Earlier this month, the Bank of England altered the bank rate of interest for the first time since 2009, pushing it from 0.5% down to 0.25%, with a further cut to 0.1% expected later in the year, and an accompanying £70 billion programme of new quantitative easing.
This dramatic — if predictable — shift in British monetary policy (further detailed in a recent Mises Wire article), has already had a significant short-term impact, with sterling falling by 1.5% against the dollar within the first half-hour after BoE Governor Mark Carney’s announcement. However, in the days since, there have been ominous rumblings in certain corners of the British economy, which hint at possibly far more grave, long-term consequences of the decision.
With central banks around the world falling into step in a seemingly inexorable race toward negative interest rates, it is worth paying particular attention to these little clues coming to the surface in Britain, and the possible bigger problems they could be pointing to on the horizon. The host of consequences which Britain will likely suffer in the coming months, may serve either as a warning to central bankers and politicians around the world against pursuing the same policies, or as a harbinger of the grim future into which the world economy may be beginning its descent.
A Flight to “Safe” Investments
Of particular note is the fact that the reduction in rates is exacerbating the already serious problem of savers being forced to flee into supposedly “safe” investments, and causing bubbles in those assets as a result. With the new rate-reduction coinciding with UK CPI inflation reaching 0.5% in June, a relative high-water mark in the past two years, savers will find it increasingly difficult to see a real return on their savings simply by holding them in the bank. The accordingly increased demand for “safe” investments has thus caused artificial, low-rate fueled bubbles in their prices.
This problem can be expected to be particularly severe in two investments which already harboured dangerous bubbles even before the new rates cut: housing and government debt. Since 2013, the UK House Price indexhas been climbing with alarming speed, back up to well above pre-crash levels, and the yields on UK 30-Year Treasury gilts have fallen persistently since 2011, suggesting an artificial disconnect between investors’ confidence in government debt over the rest of the economy. While these bubbles should be of particular concern to British investors, recent news that even Spanish 10-Year bond yields are at record lows illustrates the global scope of the problems now manifesting in Britain.
Another type of investment which can be expected to see an increase in demand after the new BoE policy is the growing set of investment opportunities which have been either outright created by, or made artificially more attractive by government interventions in the economy. Unusual types of government borrowing initiatives — such as Premium Bonds, which enter the bondholders into a monthly lottery rather than yielding direct interest — will appear relatively far more attractive in light of lowered rates in the rest of the economy. The rates cut will likely also accelerate the speed at which UK savers retreat into avenues of investment upon which the government has benignly conferred a favourable tax status, such as so-called Individual Savings Accounts (ISAs).
The State Spares No Expense
Of particular concern is the “Help to Buy ISA,” through which the government agrees to top-up the account holders’ savings by 25% if the money is used in the purchase of a first home. The source from which the government acquired this extra 25%, which it now so lavishly confers upon us, is left to the reader’s imagination. Policies like these, both in the UK and around the world, should not only be of concern due to their effects on inflation and their swelling of the new housing bubble, but also because they prompt further expansion in the level of government debt (currently rounding the corner on 90% of GDP in the UK), which will tend to worsen the government debt crash to come.
Another development since the new BoE policy, which could be a signal of problems to come, is the flight of savers from the banking system altogether. With interest on savings held in banks dwindling ever further, combined with several major UK banks announcing that they are considering charging firms to hold depositswith them, the result will be a growth in the already significant number of UK savers keeping their money outside the banking system. While this could be of concern simply due to its negative effects on banks’ ability to lend to businesses, if the trend sustains it could also panic politicians into pushing for a cashless economysometime in the not too distant future. Not only would this effectively force consumers to remain part of a banking system they no longer wished to patronise, but such digitisation of the entire money supply could potentially create a degree of government control over the economy unprecedented in history.
However, even such black clouds aren’t entirely without their silver linings. In the days since the announcement, the BoE has found itself in the extraordinary position of having to question whether it will even be able to complete its new stimulus package, as firms have appeared unwilling to sell it the bonds it has requested. Furthermore, BoE governor and de facto king of the British economy Mark Carney, has previously spoken out against the increasingly popular concept of negative interest rates. This could be taken as a sign that the future of the world economy may not be as bleak as it appears, or at least that central bankers are starting to become aware of the corner they have backed themselves into. As Shakespeare’s MacDuff grimly remarks, “Such welcome and unwelcome things at once, ’tis hard to reconcile,” a phrase which he utters shortly before lopping off the king’s head and concluding the tragedy. We can only hope for such luck.