yield from harvests and the risk of spoilage during storage.
However, it has not remained unchanged throughout. In Japan, until 2010, a “gray zone interest rate” existed between the cap of the Interest Rate Restriction Act and the criminal penalty threshold of the Investment Act (29.2% per year), and many consumer finance companies lent within that range. This created a multiple-debt problem, leading to legal amendments that unified the cap at 20% and resulted in a massive number of claims for the return of overpaid interest.
On the other hand, the standard level of interest rates has changed significantly. While 20% in ancient times was close to the market rate for average transactions, in modern Japan, mortgage rates are in the 1-2% range. 20% has become an exceptional ceiling, representing “anything above this is excessive.”
The interest rate cap reflects the human sense that “anything above this is exploitation.” It is very interesting that this has not changed much over the ages.
■ Until the modern form of interest rates was established
The current framework where central banks adjust the economy by manipulating interest rates took shape in Britain between the 17th and 19th centuries. The Bank of England, established in 1694, began adjusting the economy by raising and lowering interest rates in the 19th century.
Then, in the 1990s, starting with New Zealand, the current standard model of setting inflation targets and manipulating short-term interest rates spread globally. In Japan, the liberalization of interest rates was completed in 1994, and since then, unprecedented policies such as zero interest rates, quantitative easing, and negative interest rates have been tested one after another.
■ Borrowers and Lenders: The Same Interest Rate, Opposite Meanings
For the borrower, interest is a cost. The lower it is, the better, and what matters is whether you can generate more value than the interest rate with the borrowed money. If you borrow at 3% per year and use it for a business that earns 5% per year, the 2% difference becomes your profit.
For the lender, interest is a return. The higher it is, the better, and what matters is whether the interest rate is commensurate with the risk. Bank deposits and the purchase of government bonds are, in fact, acts of standing on this ‘lending’ side.
When interest rates rise, the lender is at an advantage and the borrower is at a disadvantage. When they fall, the opposite is true. However, be aware that the price of bonds you already hold will fall when interest rates rise.
It is easy to understand the interest rate cap as a line drawn to ensure that the lender does not become too powerful in this relationship.
■ Dividend Yield is Your Share of ‘Owning a Company’
So, how should we think about stock dividend yields? Dividend yield is calculated as ‘annual dividend ÷ stock price.’ If the stock price is 2,000 yen and the annual dividend is 60 yen, the yield is 3%.
Even though they both use the “%” symbol, interest rates are completely different in nature from dividends.
An interest rate is a promise determined by a contract. A company has an obligation to pay it even if its performance is poor, and in the event of bankruptcy, it is repaid before shareholders. In exchange, no matter how much profit the company makes, you only receive the fixed interest.
On the other hand, a dividend is your share of the profits received as an owner of the company. It is uncertain, as dividends can be reduced or eliminated. In exchange, if the company grows, there is a possibility that dividends will also increase. And unlike interest rates, there is no legal “cap” on dividends.
Shareholders are the ones who bear the loss last when a company does not perform well. It can be said that dividends and stock price appreciation are the compensation for taking on that risk.
■ The appeal of dividend investing is that “yield grows”
Dividend yield changes depending on the stock price. When the stock price falls, the yield looks high, but since this can sometimes be a precursor to a dividend cut due to poor performance, it is dangerous to jump in based on the numbers alone.
Conversely, if the dividends of a stock you bought cheaply increase year by year, the yield relative to your purchase price (yield on cost) will continue to rise. It is not rare for a yield that was 3% at the beginning to become 6% or 7% ten years later.
This does not happen in “lending” investments, where you can only receive fixed interest and, moreover, the rate is capped. The fact that the yield grows over time is the unique charm of dividend investing.
■ Summary
Interest is a “rental fee for money” that has existed for 5,000 years; it is a cost for the borrower and a return for the lender. The cap on this has remained at roughly 20% per year for the past 3,700 years, showing that human perception has not changed much.
On the other hand, dividends are a share of profits earned by “owning” a company; while uncertain, they have no upper limit and have the potential to grow alongside the company.
Even though both use the same “%” symbol, the positions and risks behind them are completely different. Understanding this distinction should significantly change how you view interest rate news and stock investments.
※This article is for informational purposes only and does not recommend any specific stocks or investments.