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Good riddance to the era of free money

by WorldFinance
0 comment 6 minutes read
Andrew Bailey

Three prime ministers, four Chancellors, the death of Britain’s longest reigning monarch, Putin’s murderous invasion of Ukraine, soaring energy bills, the collapse of crypto, and the decimation of tech valuations; these were just some of the stories that have made 2022 a year to remember – or forget, depending on your point of view. But perhaps the biggest of the lot in terms of macroeconomic importance is resurgent inflation and the seeming end of the era of cheap money. If sustained, this would qualify as a mega-trend that fundamentally changes the way finance, the housing market, and much of the rest of the economy operate and interact. I should begin with a qualification; in real terms, interest rates haven’t risen at all, but because of soaring inflation they have plunged yet deeper into negative territory. Indeed, relative to inflation, money has rarely been cheaper. The Bank Rate has risen from 0.25pc to 3.5pc, and the yield on ten-year gilts all the way from 1.4pc to 3.65pc. But neither has got within touching distance of keeping pace with inflation. A real interest rate of minus 7pc scarcely looks like the end of cheap money. All the same, the squeeze is on; rising rates are becoming an ever more potent contributor to today’s cost of living crisis. Both households and companies are feeling the pinch. Consumers with mortgages have less money to spend, and firms with high debts are struggling to stay afloat. Governments too are finding that higher borrowing costs are severely crimping their ability to spend on other things. With surging inflation also comes a tsunami of inflation-matching wage demands from public and private sector workers alike. Raising taxes to pay for it all is at best a zero sum game, since it only further depresses demand elsewhere in the economy. The price of everything from housing to commercial property and stocks and shares, buoyed by more than a decade of essentially “free money”, no longer looks like the one way bet it was. Already, parts of the commercial property market are crashing. Stripped of low cost leverage, much private equity activity has stalled. Similarly, the boom in streamed entertainment has come to an abrupt halt; multiple subscriptions are an easy saving for hard pressed households to make, while the content needed to feed demand has become more expensive and harder to finance. Boom levels of investment in tech, again financed by years of abundant, near free credit, has slumped, and with it the jobs bonanza of the pandemic, when it seemed that more or less everything would shift online. These are just some of the manifestations of distress that more expensive money is bringing. Is it just temporary, with things returning to the way they were once the current inflationary spike has subsided, or are we looking at a more permanent shift back to pre-financial crisis norms? I wouldn’t rule out the former possibility. Much official forecasting, including from the Bank of England and the Office for Budget Responsibility, is based on the assumption that inflation will no longer be a problem by the year after next. For instance, the OBR expects inflation to fall markedly throughout 2023, before turning negative in 2024 and remaining there for eight successive quarters. Yet that prediction is conditional on market expectations for the Bank Rate and gas prices, which are notably higher than those suggested by recent surveys of economists. Andrew Bailey, Governor of the Bank of England, has likewise repeatedly suggested that market expectations of interest rates are too high, implying that price stability could be restored at a rather lower interest rate than the markets assume. There is in other words a strong presumption both among policymakers and City economists that after peaking early next year, by when the economy will unambiguously be in recession, that interest rates will quickly be on the way down again, even if not quite to the levels that have ruled in recent years. The so-called “natural” rate of interest – the level judged necessary to ensure price stability – is generally thought to be somewhat higher than it was. Even so, back to what would once have been regarded as very low rates of interest is the presiding assumption. I for one very much hope that this is not the case. After a period of painful adjustment that will throw up plenty of unanticipated nasties along the way – years of easy credit is bound to have incubated some real horror stories – I hope we’ll settle for a world in which money once again has a price. Ideally, this would be in the 3 to 5pc range that ruled before the financial crisis. It’s not a mainstream view, to be sure, but there is a suspicion that despite what they say, central banks – in league with needy governments – are not as serious about returning inflation to target as they should be. A 3 to 5pc inflation rate, for instance, might be quite helpful to governments in eroding away the real value of mountainous public debt. There is, however, a good reason why the inflation target is set at 2pc, a number which might otherwise seem oddly random. The point is that 2pc is high enough to prevent the economy from slipping into a deflationary funk, but low enough for people not to really notice that prices are rising. Much higher, and it becomes difficult to anchor expectations, and therefore to prevent inflation running away with itself. In any case, inflation may prove a good deal more persistent than policymakers, stuck in the mindset of the past decade, imagine. Especially, as seems likely, if governments eventually cave into public sector wage demands. It is admittedly true that the secular global forces that have been driving inflation down since the late 1980s – globalisation in combination with the savings glut generated by an ageing population – haven’t really gone away. But with the world increasingly polarised between authoritarian and democratic regimes, both of which seek greater economic resilience and self sufficiency, the hyperglobalisation of the past twenty years probably has. And if that’s the case, then price stability may require a rather higher interest rate than those we’re used to. Nobody’s asking for, still less predicting, a return to the double digit interest rates of the 1970s and 80s; yet there is at least some reason for believing that the era of zero interest rates and seemingly endless central bank money printing has gone for good. The insanity of it all came to be seen as “normality”. Yet in truth it was a terrible aberration that significantly widened social inequalities, created dangerous distortions in the capital markets, and most certainly added to current inflationary pressures. Good riddance. Need help? Visit our adblocking instructions

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