One day, higher rates will be the good news

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The Independent Online
WHEN everyone agrees that the Government has done something sensible about its economic policy, it is time to start worrying, because the conventional view of what is right is all too frequently wrong. Last week's cut in interest rates is such an example.

For weeks, most commentators and industrialists, and the entire Opposition, were saying that the Government ought to cut rates. Timing was a moot point, but the presumption was that it was the obvious policy, and the Government had been pig-headed not do so earlier.

Of course, there is some truth in this line of argument; indeed there is a case for still lower rates. This was well put by Gavyn Davies in his column in the Independent on Monday, when he argued that real (ie, allowing for inflation) interest rates were still high and lower rates were required to help banks rebuild their capital and persuade people to switch out of cash and into government securities.

We probably will have another fall in interest rates, and the double-digit rates of last year were clearly far too high. But nothing in economics is free. Cheap money has its costs, and anyone expecting further cuts should recognise that the economic and political arguments could soon swing the other way.

For a start, we are close to the point at which interest rates will be so low that further cuts will not have much effect. Ordinary consumers do not rush out to buy just because base rates have come down a bit. We cannot borrow at base rate: we can borrow only at the rates that lenders charge. The credit card companies, saddled with the costs of advertising, fraud, 'free gifts' and so on, are still charging well over 20 per cent for credit; if interest rates fell to zero, they would still be charging somewhere in the high teens.

Something similar has happened with mortgages. The headlines in advertisements promise all sorts of low rates and other incentives to new borrowers, but existing borrowers may have to wait months for their rates to come down. Besides, most sensible people will be aware that they should not expect these rates to last too long. We all know that in a year or two the chances are that they will be heading back up again.

Other costs include the weakness of sterling and prospective inflation. The hordes of Britons who go to the United States this year will find it 25 per cent more expensive than last year. The price of Ford's imported Sierras and Granadas rose as a direct result of sterling's slide, and doubtless the new Mondeo will be more expensive than it would have been had Britain remained in the ERM. The same applies to almost all imports.

The truth is that devaluation helps the powerful. The banks may be delighted; big business may be cheering. But it does not help ordinary savers.

There are a lot of savers in the United Kingdom. Building societies have no money of their own: they have only the money that people leave with them. For every person who borrows from a building society, there are four or five savers. Each time the mortage rate comes down, savers are given a rather worse return. Since they tend to be older and more dependent on their savings for income, they may have to cut their own standard of living as a result.

Britain desperately needs higher savings to finance higher investment. Politicians, particularly opposition politicians, always emphasise the need for investment, and they are right to do so. But rarely do they explain that people will need to save more and spend less to finance that investment. In the Eighties, the Chinese saved 38 per cent of their national income, Korea 32 per cent, Taiwan 33 per cent and Singapore an astonishing 42 per cent. We managed less than 15 per cent. Now, dropping interest rates are punishing the very people who are needed to finance future growth.

Yet when base rates come down, hardly anyone points out that there are losers as well as gainers. The reason for this probably comes in two halves. Borrowers have better access to the media; industrialists can trot out someone from the Confederation of British Industry to appear on television and give the lower rates a warm welcome; but there is no articulate (and highly paid) director-general of a confederation of British savers to say that it is dreadful news; nobody represents the millions of savers.

The other half of the answer lies in the myth that savers are rich and borrowers poor. That is manifestly untrue at a macro-economic level: as a rule of thumb, it is governments and companies which borrow and ordinary individuals who save. It is even untrue at a personal level, for the incomes of people who borrow from building societies are in general higher than than the incomes of those who deposit money with them. But it is an enduring myth that financial prudence is the same as wealth, and a quirk of British social attitudes to feel sorry for people who overborrow.

Some day the politics will change. As the country ages and an increasing proportion of the population depends on pensions and income from savings, their voice will be heard more loudly. The votes will be for the savers, not the borrowers. When that happens, cuts in interest rates will be deeply unpopular, and the politicians will have to apologise and explain how necessary they are. When interest rates go up, the commentators will duly cheer. Odd? Not really. It often happens in that nation of arch-savers, Japan.