Back in 2013, I worked for a large asset manager in London. At that time, the Chief Investment Officer (CIO), ultimately responsible for looking after hundreds of billions of pounds of other people’s money, was fond of telling people that he thought it unlikely that interest rates in the eurozone would go up again in his lifetime. The CIO was in his early 50s and looked pretty healthy to me, and I guessed he was planning on living for another 20 or 30, perhaps even 40 years. These comments, delivered in presentations to well-heeled audiences in prestigious settings such as the Shard, often provoked gasps of surprise.
But I wonder if the same statement would cause even a murmur today. After all, more than a decade has passed since interest rates fell to rock bottom in the wake of the global financial crisis, unemployment has fallen sharply, and house prices have recovered strongly in many economies. Yet, borrowing costs around the globe remain at extraordinarily low levels.
True interest rates have gone up in the US to the dizzying heights of 2.5%, but no other major economy has raised borrowing costs significantly and on a sustained basis in recent years. In the eurozone, interest rates have been at record lows for years following the euro sovereign debt crisis of 2011, and they remain at astonishingly low levels in Japan.
Why are interest rates still so low?
Lock two economists in a room and you will end up with at least three competing arguments, as the old joke goes. So, you won’t be surprised to learn that there are lots of theories as to why interest rates have stayed so low for so long, even though central banks have created trillions of dollars of money to buy up government and other debt, in the hope of stimulating economies and boosting inflation.
One argument is that we are in an era of ‘financial repression’. That may sound like a peculiarly nasty psychological affliction, but actually refers to the deliberate actions of governments to hold down interest rates and transfer resources from creditors, i.e., the people who have money, to debtors such as, surprise, surprise, those very same governments. By keeping interest rates at very low levels, the cost of servicing government debt is contained. That allows politicians to maintain spending on areas that appeal to voters such as health and education. It should also allow the overall level of government debt to fall as the economy grows. So, for example, if an economy grows by 50% over a 10-year period but government debt rises by just 25%, clearly the government’s debt to GDP ratio will also decline.
At the same time, people with money find the income they receive is lower than inflation, and their wealth is gradually being eroded. Financial repression has occurred many times over history; it was applied for decades after the second world war, when governments also saw their debt burden rocket. The British deployed financial repression to eradicate the vast debts they incurred during the Napoleonic wars. Given the current scale of government debt around the world, my old CIO could well be right and this era of very low interest rates could stretch ahead for decades.
But financial repression is not cost-free. The tools of this remedy, such as printing money to buy government debt, arguably helped avert another global depression. However, they also precipitated the rise of unpredictable maverick politicians such as President Trump. That’s because the rise in the price of financial assets caused by cheap money has exacerbated inequalities, i.e., the rich have become even richer as stock markets and housing has soared in value, while the working and middle classes have seen their living standards stagnate. Is it any wonder they have turned to populists?
If, as seems likely, inequalities continue to widen, there is a risk that politicians who advocate swingeing taxes on property or financial assets could be elected. Socialism, even communism, seems to hold a fresh allure to many young people to whom the gulags of the Soviet Union and the horrors of Maoist China seem far in the past. In a world where vast multinationals earn huge profits but pay a pittance in taxes and even those earning relatively high wages struggle to buy a house, it is hard to argue against those who say capitalism needs reforming if it is to survive.
Then there are the economic costs. Very low interest rates can hinder the long-term growth of the economy, by encouraging speculative investment in areas such as property, rather than in more productive activities. They encourage borrowers and lenders to take dangerous risks, and can lead to the creation of asset bubbles.
Indeed, the very low interest rates introduced in the US in the wake of the stock market crash of 2001 encouraged poor Americans to take out very large loans in subsequent years. House prices jumped but, as US interest rates began to rise from 2004 onwards, many of those “sub-prime” borrowers suddenly found they couldn’t service their loans, thus precipitating the global financial crisis that began in 2007. That’s the problem with economics. Every variable is interlinked and often the answer to one problem simply turns out to be the cause of an even bigger one.
By Anthony Beachey
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Anthony Beachey is a former BBC World Service journalist now working on a freelance basis in Portugal, where he specialises in economics and finance.