Sunday 30 October 2022

The era of low interest rates is not over. And this is so obvious I don't even know why I have to write this...

 I didn't really want to write about economics again but something has been happening the last few months and it is so ridiculous that I just felt I had to put it in writing.

The era of low interest rates is NOT over. I know interest rates have gone up. I know everyone is talking about this like it's a long-term thing. I know that the bond markets agree with it.

But it's just wrong; and unless attitudes to government deficits changes then we will have low interest rates forever, and in the long term they will only get lower.

Interest rates have come down from their peaks recently, but in the UK the 10-year rate is still 3.5%. In Germany it is 2.1%. The rise is in response to two main events. The first was the booming economy caused by excess government deficits over the Covid period, and the second was the inflation caused by supply shocks during Covid and the Ukraine war. 

 Austerity will push interest rates back to zero, and probably very soon

There are two problems extrapolating this to the long term and assuming that interest rates should stay high forever. The first is that the government deficits are transitory, and now the talk in the UK is all about austerity. The second is that raising interest rates to deal with inflation caused by a supply shock was a dumb idea anyway and will, if anything, lead to lower, not higher interest rates in the future as demand gets crushed and disinflation rises.

Now, this may not be true the US, where my limited understanding suggests that there is more of an appetite to run deficits to invest, but looking solely at the Eurozone and the UK, the only changes from the zero interest rate environment we had 2 years ago to now,  is that there is even more of a focus on austerity. And that means we will soon be back again at the zero interest rate environment.

Someone on Twitter (and sadly I can't remember who it was) recently wrote something along the lines of "Can someone explain to me please how after 12 years of austerity we still haven't got any money?". And I find this such a beautifully succinct shut-down of the political orthodoxy of the past 12 years. It will of course be ignored, as everyone scrambles to be more 'fiscally responsible' than everyone else. 

But anyone with half a brain who looks into the subject in any detail (and sadly our politicians either don't have the requisite half a brain, or they assume that the public don't) can see that years of the under-investment and low demand caused by austerity have been steadily turning the UK and Eurozone into low-growth, low wage economies that still need increasing debt and deficits and are in a far worse positions than they started in, both politically and economically. The 'Debt to GDP ratio' is higher than before because instead of fixing it by expanding GDP, they tried to cut debt. And even when Osborne and Cameron (or Wolfgang Schaeble) found that every one step they took forward with debt reduction cost them two backwards in economic growth, the prescription has been more of the same.

Why do we need government deficits for growth?

Over the past 50 years, the economy has been financialised. This result of this has been, for various reasons, more and more money going into the hands of richer people who have low marginal propensity to consume. Putting this another way, if you give a rich person another £1000 they will invest it in something and push asset prices up. If you give a poor person £1000 they will spend most of it, creating jobs and income for other people, who can then in turn spend and create more jobs.

Inequality has grown, as has debt. Debt means that generally people with a high propensity to consume pay interest to people with a low propensity to consume. As both debt and inequality have grown, more money is sucked out of the economy and into the bank accounts or pension funds of people who don't spend it.

In order to replace the demand lost by this, we need government deficits. And in order to get real economic growth and high wages we need much more demand and much larger government deficits, focused on investment in the future. And this spending doesn't even need to be for investment. It can even be just giving money to people who will spend it and letting them allocate it to productive areas of the economy, increasing jobs and creating a virtuous cycle.

That means big government deficits, giving money to people who will spend it, and specifically not as tax cuts to the rich.

Won't that cause inflation? Yes as well as economic growth there will be more inflation, but this is really a rebalancing of the economy away from people with assets and towards people without assets (assuming those without assets benefit from the spending). There are losers, which is always sad, but the losers would largely be those that benefited from the opposite happening over the years of austerity.

Won't it cause bond market melt-down? That was one of the more curious effects of the whole tax cut scenario and was largely caused by the LDI protection that pension funds held, which meant as soon as bond yields went up, more bonds needed to be sold, causing them to go down more. When the Bank of England stepped, in this was controlled. 

It has been one of the saddest things that could have happened as it imprints austerity as a sensible policy, and means it will be much harder for future governments to argue for growth.

Interest rates will never rise again, unless we change policy.

In any case, debt has been growing, inequality has been growing and long-term interest rates have been going steadily in one direction for the past 40 years. Debt and inequality are continuing to grow and this process will continue. 

Unless the economy can be rebalanced away from giving money to savers, and towards giving money to spenders, we will continue to need large government deficits, and if we don't get them, we will continue to get the slow growth we have seen since 2008, where median wages have gone down, even as we have (in theory) had economic growth the last 12 years. 

We have a low wage, low growth, low interest rate economy and it attracts charlatans like Liz Truss claiming she wants to fix the growth conundrum by lowering taxes for the rich. It makes conditions ripe for fascist-leaning politicians, for Brexit, for blaming immigrants, for all manner of false diagnoses of the issue.

The change we need to make is to run deficits and invest in the future of the country, with infrastructure, education, a green new deal and anything else you can think of. Do it big - look to the Chinese for inspiration (although within reason) - and see what a booming, high-wage productive economy we can have.

But in the mean time

The economies will stagnate. The bond yields will fall. And who knows what happens next. It's all too miserable and predictable.

For more on the whole subject and the economic framework I created and use, please see my paper on the subject.