Zero Forever

The asymmetry in the setting of monetary policy has been evident for a number of years. I remember at Business School telling my Economics Professor that interest rates would hit zero at some point in the next five to ten years and would then bounce around that level from then on because of the myopic nature of our Central Bankers. He laughed in my face. Which I guess shouldn't have surprised me as he'd co-authored a paper with Ben Bernanke about inflation-targeting so was hardly independent of those that are entrusted with setting the most important price in finance.

I'm sure the Professor would now say that he's forgotten we even had the discussion. In fact, I'm sure he can't even remember who I am. But there we go. I'm sure plenty of students have told him plenty of stuff - he couldn't believe them all, particularly one that he disliked as much as me. I was one of those students who took pot-shots and made lots of obnoxious, too-clever-by-half comments from the back-row (we were allocated the seats, it wasn't my choice!). Anyway, I was wrong on one point - that it would take five to ten years. It took less than 3. And we've now had them for over 3 years. Aren't we kidding ourselves to think that zero interest rates aren't now the 'new normal'?

A year ago I believed that interest could rise, maybe to 1.5%, at a push 2%, before policymakers would once again decide that they needed to drop them again. And then I'd add a caveat. The only reason they'd go higher is if we get in to a currency crisis. At that point they could rocket. However, as long as all Central Bankers are singing from the same hymn sheet, then the currency race to the bottom will remain intact, which means no relative currency crisis (just one relative to gold), and no reason why they'll be forced to raise rates.

The one major Central Bank that I thought might take a different stance, and which I'm pretty sure wanted to, was the ECB. But the periphery was constraining it. And now given where Italian bonds are trading they're fully in to printing mode (via the back-door). So one can now reasonably confidently say that a currency crisis is unlikely in the UK and thus be even more confident that interest rates will not be forced to rise. And we know policymakers always like to keep the economy humming at above its natural rate (who likes pain?) and most households and businesses with any leverage (which is nearly all of both) have now normalised to zero interest rates, so even if they wanted to, rates cannot now be raised meaningfully without killing economic activity. So, interest rates really are now zero for as far as the eye can see.

Too Late to Change?

And the implications? The loss of a key policy tool, so making it harder for policmakers to respond to swings in the business cycle, though goodness knows they will still try (QEn anyone?), it means massive mis-allocation of capital, and it means the devastation of savers. Fancy retiring at these rates? Thought £1.5m (the lifetime allowance) was a lot of money? Well it is. And it will take most people a lot of years of hard grind to put away, but today it would give you an income of £45k a year (pre-tax), if you purchase 20 year government bonds with it (currently yielding 3%; inflation is of course 5% so the real yield is -2%, before you've paid tax...). Never before has it paid so poorly to be prudent. If you're one of those people that has always worked hard, lived within your means and taken little risk, you've been had. Is it too late to change your ways?!

So do I disagree with this policy? Well, it is pretty obvious that where we are today wouldn’t ideally be my starting point (and frankly it could have been easily avoided if our beloved policymakers were willing to take the punch bowl away, ever). But we are where we are, so policymakers have two choices:

1) To soften the necessary deleveraging process through using policy to avoid the worst of the pain and out-right depression or collapse, but to do what they can to prevent other bubbles from developing (through raising rates if possible at any points and through more controls e.g., maximum LTVs); or

2) To try and mitigate any deleveraging and push the pain out as far as possible in the hope that growth will miraculously re-appear and be the panacea for all ills.

I think you can guess which of these two options I believe they are going for. The result, the creation of a zombie and ultimately sclerotic economy. Schumpeter’s “creative destruction” be damned.