After a few weeks of apocalyptic visions of a warming world, it is perhaps reassuring to return to today’s economy emerging from the deep freeze of Covid restrictions and lockdowns.
It is tempting to think that the world is returning to “normalcy”, but with a very uneven recovery, characterized by supply disruptions, especially energy, and a surge in inflation. But there are some aspects that are very troubling. Most notable is what is happening to interest rates.
We have become used to the idea that interest rates are very low, close to zero. After the economic crisis of the 2008 financial crisis, cheap money – very low interest rates and quantitative easing – was used to keep the patient alive. This life support system remained connected throughout the decade and then became necessary during Covid lockdowns. But surely this is only a temporary emergency? When does ânormalcyâ return?
There are endless discussions about when and how central banks, through their control of short-term interest rates, and capital markets through their impact on long-term rates, will return to levels of long-term interest rates. higher interest, and pain whether or not this may cause borrowers. What we forget is that with inflation taken into account, interest rates become strongly negative. Simply put, those who save pay for the privilege; creditworthy borrowers, especially governments, are paid to invest.
To give examples, those who hold UK indexed bonds that mature in a few years get a yield of minus 4 percent and long-term bonds a little more – minus 2 percent. The figures for the United States are a little higher but still negative. German 30-year government bonds are sold, offering their buyers a zero return with inflation, meaning that investments will experience negative growth. The same is true for Japanese bonds. Corporate bonds tell a similar story.
China is the only major country with high real interest rates reflecting the authorities’ concern to curb a frenzy of wild and often unnecessary investment. And in major emerging markets like Brazil and Turkey, creditors are panicking over future debt problems, so these countries don’t have the luxury of cheap capital.
Overall and throughout the developed world, however, capital markets deem interest rates, in real terms, to be negative for the next generation. American economist Larry Summers has called this situation “Secular stagnation”.
What is behind this phenomenon is that the desire of society to save (at least in rich countries) is considerably greater than the collective desire of companies and governments to invest. Under normal circumstances, this would have produced a collapse in demand and a collapse. But this has been kept at bay by central banks pursuing a policy of “money printing”.
Now that the printers are off, we need to look at the underlying problem. Various factors come into play to explain the imbalance in individual savings compared to public and private investment. Aging populations tend to save. The rich save more than the poor, and although we are increasingly unequal, there are more rich people every year. The pandemic put their instincts on stilts as shops and hospitality areas were closed, forcing people to save.
At the same time, governments, businesses and individuals have hesitated to invest due to uncertainty surrounding the course of the pandemic and concerns about accumulated debt. The overall business environment has been damaged by factors such as former US President Donald Trump’s trade war, Brexit, and current geopolitical tensions between China and the United States. Money is pouring into high-tech companies, but there is not enough investment to absorb all the savings.
These problems may seem abstract, but they have serious consequences for the real world. Because banks and other financial institutions can no longer make profitable their holdings of âsafeâ financial assets, they are tempted to adopt riskier behavior. In practice, this means borrowing more (leverage) to invest in high risk / high return assets, such as complex derivatives or high loan to value mortgages.
There are, in turn, growing pressures to relax the regulations that prevailed after the financial crisis, forcing institutions to hold more capital on their balance sheets, to hedge against the risk of default. Phrases like “we need to strengthen the competitiveness of banks” are heard more and more and concessions are made. We know where this is leading – to financial crises of the kind we experienced in 2008.
For the individuals, pension funds and asset managers who manage our money, the frustration with negative or paltry returns on bank deposits and other âsafeâ personal investments has led to seeking higher returns in more âsafeâ activities. risky. Stocks are one example and the stock markets – with the notable exception of Brexit Britain – have exploded, especially in high-tech stocks.
More seriously, the money has moved into property where there is a reasonable prospect of profiting from escalating house prices. From London, Melbourne, Berlin, San Francisco and Stockholm to Tokyo, Beijing, Seoul and Mexico City, house prices have jumped, creating a self-fulfilling spiral of asset inflation. While there are also asset bubbles in cryptocurrencies and exotic financial products, nothing beats ‘bricks and mortar’, perhaps because the owner has something tangible and useful, at the end of the day. – beyond a simple store of value.
The social consequences are profound. A McKinsey study in 10 countries suggests that house prices tripled on average during the first two decades of the century, severely undermining the aspirations of young people to buy or rent affordable housing; and this, in turn, weakens their ability to spend. Overall, in these 10 countries, real estate represents two thirds of household net wealth. And since investing in real estate does not add to economic performance and future growth, it is unproductive and acts as a long-term drag on the economy.
It was the nominally Communist President of China who had to point out the truism that housing is for living, not for speculating. The conference seems particularly infuriating when much of the property – particularly in London – is owned by foreign speculators.
One of the lessons of recent years is that even when interest rates are very low or negative, private investment will not necessarily happen due to political uncertainty or lack of demand. Governments must therefore intervene. Yet governments often did not understand the importance of low or negative market interest rates, or did not take advantage of them. In the UK, the Treasury – assuming the interest rate phenomenon is just a short-term burst – assumed rates would rise in its own valuation of long-term projects, causing serious economic damage. and unnecessary.
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The result is that unnecessarily high interest rates have been charged on everything from student loans to Green Deal loans to home insulation, killing a valuable program for the environment. Low risk and environmentally important projects like the South Wales Tidal Power Project have been killed because they would not make a quick comeback. Bonkers.
In fact, relying on public investment to ‘build back better’ is a crucial part of the response to the larger problem of ultra-low, often negative real interest rates, and structural excess savings by society. in relation to the investment. Borrowing to finance it is extremely cheap, which minimizes the risk of long-term debt service issues. Public investment, if judiciously deployed, also produces a return. And it can renew transport and electricity infrastructure, which is absolutely necessary for the transition to a low-carbon economy.
Even the divided and cranky US Congress grabbed this essential point by passing the Infrastructure Bill. The EU has taken the first stopping steps to engage in debt-financed investments on a European basis. The British Treasury, meanwhile, is cutting investment in rail projects in the north of England to the despair of those who see it as a unique opportunity to exploit the availability of cheap capital.
Negative real interest rates may not be an easy topic for political jokes and are quite bizarre in economic terms, but they represent a crucial fact of current economic life that our still-conservative treasury ignores at a certain price.
Sir Vince Cable is the former leader of the Liberal Democrats and was Secretary of State for Business, Innovation and Skills from 2010 to 2015