Inflation & Interest Rates: Art Market Allies or Enemies?
What can the art market expect as surging inflation puts pressure on central banks to tighten their, until now, super-easy monetary policies? Is inflation good or bad? Do higher interest rates positively or negatively impact the overall performance of the art market? To answer these questions, let’s start with the basics.
Di-Faced Tenner, 10GBP Note by Banksy, 2005. Source: Artsy.
Rising at its fastest rate in decades, inflation has become a global trend. In the UK, the US, and the EU alone, prices in January 2022 increased by 5.5%, 7.5%, and 5.1% respectively, compared to the previous year. Surging global energy costs worsened by the Ukraine crisis, strong demand that was driven by an increase in the money supply during the pandemic, and supply chain disruptions are among the main causes of the 30 year high rates. We are assisting at a combination of demand-pull and cost-push inflation.
With Consumer Prices Index (CPI) expected to further peak around spring, alarmingly surpassing the general 2% desired target, central banks are receiving added pressures to apply tighter monetary policies. Those national monetary authorities, such as the Bank of England or the Federal Reserve System, seek to ensure price stability and general trust in their nation’s currency by adopting a set of monetary policies. These policies involve the use of conventional instruments such as interest rates, but also of unconventional instruments such as quantitative easing, also known as ‘money printing.’ Interest rates determine the price paid for borrowing money in the form of credits or mortgages but also the reward received for saving that money in the form of yields. Decreasing interest rates accompanied by quantitative easing programs aim to stimulate the economy traditionally during a recession. Such expansionary monetary policy was applied during the 2020 pandemic by most central banks, cutting interest rates to their lowest levels ever of close to 0% and boosting their money-printing programs, with countries like the US and the UK ‘printing’ $13 trillion and £895 billion respectively. Such policies made credit less expensive, encouraging households and businesses to borrow and spend, ultimately boosting demand and economic growth.
Sophie Calle, Cash Machine, 1991-2003. Source: MET.
However, when demand grows faster than supply, pushing prices in an upward spiral, inflation hits economies and demands contractionary monetary policies to restabilise the money supply. A traditional response to inflation has been to increase interest rates to control spending and encourage saving, reducing demand and the pressure on prices. Following the recent surge in inflation, central banks have started increasing interest rates for the first time since the pandemic. The Bank of England raised its rates twice in a span of three months in December 2021 and February 2022 from 0.1% to 0.25% and then to 0.5%. Similarly, the Fed is set to increase its rates by 0.25% at the end of March. However, the European Central Bank has expressed an interest to keep its rates unchanged as the crisis in Ukraine remains unresolved.
Having set the basis for the understanding of monetary policies and their instruments, what are the implications of those policies for the art world?
David Shrigley, I Ate Your Credit Cards, 2020. Source: Artsy.
Art Lending
The low interest rates of 2020 triggered a 30% increase in art loan requests compared to 2019, according to the Fine Art Group and Bank of America. The almost non-existing cost of borrowing incentivised collectors to use their art collections as a way to unlock capital for both personal and business purposes. Access to affordable debt also made owning art less expensive. Collectors could use leverage to acquire artworks, multiplying their potential returns and thus making art investment more attractive. Therefore, low interest rates paired with an expansion of the money supply contributed to further fueling the impressive growth of the overall art market during the pandemic. That lending frenzy even saw the emergence of a reselling art loans market. The alternative investment online platform Yieldstreet pioneered the addition of an $11 million junior loan participation to its Diversified Art Fund 1, pooling together art loans backed by blue-chip artists such as Andy Warhol, Roy Lichtenstein, and Pablo Picasso. Executive chairman of Sotheby’s financial arm Alex Klabin estimates that art lending could currently be a $400 billion market.
However, a rising interest rate cycle can drastically increase the cost of owning art, and with it, its cost of opportunity when compared to other investment opportunities. Higher interest rates prioritise saving over borrowing, and holding onto your art does not generate any annual income and yield in itself, contrarily to other assets like government bonds. According to James Goodwin, author of The International Art Markets: The Essential Guide for Collectors and Investors, the art market has been adversely affected during periods in which the rate of borrowing increased as a response to inflation. As a market especially linked to lending, constituting one of the only ways of obtaining capital from the assets during the period of tenure, art negatively correlates with increased interest rates.
Art Investment
Whilst art seems to negatively correlate with interest rates, it is also believed to have traditionally performed well in times of rising inflation, according to the Founder and CEO of Arthena, Madelaine D’Angelo. Looking at historic auction data recorded by the Mei Moses Fine Art Index since 1950, art object prices have followed an upward trend over long periods, exceeding inflation rates. Hence, art has been considered a storer of value, as it provides a hedge against the reduction in purchase power provoked by inflation. Following that rationale and empirical evidence, investors would choose art as an investment in periods of high inflation. Nevertheless, it is important to note that even if trends for the broader art market would suggest that, performance and volatility vary substantially over shorter time periods and art sectors.
Beyond the macro-economic scene, evaluating the impact of inflation and rising interest rates on the art market also requires the relative comparison of art to other assets. Cost of opportunity, as mentioned when presenting the choice between saving or spending, also applies to different alternatives that exist within each of those categories. Investors will allocate their money to what promises higher returns within the same level of risk, or to what promises lower risks within the same level of return.
Art has increasingly been treated as an alternative investment asset in recent years since it has been proven, both by repeated sales and hedonic regression models, that returns in the art market are largely non-correlated with returns in the stock market. An analysis from J.P. Morgan showed that the S&P 500 and 10-year treasury moved together below a rate of 3.5% from 2009 onwards, inferring that rising rates can be good for the overall stock market. Can we thus expect collectors to restructure their collections, increasing their exposure to other asset classes, as monetary authorities keep putting pressure on interest rates to control the rampant inflation? Or will we see them betting on the long-term appreciation of their art collections?
Ed Ruscha, Standard Station, 1966. Source: MoMa.
Uncertainty surrounding Ukraine’s crisis constitutes the main threat preventing Europe and the US from drastically raising their interest rates, as it is still unclear as to how the crisis will affect the world’s economy. As long as the possibility of an economic recession remains on the horizon, central banks will bet on slow monetary tightening. The question is, if interest rates don’t control inflation, will art prices keep skyrocketing as we reach an unprecedented state of stagflation not seen since the 1970s? Only time will tell.
Mireia Carbonell
Art Markets & Business Co-Editor, MADE IN BED