Governments have thrown just about everything at their economies since the terrible impact of lockdowns eliminated millions of jobs and slashed growth.
Their efforts – trillions in ‘stimulus’ spending, helicopter money, interest rate cuts, ‘furlough’ schemes, holidays on this and that tax – have had some hefty unintended consequences. The pace of developments has been remarkable. One of the macro-economic tools that’s been tried is cutting interest rates, and even making them negative – in other words you would have to pay a bank to deposit your money.
In February, the Bank of England (BoE) formally told the UK’s high street banks they had six months to prepare for negative rates. The possibility of negative interest rates should send shivers down everyone’s spine. This week we may learn if the BoE intends following through on its warning.
A shift into negative rates will however do little to get the economy moving again. It may produce its own distortions – and market distortions can last much longer than the policy changes that gave rise to them. There’s always a time lag.
For example, few people this time last year would have forecast that household wealth would have soared under the pandemic – yet it has. In March average US household income went up by more than 21%, the largest monthly rise since 1959. UK households that same month put £16.2 billion into their bank accounts, 3.4 times the monthly average for the year to February 2020, prior to the first UK lockdown.
In the UK, we have an extra twist. The UK Chancellor Rishi Sunak announced in July 2020 a temporary stamp duty holiday. Stamp duty is the tax levied by the UK government on residential property – on homes. Sunak cut the rate to zero for all properties sold for less than £500,000 ($693,000) until the end of March. He later extended this until the end of June this year. It’s not clear why the Chancellor chose this policy instrument in the anti-Covid/economic slump fight but its effect has been to create a “red hot” property market according to one UK mortgage adviser.
Governments lack dexterity
Demand for mortgages in the UK has become “red hot” and – the laws of supply and demand being what they are – average UK house prices went up by an astonishing 7.3% in April year-on-year. In the US, house prices rose by 16% in the past 12 months. The price of lumber – the main component in the typical US house – has risen by more than 230% since the start of the Covid-19 pandemic. UK household wealth has risen to record levels, the equivalent of £172,000 ($238,400) per person. In the US, personal incomes went up by 21.1% in March against the previous month – the highest jump since 1946.
US citizens – even those working and living abroad – have received their $1,400 Biden “stimulus check”. Some UK citizens have been paid by the government while their job is put on pause (“furloughed”).
But the hand of government is by definition clumsy. All state instruments are blunt; they’re not built to take account of individual cases. Thus the Legatum Institute, a think-tank in the UK, estimated last November that almost 700,000 people had been pushed into “poverty” in the UK as a result of the Covid-induced economic crisis. Human Rights Watch, the international NGO, said that eight million more US citizens were living in poverty in January this year than six months’ previously.
The gap between the “haves” and the “have nots” has just got bigger; the collective wealth of the more than 600 US billionaires has gone up by 36% during the pandemic. The richest 1% of Americans have added about $4.8 trillion of wealth from the end of March to the end of December 2020.
We should be wary therefore of any attempt to stimulate growth by making interest rates negative. The money that would supposedly be teased out and put to productive use (into the “real” economy of making things people need to buy) will not necessarily end up there. Those who put their spare cash in banks would find themselves forced to pay for the privilege. Savers in cash are already punished by record low-interest rates; they would suffer even more punishment if rates went negative.
Nor is there any guarantee that the cash would flow into the economy; since the European Central Bank (ECB) introduced a negative deposit rate in 2014 physical cash holdings in Germany have trebled to €43.4 billion ($52 billion, £37 billion). People prefer to hold cash than pay banks, or to risk it by investing it. People have become even more wary of spending on anything but tangible assets in the wake of Covid. In the seven years since then the 19 countries within the Euro area have grown very sluggishly – peaking at 2.6% gross domestic product (GDP) growth in 2017 and as low as 1.3% in 2019 – the year before Covid-19 struck. Their example of negative interest rates does not seem to encourage growth.
Governments right now want to see their populations spending, injecting money into the economy and theoretically driving economic growth. Negative interest rates – which would have a knock-on effect on many financial products and institutions, from tracker funds to banks – are not the answer when economic growth already appears to be rebounding. The “reflation trade” has become a buzz phrase in recent weeks; crafting policy to ensure that inflation does not get out of hand is rapidly becoming the main concern for the US and others.
With interest rates so low, taxes bound to rise, prices soaring – lumber is only one example – protecting what one has is becoming daily more important. The gold price is having one of its periodic dips; but if history is any guide, then gold remains an important part of anyone’s portfolio.