Real Interest Rates vs. Collectibles Prices

The key to understanding the price performance of hard assets—and of collectibles in particular—is real interest rates. The relative price performance of hard assets vs. financial assets is dependent on the level and direction of real interest rates.

Interest rates, or "nominal interest rates," measure the annualized percent return a lender requires from a borrower. We use a standard interest rate index, the annualized rate on U.S. 90-day Treasury bills. The rate has ranged from over 15% in times of high inflation (1981) down to below 0% at the depths of the Great Depression. The current rate is 3%.

If a lender (investor) gets a 3% return on a Treasury bill in one year, she will end up with $103 for the $100 originally loaned (invested). If there were no inflation during the year, the investor will have $3 extra to spend and can buy 3% more than she could have done a year ago. The investor has earned a "real return" of 3%.

Real (after inflation) interest rates

What if there has been 3% inflation during the year? The $103 can buy $103 worth of widgets. Since the price of widgets has presumably risen 3% during the year, the investor will still get the same number of widgets she could have gotten a year earlier.

The "real return" on the investment is 0%, derived from the 3% nominal return less 3% inflation. The real return is the nominal investment return less price inflation over the period. (The Consumer Price Index is used to measure inflation.)

The chart below of "Real Interest Rates" (1969-2005) shows that real rates went negative for the seven years 1974-1980, hitting a low of −3.3% in 1975. During the period, the average real interest rate was -1.7%. Negative real interest rates are rare in U.S. financial history. Investors in financial assets generally catch on to the fact that they are playing a losing game when real interest rates approach 0%, let alone go negative.

real rates

In the 1970s, however, investors in financial assets were slow on the uptake; and they paid dearly for it. The winners then were investors in hard assets. These smart investors decided that they would rather own widgets rather than financial assets, which represent a promise to pay in depreciated currency that will buy fewer widgets in the future.

For "widgets" substitute hard assets—oil, gold, collectibles, vintage clothing. During the 1970s, these asset classes moved up in price much more rapidly than inflation. We do not have good price data for vintage clothing in the 1970s. A reliable proxy for a vintage clothing index has been the "Antique Furniture Price Index" ("FPI"), maintained by the "Antique Collectors Club-U.K."

The Furniture Price Index

This index started with a base of 100 in 1968 and rose to 3349 in 2001 for an average appreciation of 11.2%/year over the 33-year period. This average is better understood by breaking down the 33-year period into two sub-periods, 1968-1980 and 1980-2001. During the first one, there was rapid appreciation of 20.3%/year. During the second one, the FPI continued to move upwards, though more gradually, 6.4%/year.

The 1970s were a truly phenomenal period for collectibles. In two years during the period, the FPI appreciated by over 40%, and in another two years, by over 30%. Even during the sensational 1970s, however, there was one exceptional down year, 1975, when the FPI declined by 8.4%, a delayed reaction to the recession of 1974-1975.

The Link between real rates and collectibles

There is a lesson to be learned from the 1975 experience. When real interest rates are low or negative, as in the 1970s and again in the period 2011-2012, even a severe recession may have only a temporary effect on collectibles. From 1974-1980, when the average real rate was -1.7%, the average annual return for the FPI was 21%. Fine collectibles respond to negative real rates by rapid appreciation.

The chart above shows that from 1981-2001 real rates stayed positive, hitting zero in 2002. They turned negative for 2003-2005, averaging -0.9%. While not as negative as the -1.7% real rate for 1974-1980, conditions are now approaching those of the sensational 1970s. As inflation picks up and real rates go more negative, one can expect the collectible appreciation that we saw in the 1970s, although naturally the past is not a guarantee of the future.

The chart below ("Excess Returns of FPI vs. Inflation") does not show the actual FPI returns discussed above. Rather, the chart shows by how much (%) the FPI surpassed inflation. We can see that fine collectibles, using the FPI as a proxy, produced large excess investment returns vs. inflation over the period 1974-1980, when real interest rates went negative.

excess returns

The one exceptional year was again 1975, when the FPI was down 8.4% and trailed inflation by 18%. Some collectible investors foolishly sold their collectibles that year, when the smart money, recognizing that the long-term trend was intact, kept buying.

I have not updated the above chart after 2001 because the FPI appears to have decoupled from the overall collectible category. Furniture, though still an important collectible category, no longer seems the best proxy for collectibles as a whole. Over the last five years, fine vintage clothing has appreciated 8%-10%/year and fine art (paintings) about 7%/year.

But furniture has fallen out of bed (excuse the metaphor). Falling three years in a row from the 2002 peak, the FPI declined a total of 12% by 2005. The furniture category may be subject to special negative factors which have not affected other collectible categories. These factors make the FPI no longer a good proxy for collectibles or vintage clothing.

Future returns for investment collectibles

What can we divine about future returns of investment collectibles, based on the roadmap provided by real interest rates? The far right part of the chart "Real Interest Rates" tells us that we have again moved into a period of negative real rates, as in the 1970s. The stage is set for hard assets—vintage clothing in particular—to again respond powerfully to the stimulus of low and negative real interest rates.

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