Monday, 30 July 2012

The canard of lowering interest rates



I have noticed of late the growing calls for further cuts in interest rates. Now, as I have a rather timely bought tracker mortgage this would be welcome on my own part; but really this is economic delusion of the first order.

If low interest rates are the answer...what was the question? Well, we have a balance sheet recession where there is far too much debt built up in the system. Lower rates would in theory help to give more time to those who need to repay their loans.

Even the Bank of England has not been convinced that this is the way. The reason for this is the Japan style liquidity trap it creates. Firstly, with no interest to be gained, nobody saves, this leads to less bank deposits - so banks hoard more money and make fewer loans. This is a liquidity trap. Secondly in the liquidity trap, because rates are so low, banks can't make a decent return anyway, so further adding to their desire not to lend. Finally, Quantitative Easing means they can make a nice small amount of money by just swapping monetary instruments with the Bank of England - so why bother with the real economy and real lending?

As if all this is not bad enough, if you are small lender like a Mutual, struggling to raise cash and having to offer high interest rates to attract depositors- whilst having no access to QE money - then you are finished as you can't raise money at 0%. We have already seen the decimation of the Mutual industry and this would probably spell the end for many Mutuals - how does that tally with the Vickers report aim of making banking more competitive?

And of course say you are a saver, this reduction in rates is very penal, rates being already far below the inflation rate which is likely to start going higher again son as food prices and Oil & Gas go up during the course of this year.

Interest rates are not the problem, the problem is too much debt to be serviced; this needs to be written off and the economy made more flexible. Maybe lower taxes would be a better way to provide the money to repay the debt or to reduce regulation so that new businesses may grow and prosper. The time for propping up the sick by juicing their rates is long-gone. It's time to face reality not try to resuscitate the debt patient.

12 comments:

Lord Blagger said...

Except, its not corporates or individuals who have a debt problem.

Its the government. 7 trillion not 1 trillion when you include all the debts they have hidden off the books.

All of QE etc, is for the benefit of the state, in the short term. Nothing else.

Barnacle Bill said...

It would be better if our politicians faced up to the reality of unbailable out bankrupt banks.

There's only so much of our money that can be thrown at them with a bucket with some many holes in it!

Electro-Kevin said...

Writing off debt ?

Isn't that called going bust ?

I'm off to Portugal. You have a couple of week's rest from me.

formertory said...

@Lord Blagger - with respect, m'Lord, it is indeed individuals who have debt problems. The popularity of low rate short term Trackers is in large measure because people withdrew equity from the ridiculously inflated "value" of their home and used it to pay off credit cards (many were then run up all over again); or they bought their bijou and oh-so-socially-desirable holiday cottage in France (now worth 1/3 of what they paid), or maybe that nice 4x4 for the missus to run the kids to school in (also now worth 1/3 of what they paid and costing £hundreds a month to run, service and insure.

Plus a goodly proportion of borrowers are on interest-only terms which won't be renewed when their present product ends. So they'll be left having to fund C&I payments, or stay marooned on whatever savage Standard Variable Rate their lender is charging. The low rate Tracker allows them to breathe, just, meantime.

And as a result, more people that ever are in the fifties and retiring with a mortgage and credit card debt still strung round their necks.

And the cry goes up: "We worked hard and struggled! We own land! They can't repossess our house! We shouldn't be expected to sell and downsize! Bail us out!"

And the Home-Owner-Ist (h/t Mark Wadsworth) of the NuBluLabour Government will find a way to oblige "to protect house prices and hard-pressed families", while those of us who saved and repaid debt get stretched out over the barrel again for another rogering.

They'll probably forget the Vaseline this time, too.

Hopper said...

+1. For your next article, CU, how do we go about writing off this debt? Credit card debt looks relatively simple - call it in, put together a suitable IVA or personal bankruptcy, and eat the loss - but mortgages look rather more involved. Is it time to get the banks in the business of renting out repossessed houses to the former owners until they move or it can find a reasonable buyer?

