Do Low Interest Rates Ensure High Asset Prices?

Asset prices– stocks, commercial real estate, and even oil – are, historically, at high levels around the world. Although history is often a good predictor of future trends, every now and then something fundamental changes that makes for a new pattern. The important question now is whether today’s high asset prices are the result of some such fundamental development, or whether bubbles have formed.

One oft-heard justification for high asset prices is that real (inflation-adjusted) long-term interest rates are very low. But investors should be wary of this argument. It may sound plausible, but it is hardly conclusive, and, more importantly, it certainly does not tell us that high prices are sustainable.

It is, of course, true that real long-term interest rates have declined quite markedly – not suddenly and not only recently, but at a fairly steady pace for more than twenty years. According to the IMF, world real long-term interest rates peaked at nearly 7% on average in 1984, and fell to just below 2% by 2004. There were some ups and downs along the way, but the overall trend has been downward, and the magnitude of the decline – nearly five percentage points – is striking.

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