Five years of disastrously low interest rates have left Britain addicted to cheap credit

The Bank of England

This article originally appeared in The Telegraph on 5 March 2014. It is reproduced by permission of the author.

Five years ago today, the Bank of England cut interest rates about as low as they can go: 0.5 percent. And there they have remained.

If rates have been rock bottom for five years, our central bankers have been cutting them for even longer. You need to go back almost nine years to find a time when real interest rates last rose. Almost a million mortgage holders have never known a rate rise.

And this is all a Good Thing, according to the orthodoxy in SW1. Sure, low rates might hit savers, who don’t get such good returns, but for home owners and businesses, it’s been a blessing.

Don’t just compare the winners with the losers, say the pundits. Think of the whole economy. Rates were set at rock bottom shortly after banks started to go bust. Slashing the official cost of borrowing saved the day, they say.

I disagree. Low interest rates did not save the UK economy from the financial crisis. Low interest rates helped caused the crisis – and keeping rates low means many of the chronic imbalances remain.

To see why, cast your mind back to 1997 and Gordon Brown’s decision to allow the Bank of England to set interest rates independent of any ministerial oversight.

Why did Chancellor Brown make that move? Fear that populist politicians did not have enough discipline. Desperate to curry favour with the electorate, ministers might show themselves to be mere mortals, slashing rates as an electoral bribe.

The oppostite turned out to be the case.  Since independence, those supermen at the central bank set rates far lower than any minister previously dared.  And the results of leaving these decisions to supposedly benign technocrats at the central bank has been pretty disastrous.

Setting interest rates low is simply a form of price fixing. Set the price of anything – bread, coffee, rental accommodation – artificially low and first you get a glut, as whatever is available gets bought up.

Then comes the shortage. With less incentive to produce more of those things, the supply dries up. So, too, with credit.

With interest rates low, there is less incentive to save. Since one persons savings mean another’s borrowing, less saving means less real credit in the system. With no real credit, along comes the candyfloss variety, conjured up by the banks – and we know what happened next.  See Northern Rock…

When politicians praise low interest rates, yet lament the lack of credit, they demonstrate an extraordinary, almost pre-modern, economic illiteracy.

Too many politicians and central bankers believe cheap credit is a cause of economic success, rather than a consequence of it. We will pay a terrible price for this conceit.

Low interest rates might stimulate the economy in the short term, but not in a way that is good for long-term growth. As I show in my paper on monetary policy, cheap credit encourages over-consumption, explaining why we remain more dependent than ever on consumer- (and credit-) induced growth.

Cheap credit cannot rebalance the economy. By encouraging over-consumption, it leads to further imbalances.

Think of too much cheap credit as cholesterol, clogging up our economic arteries, laying down layer upon layer of so-called “malinvestment”.

“Saved” by low rates, an estimated one in 10 British businesses is now a zombie firm, able to service its debts, but with no chance of ever being able to pay them off.

Undead, these zombie firms can sell to their existing customer base, keeping out new competition. But what they cannot do is move into new markets or restructure and reorganise. Might this help explain Britain’s relatively poor export and productivity performance?

What was supposed to be an emergency measure to get UK plc through the financial storm, has taken on an appearance of permanence. We are addicted to cheap credit. Even a modest 1 per cent rate rise would have serious consequences for many.

Sooner or later, interest rates will have to rise. The extent to which low interest rates have merely delayed the moment of reckoning, preventing us from making the necessary readjustments, will then become painfully evident.

We are going to need a different monetary policy, perhaps rather sooner than we realise.


The End of Politics and the Birth of iDemocracy

The West is in crisis.  Our Big Government way of doing things does not work.  It is no longer going to be possible to run a burgeoning welfare state on the back of a shrinking wealth-creating base.

For several generations, officialdom has been able to divert ever greater resources toward officialdom by concealing the costs of extra government.

How? Partly through unequal taxation, and partly by manipulating the money.

Taxation is, in the words of Louis XIV’s finance minister, Jean-Baptiste Colbert, the art of “plucking the goose as to obtain the largest amount of feathers with the least possible amount of hissing”.  Too much hissing, and the king might lose more than the extra revenue.

The introduction of so-called progressive taxation a century ago enabled the governing elite to extract more feathers from a minority of geese at any one time, confining the hissing to a few.  Government has grown every decade since.

Since 1971 Western governments have lived beyond the tax base by manipulating the money, transfering wealth from the governed to the governing without many voters even noticing.

Indeed, Western finance ministers meet regularly in order to discuss the rate at which they internally devalue their currencies such that they might ensure the external consequences are manageable.

The trouble is that these pillars on which the Big Government model rests – unequal taxation and money manipulation – are starting the crumble.

The digital revolution will redefine money.  Instead of having to live under monopoly money regimes, we will have currency competition.  Governments simply won’t be able to keep on debasing the currency at our expense.

In the digital economy of the future, taxes will, I argue, need to be much flatter.  A consequence of flatter taxes is that even quite modest attempts at plucking us for more taxes will be met with a great deal more hissing.

The digital revolution will  reinvigorate the West, lifting us out of our Big Government induced stupor.

Douglas Carswell is Conservative MP for Clacton. His book The End of Politics and the Birth of iDemocracy is published by Biteback


The economic consequences of central bankers

More unemployment.  More recession.   More massive public debt.  More print-more-money-and-pray quantitative easing.

More Mervyn King bleating on about the stalled economy – but failing to explain why he has missed his inflation target for years.

What passes for economic “debate” in Britain today is between those who still believe monetary stimulus is the way to engineer growth versus those who say we need fiscal stimulus.

Each time more monetary stimulus fails to produce prosperity, the fans of fiscal stimulus say we need to spend more. Each time public debt gets a little bit less manageable, those who favour monetary stimulus claim it is they who are right.

But what if they are both wrong?

If central bankers knew how to make us wealthy, the West would be booming.  Instead, having handed them the macroeconomic controls, we find ourselves trapped in a decades long spiral of debt and stagnation.

It was attempts by central bankers like Mr King to engineer growth through monetary manipulation that landed us in this mess to start with.  Further monetary stimulus today can no more restore us to prosperity than fiscal stimulus was able to in the 1970s. Debauched monetarism is no more the answer than debauched Keynesianism.

If you cannot engineer growth from on high, who in Whitehall is working on plans to set the economy free to grow from below?

What “winter of discontent”-style event might it take to prove that we need something altogether bolder and more radical than the current bankrupt orthodoxy.

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