Currency and the Collapse of the Roman Empire
At its peak, the Roman Empire held up to 130 million people over a span of 1.5 million square miles.
Rome had conquered much of the known world. The Empire built 50,000 miles of roads, as well as many aqueducts, amphitheatres, and other works that are still in use today.
Our alphabet, calendar, languages, literature, and architecture borrow much from the Romans. Even concepts of Roman justice still stand tall, such as being “innocent until proven guilty”.
How could such a powerful empire collapse?
The Roman Economy
Trade was vital to Rome. It was trade that allowed a wide variety of goods to be imported into its borders: beef, grains, glassware, iron, lead, leather, marble, olive oil, perfumes, purple dye, silk, silver, spices, timber, tin and wine.
Trade generated vast wealth for the citizens of Rome. However, the city of Rome itself had only 1 million people, and costs kept rising as the empire became larger.
Administrative, logistical, and military costs kept adding up, and the Empire found creative new ways to pay for things.
Along with other factors, this led to hyperinflation, a fractured economy, localization of trade, heavy taxes, and a financial crisis that crippled Rome.
The major silver coin used during the first 220 years of the empire was the denarius.
This coin, between the size of a modern nickel and dime, was worth approximately a day’s wages for a skilled laborer or craftsman. During the first days of the Empire, these coins were of high purity, holding about 4.5 grams of pure silver.
However, with a finite supply of silver and gold entering the empire, Roman spending was limited by the amount of denarii that could be minted.
This made financing the pet-projects of emperors challenging. How was the newest war, thermae, palace, or circus to be paid for?
Roman officials found a way to work around this. By decreasing the purity of their coinage, they were able to make more “silver” coins with the same face value. With more coins in circulation, the government could spend more. And so, the content of silver dropped over the years.
By the time of Marcus Aurelius, the denarius was only about 75% silver. Caracalla tried a different method of debasement. He introduced the “double denarius”, which was worth 2x the denarius in face value. However, it had only the weight of 1.5 denarii. By the time of Gallienus, the coins had barely 5% silver. Each coin was a bronze core with a thin coating of silver. The shine quickly wore off to reveal the poor quality underneath.
The real effects of debasement took time to materialize.
Adding more coins of poorer quality into circulation did not help increase prosperity – it just transferred wealth away from the people, and it meant that more coins were needed to pay for goods and services.
At times, there was runaway inflation in the empire. For example, soldiers demanded far higher wages as the quality of coins diminished.
“Nobody should have any money but I, so that I may bestow it upon the soldiers.” – Caracalla, who raised soldiers pay by 50% near 210 AD.
By 265 AD, when there was only 0.5% silver left in a denarius, prices skyrocketed 1,000% across the Roman Empire.
Only barbarian mercenaries were to be paid in gold.
With soaring logistical and admin costs and no precious metals left to plunder from enemies, the Romans levied more and more taxes against the people to sustain the Empire.
Hyperinflation, soaring taxes, and worthless money created a trifecta that dissolved much of Rome’s trade.
The economy was paralyzed.
By the end of the 3rd century, any trade that was left was mostly local, using inefficient barter methods instead of any meaningful medium of exchange.
During the crisis of the 3rd century (235-284 A.D), there may have been more than 50 emperors. Most of these were murdered, assassinated, or killed in battle.
The empire was in a free-for-all, and it split into three separate states.
Constant civil wars meant the Empire’s borders were vulnerable. Trade networks were disintegrated and such activities became too dangerous.
Barbarian invasions came in from every direction. Plague was rampant.
And so the Western Roman Empire would cease to exist by 476 A.D.
About the Money Project
The Money Project aims to use intuitive visualizations to explore ideas around the very concept of money itself. Founded in 2015 by Visual Capitalist and Texas Precious Metals, the Money Project will look at the evolving nature of money, and will try to answer the difficult questions that prevent us from truly understanding the role that money plays in finance, investments, and accumulating wealth.
Do You Know Where the British Pound is Heading?
This infographic uses the recent Brexit-related volatility of the British pound to illustrate how currency risk can impact an investor’s portfolio.
In developed economies around the world, it’s generally expected that currencies will retain their purchasing power over time.
While this is most often the case, sometimes there are situations in which currency markets begin acting in ways that are less predictable.
Growing amounts of political or economic uncertainty, for example, can cause a currency to experience amplified levels of volatility — an environment in which it may see bigger ups and downs than most market participants are used to.
Brexit, Currency Risk, and the Pound
Today’s infographic comes to us from BlackRock, and it focuses in on the recent volatility of the British pound to illustrate how currency risk can impact a UK investor’s portfolio, and how this risk can be mitigated through currency hedging techniques.
Currency risk is present in any unhedged portfolio that holds investments denominated in international currencies.
When currencies experience increased levels of volatility — such as the British pound over the last five years — it can make this risk even more evident, ultimately impacting investor returns.
Brexit in Focus
In the lead-up to the EU Referendum in June 2016, and certainly afterwards, it’s been clear that the sterling has decoupled from its typical trading patterns.
Sterling volatility, as you would know, is at emerging market levels and has decoupled from other advanced economy pairs.
– Mark Carney, Bank of England (September 2019)
Every twist and turn in the Brexit saga has helped stoke fluctuations in the value of the pound, especially in usually stable pairs such as EUR/GBP or USD/GBP. It is possible that these swings could continue throughout 2020, and even beyond.
