The notion of negative interest rates, even for those who fancy themselves to be sophisticated in financial matters, is a strange, unfamiliar and disquieting one. And yet it may be closer than we think.
The majority state-owned RBS Group, which includes NatWest, has warned that it may need to introduce negative rates on business accounts, given where forecasters think the Bank of England is heading. If it does proceed with such a thing, then negative rates applied to consumer saving accounts may not be far behind. That would mean that savers would, in effect, be paying the bank or building society a small fee for the privilege of looking after their money, rather than them offer some positive interest return for lending them it.
In the world of government bonds, something like this has already happened: institutional investors, even including pension funds, are buying expensive government-backed bonds knowing that the interest they receive on them will not cover the assured loss they will make when the bonds redeem. It is a topsy-turvy world.
But why do people invest in such a way? And why do the world’s central banks seek to impose such an unnatural burden on savers? The phenomena are connected. When people are fearful they tend to save; and when they become especially fearful then they save even more, even if the returns on their savings are extremely low. Much the same goes for businesses, and there are increasing reports of them “hoarding” their profits rather than reinvesting them in their business, such is the great “uncertainty” around the world economy. Brexit obviously only added to the fears and misgivings about the future.
As John Maynard Keynes pointed out long ago, a business leader will not borrow, no matter how low the interest charge, if there is no prospect of making a profit because there is a general belief that sales revenues will fall. If such a psychology takes a grip on an economy then it soon becomes a self-fulfilling prophecy. In that case, even negative rates of interest are insufficient to push spending back up again. To use Keynes’s analogy, central banks will find negative rates have very little impact on the real economy – like “pushing on a string”.
The most recent and striking example of this is Japan. For about a quarter of a century the Japanese have proved to be fanatical savers, and no matter how low the Bank of Japan cuts rates, they simply cannot be persuaded to spend their money, or even invest it in the stock market. They fear losing their jobs; they fear a further fall in shares or property values; they have no confidence in the investment opportunities in front of them. So pathological has this psychology grown that they would rather see the value of their savings fall than spend the cash. That draining of confidence after the collapse of the 1980s “bubble” economy has depressed Japanese growth for decades.
Faced with such a resistance to spend, central banks can become desperate. It used to be assumed that interest rates could not go below zero, but it is perfectly practical, although it is extremely bad news for the nation’s savers and makes banking more difficult. Theoretically, if you left a deposit in a building society account for long enough, it would one day dwindle to nil, (or near-nil in a version of Zeno’s paradox). Then, surely, you’d have an incentive to blow it on something, or so the argument goes.
The alternative to extreme monetary policy is extreme fiscal policy, and in particular increasing public spending, that is unfunded by tax rises. Despite the apparent polarisation of the Conservatives and Labour on economic policy, some consensus around this seems to be emerging. All sides agree that infrastructure spending, especially in the post-Brexit environment, would provide an immediate boost to the economy and raise the long-term productivity rate of the UK.
Given decades of underinvestment, it might well provide a remarkably rapid return on a comparatively modest investment. With interest rates so low, even with Britain having lost its AAA rating, the cost of such investment is low. As an alternative to pushing on the string of ultra-low or negative interest rates and destroying the prospects for British savers, it is the increasingly attractive option.
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