Money & Markets: Governments splurge money to keep interest rates low
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After the 2007-8 financial crisis governments realised they could make high interest rates vanish at the stroke of a pen using quantitative easing. Now with massive Covid-19 debts this tool is going to be even more valuable.
The last week of February 2021 was the first time since the beginning of the Covid-19 crisis that global interest rates took a run up. The stock markets of the world quivered.
The interest rate on debt is a big deal because very few listed engineering companies would not go bust if they were unable to renew their borrowings. There is a mighty system of liquidity that keeps pumping money from one part of the economic body to another to keep it functioning, and interest rates are core to that process.
In 2007-2008 that system had a seizure because a large part of the system had morphed to pumping money into real estate using financial instruments that malfunctioned and consequently froze the whole system. Unaddressed, that would have wrecked the global economy for decades. Happily, the governments of the world synced up to defibrillate the system and then spent the next decade tidying up. However bad that outcome, the situation would have been dramatically worse if what was then called ‘unorthodox monetary policy’ had not been invested.
What governments learnt was that ‘unorthodox monetary policy’ not only worked but was a fabulous new method whereby every downturn could be softened. It became the new orthodoxy.
It turns out that interest rates can be magicked away by the stroke of a pen and that debt is in fact wealth, not a milestone to crush and shame the borrower. Well let’s hope so, because debts are now mushrooming to unprecedented levels and at the centre of it all, interest rates must remain incredibly and historically low.
To keep them low there need to be lenders, and those lenders need to have money to lend. Under the new rules, the government lends the money for nothing to itself and others, with the others responsible for spreading their loan out at a higher rate to those on the lower rungs of finance and society. You could envision it like this: the government prints money and gives it to banks for near free to charge you very little to borrow the money to buy a house at what amounts to ever-inflating prices, so the seller can spend a little more or the buyer borrow some on top too. Asset prices inflate and that becomes an ATM of sorts.
The government prints this money via swapping its highly rated bonds for not so highly rated bonds, so there is not an immediate gush of cash, just a stream of new assets that can be swapped later into others and then into numbers on a screen that mean the economy has more money. This is where the ‘liquidity’ idea comes from.
So, for example my £100 Clem Bond is worth £0, because no one will buy it, but the moment the Bank of England will give me £90 of government bonds for it, I am in business. I can sell that government bond for £90 and go play. The government might even buy that same bond back a little later from whoever bought if off me for freshly printed pound notes, so up goes the money supply and everybody is happy.
So what could go wrong?
It would be inconvenient if central banks became not only the buyer of last resort but also the only buyer in the market at all. When other parties stop wanting to put their cash on deposit for ‘zero point very little per cent’ interest, then interest rates in the bond markets will rise unless the central bank takes up the slack. It is not the rising interest rates that count as much as the lowering of the amount of money flowing that causes the problem. The more flowing money the lower the rates, so a bond-buyers’ strike means there simply isn’t the money out there in the system to borrow, and that is when all those companies get into cashflow problems and start to go bust. That would be bad.
Right now many a Covid-poleaxed company has access to generous funding because the central banks of the world have made so much money available that it is worth funders punting money into risky situations. These huge liquidity moves continue to save whole swathes of the economy from ceasing to exist.
So when suddenly there is the beginning of a buyers’ strike in bonds as per the last week of February 2021, then panic quickly spreads in the stock market.
The good news is this. Government cannot afford for interest rates to rise and therefore the money printing cannot and will not stop. Even when serious inflation sets in, they will not stop because they cannot. The loss of GDP through this crisis means that the only way for the state to maintain its spending is to make up the gap between its budget and its income through printing money. To get back to a 3-4 per cent deficit to GDP will take years and that goal can’t be reached through austerity even if it was politically possible.
The upshot is that there will be a never-ending flow of hot money coming into the economy and prices will surge – as well as taxes, perhaps. That means rather than fear interest rate rises and retrenchment, the way to go is ‘pedal to the metal’ because we may be looking at shifting the decimal point to the right this decade in prices, and if you don’t dive head first into the liquidity you are going to be left stranded on the muddy banks of this Amazon of money.
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