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Money & Markets: Could we be heading for negative interest rates?

Governments have always used interest rates as a crude lever to influence the economy, but in these times of Covid-19 that bit of financial engineering no longer works.

If today’s economics are true, then we have unnecessarily suffered a series of booms and busts brought on by governments intent on engineering the economy through interest rates. Remember when everything revolved around higher or lower interest rates? When the economy slumped, down would come interest rates to make it grow faster. When the economy was seen to be overheating, up they would go, and down would go the economy. It was a blunt instrument designed to inflict pain on borrowers and thereby cramp their ability to drive demand. Less demand, less inflation.

Back in the days of Harold Wilson’s “white heat of technology”, interest rate policy was used to micromanage industry through macro policy. For years, everyone waited with bated breath for a 0.25 per cent cut here or a boost there and the mortgage payment adjustment that went with it.

So, when the world economy hit the skids in 2007-08, there was a great yanking down of interest rates that had been jammed sky-high only months before. Higher interest rates certainly exerted pressure, but it squeezed a system made fragile by underground oceans of debt created by ‘innovative’ new financial technology. The system didn’t bend: it broke.

Interest rates were lowered to levels once thought impossible, and critically another innovation, Quantitative Easing (QE), was unveiled. Central banks backstopped assets that no one else would touch and bought or swapped them for assets that could be turned into cash, thereby saving the day.

This created the playbook for the Covid-19 rescue plan. QE to infinity and 0 per cent interest rates: free money for many.

If you borrow money at 0 per cent and roll that debt forever, that is free money. If you can take that free money but you must pay it back sometime and you can park it somewhere for 0.5 per cent, that is free money too. One million pounds borrowed is £50,000 a year in profit. This process gets money into the system, but sadly it gets parked, usually in residential real estate, which is secure, or any other extremely low-risk place that might scrape some yield and be quickly liquidated for repayment. There aren’t many homes for free money so little gets into the economy.

Now it is discovered that low interest rates don’t necessarily fire up the economy; the general economy can’t borrow it cheap because the banks won’t lend it. The banks, the conduit for credit, won’t play ball because if they get a bad debt, they lose 100 per cent. Returns are just not enough for them to take on the risk, especially after being whipping boys of government and media for almost a decade.

So what to do?

Well the old logic says, put interest rates down more. With interest rates at 0 per cent that is tricky, the whole logic of borrowing and lending goes into reverse if interest rates go negative. Get paid to borrow? The Japanese have it, Europe has it, and the UK is thinking about it.

Now some say, like a crazy pocket calculator operation, you are not going to get a solution, you are going to get an error producing a downward spiral. Negative interest rates have not, so they say, helped Japan. Europe is no economic chocolate box either, with its piles of negative interest corporate bonds.

But there is no reason negative interest rates won’t work – that’s what invention is all about. Negative interest rates have happened many times before. Remember Glam Rock? You got paid 15 per cent interest a year with inflation at 25 per cent: those were interest rates that were extremely negative. For anyone with a scientific bent, that’s a pretty obvious transform, and a world where inflation is higher than interest rates has been a very normal affair, so real negative interest rates are nothing new.

So what does ‘negative interest rates’ mean? Top down, it means that capitalism is dead, as ‘capitalism’ means capital gets paid. Negative interest rates mean the opposite. It’s not a political thing, it is a systemic economic reality. What has replaced it is anyone’s guess, and no doubt someone will look back and give it a name.

Whatever the new reality is, it will not return the UK or Europe to growth. The problem is one of moribundity. It is just too hard to do stuff in the West. Engineers and technologists are not insulated from the explosion of regulation, which makes it a herculean task to get anything done. Citizens and businesses find themselves a ward of the state at every turn: terrible for commerce.

Every election, promises are made to cut red tape, yet every year more red tape ties down the Gullivers that would drive the economy. Meanwhile, negative interest will likely appear, and house prices will rise to yet dizzier levels, but few businesses will get to be lent money at any rate, even if they do put up their value-inflated house as security.

An economic dunce once said to me, “If rising interest rates don’t spur the economy, why not put them up and see if that does”. If repeating an action and expecting a different result is the definition of insanity, then this idea suddenly seems sane; after all, interest rates in China are 4.6 per cent. Yet if dropping them doesn’t help and raising them couldn’t possibly, then maybe it’s time that the central banks left them alone.

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