Ultra-low interest rates carry a cost and it’s starting to rack up
January 20, 2014
Mark had the following article published in today’s Daily Telegraph:
No one ever said it would be easy. But it is fair to raise two cheers at least to George Osborne (and Alistair Darling before him), successive Chancellors who have sought to cushion the shock of the banking crisis and economic turmoil since 2008.
As in the 1930s, and once more in stark contrast to many of our European neighbours, we in the UK have been able to withstand recent shocks to the capitalist system with an air of relative stability.
This has come at a price, however, albeit one that is perhaps only slowly dawning on the electorate.
Whilst eight decades ago the industrial areas of central Scotland, south Wales and the North bore the brunt of the collapse in global trade that followed the great stock market crash of 1929, today it is the young and middle-class savers who are being significantly impoverished by Treasury policies designed to maintain order in an era of crisis.
Since the financial collapse of 2008, UK government policy has been driven by an overwhelming desire to minimise the impact of the economic shock. The generation that enjoyed an expanded welfare state, cheap goods, never-ending lines of credit and inflated house prices has been broadly protected, notably by rock-bottom interest rates.
Less consideration has been afforded to those excluded from this influential and sizeable cohort – today’s young people who grapple with sky-high rents and house prices, a less secure employment market and increasing personal debt.
I suspect the friction between the old structure’s beneficiaries and its hapless young inheritors will define the West’s story for some time. Nevertheless, David Cameron’s recent hint that both the pension “triple lock” and raft of pensioner benefits will be protected beyond the next election, indicates that there will be no radical change to the status quo any time soon.
The Coalition’s primary stated objective on taking office was the elimination of the UK’s structural deficit within a five-year term. In this it has palpably failed. Collectively, we are set to borrow £190bn more during the course of this parliament than planned at the time of the June 2010 emergency Budget.
Paradoxically, however, the international capital markets have maintained their confidence in George Osborne and his economic plan. Fears that excessive borrowing on this scale would lead to vastly higher borrowing rates have proved unfounded. Osborne’s broad-brush, combative confidence and chutzpah may grate on occasion, but, during times of crisis, political leadership requires the self-assured skills of an illusionist rather than a mastery of detail.
Yet history indicates that policies designed to insulate from short-term shock often come with long-term consequence.
The impact of the 1930s Depression was cushioned by restrictive practices and cartels in British industry (which had been subject to widespread consolidation after the First World War) and the then National Government driving through tariff reform. The latter resulted in a 10pc levy on imports, designed to insulate domestic manufacturers from international competition. This helped accelerate a move away from global trade towards a policy of Imperial preference. These captive Empire markets featherbedded UK business in difficult times, but did lasting damage to Britain’s longer-term competitiveness, as became evident from the 1950s onwards, since domestic companies had little incentive to modernise and innovate.
Today’s ultra-low interest rates have similarly provided UK business and individuals alike with breathing space. Nevertheless, the real question that should be foremost in the minds of policymakers after five straight years of emergency monetary stimulus, is at what cost to the nation’s long-term economic interests?
Persisting with near zero rates of interest has retarded the essential cleansing mechanism of capitalism. Countless so-called “zombie companies” remain in existence as lending banks have no need to pull the plug on non-performers.
This tying up of capital and labour in non-productive activity has engendered a false sense of security and boosted short-term employment levels, but it augurs ill in the teeth of fierce global competition in the decades ahead.
Similarly, George Osborne has continued the distorting impact of in-work benefits (working tax credits), first introduced in 1997 by then-chancellor Gordon Brown who had faithfully assured his Downing Street neighbour that their annual cost would never exceed £600m (on average the Treasury has spent over £8bn per annum since 2010).
Recent talk of a substantial hike in the minimum wage will only compound the problem. The stark truth is that millions lack the basic skills, aptitude or consistent record of employment to justify the expected level of workplace earnings – let alone a “living wage” – in this highly competitive global economy.
The risk now is that the relatively unskilled – assuming employment can be found for them – will find employers who will regard the enhanced statutory minimum wage as a maximum to be paid. Once employers are confident that any shortfall between a statutory minimum wages entitlement and the wage level required to be “better off in work” will be covered by the State, where is the incentive to pay more …or to ensure a properly skilled workforce for the rigours of the 21st century?
Once again, current policy designed to promote social cohesion kicks into the longer grass the need to make tough decisions. All of this harms the future competitiveness of the UK economy in the global race.
A sustainable household recovery cannot feasibly emerge from a diet of never-ending cheap credit and a new housing boom. Whilst it may be politically canny to shower more future public spending on pensioners in preference to investing in younger voters, it is not the route towards a more competitive economy. Indeed it has been a long-held fear of mine that the most talented of our younger generation will react to their raw deal simply by leaving these shores, probably never to return.
A price cannot be put on the relative social harmony we have enjoyed since the financial crisis took hold. Extra borrowing and low interest rates have unquestionably staved off considerable personal misery for many and bought politicians time to shore up a rapidly sinking ship. But it should never have been part of the plan to get addicted to this medicine. In the immediate aftermath of the 2008 financial crisis, the lessons of the 1930s were constantly evoked by reference to Keynesian pump-priming. For stage two, that decade offers equally valuable lessons.
Just as the tariff wall of 1932 condemned British industry to years of uncompetitive mediocrity, so today’s near-zero interest rates are beginning to rack up their own, considerable cost.