Anonymous said...

I hate to say it but in the days when I was very young just after the war, just about everything was rationed, things like sweets were rationed right into the early 50's, people had not choice but to make do and mend, if you could not afford it you went without or paid a small amount each week, these were just for things like washing machines, the restarted TV service (my parents actually got a telly to see the Coronation in 1953. It was only in the late fifties that folkes started to get HP for a car and then they had to juggle their money, many were slightly envious of the Yanks (American Dream) houses, cars, and general living standards, which of course was obtained on the never-never finally business finally twigged that was a large untapped source of new customers out there, and then things ripped. As time rolled on people borrowed more and more they never though how they would pay back the loans (I am not just thinking of the "working class" low wage earners). Then in the early 1970's credit cards appeared in the UK (store cards had been going for a few years), there really should be a sort of psychological test before someone takes those out, not got the money pay by credit card. The icing on the cake was the alteration to the bankruptcy rules by the B'Liar/Broon conspiracy, before that bankruptcy was considered a disgrace. I could mention the various governments since the late 1950's but that will totally fill this blog but I will mention one though, dreamed up Margaret Thatcher's government but only fairly lightly (by today's standards) gradually increasing use by Major and flogged to death by the B'Liar/Broon conspiracy.

Anonymous said...

Sorry the last item incase you did not get it was PFI

CityUnslicker said...

Lord blagger - yes, private debt in the UK is the HIGHEST in the G20.

We do have a problem, a real bad one.

Is bankruptcy the answer...well pretend you are a foreigner looking in...200% real GDP govt debt, corporate and personal at another 200% - would you suggest soldiering on?

As for how to make a bust, well I will come to that tomorrow or Weds

Budgie said...

Personally I blame the Foodmixer-Owner-Ists (h/t formertory). If these people had not taken out a third mortgage to splash out on (oops! mind the lid!) their state-of-the-art Foodmixers we wouldn't be in this mess (!).

Alternatively, we all know what would actually get the economy moving again: cut taxes.

The tax cuts could easily be paid for by not giving our money away to other people - the EU, Foreign Aid, and Bankers. And by drastically cutting regulations and Quangos. And by that guy Laffer.

hovis said...

Budgie absolutely, I think this is being played out in too many peoples minds as a morality tale - it isnt. The stories of equity release are the tiresome drivel written in the papers. The real problem was the rational call to action (interest rates),were set too low deliberately.
It is also too late to avoid moral hazard - that happened long ago, and the bank bailout was the icing on the cake. We need to soleve the problem not wag fingers in a sanctimoniously, that solves nothing.

formertory said...

Now, now, budgie and hovis..... who's wagging fingers? Not me. I'm making a general point contradicting Lord Blagger, who believes there's no such thing as personal debt that matters.

Simple fact is that many homeowners have taken equity out of their properties to pay for consumer goods and services. They did it because they saw their home as an ongoing source of cash. They're rewarded with low interest rates (because the Govt understands it'll never get elected again if it allows rates to rise) and then they move to retirement with debt round their necks.

It's not my place to be their moral guardian, but they did it, not me. And I object to paying for it.

As for cutting taxes and regulation - that's a different argument and one I wholeheartedly support.

Anonymous said...

The issue of private debt keeps arising , yes it is too high, and government debt is too high, agreed again, but the big thing is who owns the debt, is it all or most of it within the UK or is it held by foreign creditors, if held mostly by foreign creditors it affects the balance of payments of the UK. The latter seems to be the problem with countries in the PIIGS group plus of course our wonderful banks and wonderful government and they still ask for more, MORE. I maybe getting old but the economics of the past 40 years have got madder and madder, first one system (which had been working for 30/40years with varying degrees of success) and a new system started in the early 70's which again has had varying degrees of success. Surely in economics you can not say this or that system is the one, the economy is like a balloon, if you say, I will pinch this part, the effect is that you reduce the volume where you pinch but the air goes elsewhere within the balloon.