What impact can these fluctuations have on investment portfolios, and what can investors do to avoid them?
Currency Risk 101
The challenge of currency risk is that it can affect returns, either positively or negatively.
In other words, in addition to the risk you are exposed to by owning a particular investment, you are also at the mercy of foreign exchange rates. This means the performance of your investment could be canceled out by currency fluctuations, or returns could be amplified if exchange rate movements are to your advantage.
For example, in a typical UK portfolio that holds 60% global equities and 40% global bonds, currency risk actually has the highest projected risk contribution:
Projected Risk Contribution (60/40 Global Portfolio)
- Foreign Exchange Risk: 4.55%
- Equity Risk: 3.36%
- Interest Rate Risk: 0.44%
- Spread Risk: 0.06%
- Total: 8.40%
When there is added volatility in currency markets, like in recent times, even a home-biased portfolio can be adversely affected. Given this, how can investors be sure they are getting a return from the underlying assets in a portfolio, instead of from unpredictable currency swings?
To Hedge, or Not to Hedge
There is a range of strategies that allow investors to hedge currency risk, but one simpler option may be to simply buy a fund (such as an ETF) that is hedged.
That said, not all investors may want to hedge currency risk. For example, an investor has a specific foreign exchange view (i.e. that a currency will go up or down in value) may want to purposefully get exposure to currency risk to take advantage of this view.
While it may not always make sense to use currency-hedged funds, they can reduce the overall investment risk on international exposures.
And if you are not so sure of where the pound is heading in coming months, now could potentially be a good time to explore such a tool.
The History of Interest Rates Over 670 Years
Interest rates sit near generational lows — is this the new normal, or has it been the trend all along? We show a history of interest rates in this graphic.
The History of Interest Rates Over 670 Years
Today, we live in a low-interest-rate environment, where the cost of borrowing for governments and institutions is lower than the historical average. It is easy to see that interest rates are at generational lows, but did you know that they are also at 670-year lows?
This week’s chart outlines the interest rates attached to loans dating back to the 1350s. Take a look at the diminishing history of the cost of debt—money has never been cheaper for governments to borrow than it is today.
The Birth of an Investing Class
Trade brought many good ideas to Europe, while helping spur the Renaissance and the development of the money economy.
Key European ports and trading nations, such as the Republic of Genoa or the Netherlands during the Renaissance period, help provide a good indication of the cost of borrowing in the early history of interest rates.
The Republic of Genoa: 4-5 year Lending Rate
Genoa became a junior associate of the Spanish Empire, with Genovese bankers financing many of the Spanish crown’s foreign endeavors.
Genovese bankers provided the Spanish royal family with credit and regular income. The Spanish crown also converted unreliable shipments of New World silver into capital for further ventures through bankers in Genoa.
Dutch Perpetual Bonds
A perpetual bond is a bond with no maturity date. Investors can treat this type of bond as an equity, not as debt. Issuers pay a coupon on perpetual bonds forever, and do not have to redeem the principal—much like the dividend from a blue-chip company.
By 1640, there was so much confidence in Holland’s public debt, that it made the refinancing of outstanding debt with a much lower interest rate of 5% possible.
Dutch provincial and municipal borrowers issued three types of debt:
- Promissory notes (Obligatiën): Short-term debt, in the form of bearer bonds, that was readily negotiable
- Redeemable bonds (Losrenten): Paid an annual interest to the holder, whose name appeared in a public-debt ledger until the loan was paid off
- Life annuities (Lijfrenten): Paid interest during the life of the buyer, where death cancels the principal
Unlike other countries where private bankers issued public debt, Holland dealt directly with prospective bondholders. They issued many bonds of small coupons that attracted small savers, like craftsmen and often women.
Rule Britannia: British Consols
In 1752, the British government converted all its outstanding debt into one bond, the Consolidated 3.5% Annuities, in order to reduce the interest rate it paid. Five years later, the annual interest rate on the stock dropped to 3%, adjusting the stock as Consolidated 3% Annuities.
The coupon rate remained at 3% until 1888, when the finance minister converted the Consolidated 3% Annuities, along with Reduced 3% Annuities (1752) and New 3% Annuities (1855), into a new bond─the 2.75% Consolidated Stock. The interest rate was further reduced to 2.5% in 1903.
Interest rates briefly went back up in 1927 when Winston Churchill issued a new government stock, the 4% Consols, as a partial refinancing of WWI war bonds.
American Ascendancy: The U.S. Treasury Notes
The United States Congress passed an act in 1870 authorizing three separate consol issues with redemption privileges after 10, 15, and 30 years. This was the beginning of what became known as Treasury Bills, the modern benchmark for interest rates.
The Great Inflation of the 1970s
In the 1970s, the global stock market was a mess. Over an 18-month period, the market lost 40% of its value. For close to a decade, few people wanted to invest in public markets. Economic growth was weak, resulting in double-digit unemployment rates.
The low interest policies of the Federal Reserve in the early ‘70s encouraged full employment, but also caused high inflation. Under new leadership, the central bank would later reverse its policies, raising interest rates to 20% in an effort to reset capitalism and encourage investment.
Looking Forward: Cheap Money
Since then, interest rates set by government debt have been rapidly declining, while the global economy has rapidly expanded. Further, financial crises have driven interest rates to just above zero in order to spur spending and investment.
It is clear that the arc of lending bends towards ever-decreasing interest rates, but how low can they go?
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