The Bank of England (BoE) has “written to UK banks asking them how ready they are if interest rates were cut to zero or turned negative”. Never mind the banks – how ready are you?
Reducing interest rates to zero or less – as is the case in the Eurozone, Denmark, Japan and Switzerland – is an economic policy primarily designed to stimulate demand, but in has proved to be a mug’s game. President Donald Trump wants the US Federal Reserve to take rates negative. But one of the deputy governors of the BoE, Sir Dave Ramsden, said last month he didn’t see the need for the Bank to reduce interest rates below their present 0.1%.
“Negative rates [are] a bit like steroids”, said Huw van Steenis, a former Bank of England adviser, told CNBC in October 2019. “They are great in a short, sharp usage but long-term usage of steroids starts to dissolve your bones”.
Among the bones that would be dissolved by negative interest rates in the UK are pensions, all savers, commercial banks, and those saving to buy a home, as negative rates encourage inflated asset prices. Commercial banks will lose money as they understandably don’t want to charge customers for their deposits for fear of a mass charge through the door marked ‘exit’. So banks would have to absorb the charges they are paying to deposit their own money with the central bank every day. Negative rates also encourage the accumulation of debt, as the incentives to repay debt disappear.
2020 – the year of mug’s games
2020 will surely be remembered not so much for Covid-19, but as the year in which the central bankers and their political masters of the world lost their sense of relative importance.
Under pressure from governments – whose cry since late January has been an increasingly hysterical ‘we must do something!’ – central bankers have indeed done something but it’s now occurring to those same governments that the cure might be as bad as the disease.
Trillions of dollars have been borrowed and given to individuals and businesses in a laudable attempt to prevent them from going under as they were forced to stay at home and their customers disappeared.
In now turns out this has been a mug’s game, in which today’s lives are protected but at the cost of ruining those of tomorrow. There have been more than 37 million confirmed cases of Covid-19 and more than 1 million deaths attributed to it, a lethality rate of 2.7%. The annual mortality rate of influenza – which is never accompanied by such economic damage as wrought by Covid-19 – is about 2%. At some point someone will do a cost-benefit analysis of the measures taken to combat Covid-19. Perhaps the Institute of Fiscal Studies (IFS) has already started. It said this week that the UK Chancellor, Rishi Sunak, will need to raise taxes by more than £40 billion a year by 2025 to stop public debt spiralling upwards. The IFS forecasts that UK government borrowing will this year reach £350 billion, 17% of GDP, the highest peacetime level since the 1700s. Pushing up taxes will be a deeply unpopular move and could stifle any nascent economic recovery.
Drowning in fiat cash
Since the financial crash of 2008 and the failure of demand to recover central banks have been searching for a magic key in their toolbox to stimulate demand and hence GDP growth.
This year, in the wake of the viral pandemic, monetary expansion – the amount of paper money shovelled into the system – has been the option which has gained universal consensus. In March, the US Federal Reserve pledged to buy government bonds in unlimited amounts, facilitating monetary inflation. In the US, GDP collapsed by 31% on an annualised basis in Q2 2020, while M2 – the measure of money supply which includes cash, deposits and easily convertible ‘near’ money – expanded by 9.4%, an annualised rate of 37.6%. Has that money given out in Q2 actually been spent, actually helped stoke demand? Simply adding more money supply does not translate into increased spending; the money can be saved or used to pay off credit card debts.
According to one commentator, the “Fed has effectively committed itself to supporting all economic and financial activities with newly issued money… it must ensure financial markets, particularly for government debt, remain strong, so that the interest cost of the US Treasury’s debt is contained close to the zero bound. The Fed’s only real tool is the expansion of M1 money supply, which currently stands at $5.577 trillion. How many multiples of this figure will be required? Five, ten times, or even more?”
Right now we are stuck in a period of deflation, with businesses closing and the threat of big unemployment in the UK, US and European Union by the end of 2020. The latest International Monetary Fund (IMF) World Economic Outlook says that economies will be smaller and that tax bases will concomitantly be smaller.
Yet with the world now so hugely indebted and economies struggling to lift themselves from the floor, governments will do whatever it takes to kick economies back to life, and to stay in office. They are, frankly, desperate to see their loose fiscal and monetary policies translate into much greater levels of consumer spending. Desperate, that is, to see inflation start to return. Gold is a protective asset. What will happen to the gold price depends a great deal on how the US dollar weathers the current storms. The US dollar has weakened this year and many expect it to weaken further.
If the UK moves to negative interest rates it will be a further sign that the BoE is scrabbling around at the bottom of its tool bag. It will be a further indication that one needs to get a Glint card and load it up with gold, which is beyond the reach of all governments.