MERVYN King’s claim that a normal level of interest is going to put young adults in the poor house is a dubious one, writes George Kerevan
Faithful readers of this column will know that I have scant regard for Sir Mervyn King’s forecasting abilities. So when he gave a valedictory message to the Treasury Committee this week on the future of interest rates, I shivered.
In recent weeks world stock markets have been worried by fears that the US central bank will wind down stimulus measures. “Don’t panic!” was Sir Mervyn’s message to MPs: “I think people have rather jumped the gun thinking this means an imminent return to normal levels of interest rates. It doesn’t.” He went on: “Until markets see in place policies to bring about that return to normal economic conditions…it will not be sensible to return interest rates to normal levels.”
Don’t bet on it. Base rate has been stuck at 0.5 per cent since 2009. As we return to economic normalcy, higher interest rates will start to bite. As well as your mortgage bill rising, this will drive a coach and horses through the chancellor’s latest budget plans. However, just to be contrary, there is a silver lining.
The world has enjoyed rock bottom interest rates since the dot-com bubble burst at the start of the millennium. These low interest rates triggered the credit boom that exploded in our faces in 2008. Yet Sir Merv thinks central banks will go on printing dollars, pounds and euros like wallpaper and stuffing them into the banking system for years to come. But there is a wee problem: printing money is – ultimately – inflationary. At some point, the mountain of new cash will trigger hyperinflation and economic collapse.
It has not done so to date for a variety of technical reasons. First, for the past five years, banks have used this newly minted cash to shore up their internal reserves following the 2008 credit crunch, rather than lend it to you or me. This has had a bizarre consequence: while there is a lot more money around, less of it is in circulation. This has actually caused prices to fall in America. Imagine a dam with water piling up on one side and a drought on the other, and you’ll get the picture.
Second, low interest rates have allowed investors to borrow to buy shares, soaking up some of the new printed money and keeping it out of harm’s way. This explains why the American and German stock markets reached historic highs last month, despite the global economy still being in the doldrums. But investors need share prices to rise indefinitely so they can pay back the loans – a Ponzi scheme that is starting to unravel.
The US Federal Reserve has been printing new money at the rate of £55 billion a month. But the Fed Chairman, Ben Bernanke, is dropping broad hints this monetary stimulus could end next year. If the money tap gets turned off then share prices will drop. Investors are in two minds: should they sell now before shares lose value, or stay in the market and look for bargains. Result: this month, world stock markets have been going up and down like a yoyo.
Enter Mervyn King, trying to reassure everyone that nothing is going to change quickly and interest rates will stay low for years. My instinct is that Bernanke is being absolutely straight: the Federal Reserve can’t go on printing money indefinitely and will start to wind down the stimulus next summer.
This new reality was signalled by Mark Carney, who takes over from Mervyn King at the Bank of England on Monday. Contradicting demob-happy Sir Merv, Carney told an interviewer that UK companies “need to manage their business for the possibility of a slight or material change in the level of interest rates.” While media eyes were focused on the chancellor’s fantasies about public spending post 2015, the markets were pricing in a rise in base rates to 0.75 per cent before the general election.
Would higher interest rates actually be a bad thing? A Bank of England report this week suggested that nearly 10 per cent of mortgage holders would be forced to reduce spending if rates went up just one percentage point.
Mervyn King told the Treasury Committee that people in their thirties and forties would be left in an “unsustainable” position if interest rates hit only 3 or 4 per cent.
However, there is a brighter side. Savers would get more for their money. Even firms would benefit: in the past three years alone, low interest rates have forced companies to divert £90 billion to cover pension deficits. It is plausible to argue that low interest rates, allied with the UK’s high inflation, have depressed consumption by destroying private wealth and curbing investment.
I’m dubious about Mervyn King’s contention that a normal level of interest is going to put young adults in the poor house. Rising interest rates are only a problem if real incomes are falling – which they have been because the Bank of England failed to curb inflation. To curb inflation you need higher interest rates.
True, some indebted property companies are vulnerable to a rate rise. Commercial property loans, many of them duff, account for 40 per cent of bank corporate loans. Yet it might be better to clear the slate rather than keep zombie investments alive, tying up capital and buildings uselessly. It might even spark an urban renaissance.
Mervyn King’s experiment with fixing the price of credit has not stimulated the economy. Bank lending in the UK actually fell by £300 million in the first quarter. The real reason interest rates are being kept low is to reduce the cost of borrowing for the Treasury. Fortunately, the Bank has spent the past five years buying so much of the new debt issued by the chancellor, that we owe the interest debt to ourselves.
Price fixing, including of credit, is always a dangerous delusion as it ignores the underlying realities of supply and demand. Any return to economic normality means accepting interest rates are going to rise – sooner rather than later.