However bad they might be, some ideas just refuse to lie down and die. One of those is that of negative interest rates, which despite the reservations of Andrew Bailey, Governor of the Bank of England, and a number of other members of the Monetary Policy Committee, continue to be under active consideration by Bank policymakers.
Only this week, one of them, Silvana Tenreyro, made another impassioned plea for a negative bank rate as a way of mitigating what is now the near certainty of a double dip recession as the economy struggles with the consequences of a third national lockdown.
Already they are the norm on the Continent. Bank deposits over a certain amount are charged an average negative interest rate of 0.6 per cent in euros and 0.75 per cent in Swiss francs.
Going back to the deposit box origins of banking, where customers paid the bank a fee for keeping their valuables safe, there is nothing particularly odd about the concept as such. But things have moved on a bit since then. Today, banks make much of their money from the spread between deposit and lending rates, or by borrowing from you and then lending it on at a higher rate to someone else.
Unfortunately, it is in practice much harder to reduce retail deposit rates than lending rates, and it may be virtually impossible, in Britain at least, to cut them below zero. The upshot is that if the Bank of England introduced a negative rate of interest, it would likely further reduce the profitability of commercial banks, making them less likely to lend to the economy, the very reverse of what the policy would be intended to do.
More worrying still, it would further undermine wafer thin public trust in the very concept of fiat currency as a reliable store of value.
There is a large element of Tulip-mania in the stupendous rise in the value of Bitcoin over the last year, but it also reflects a genuine yearning for alternatives in the face of seemingly endless devaluation of the main means of exchange.
Who needs wealth taxes to pay for the devastating costs of lockdowns when negative real interest rates perform much the same function? The effect is to transfer wealth from creditor to debtor. In today’s world, the biggest debtors of the lot are governments; the intention may arguably be reasonable enough, but they’ve been deliberately rigging the system to their own advantage.
If you think I’m wandering into swivel eyed conspiracy theory, just consider this. The Government is expected to borrow a jaw-dropping £400 billion this financial year to help cover the costs of the pandemic. You’d normally expect to pay dearly for such a humongous loan, but no; despite the scale of the debt accumulation, the total costs of servicing the national debt are falling, not rising.
That’s not just because of ultra-low interest rates. It is also because as fast as the Government issues the debt, the Bank of England hoovers it up in secondary markets via its asset purchase programme, or quantitative easing (QE). In effect, the Government pays no interest at all on the 40 per cent of the national debt the Bank of England has acquired since the financial crisis. The boundaries between monetary policy and government debt management have become so blurred as to be virtually non-existent.
As the Office for Budget Responsibility has observed, this makes the Government’s finances particularly vulnerable to any rise in short-term interest rates, such that any one percentage point increase in the Bank of England’s interest rate would raise the servicing costs of the public debt mountain by 0.45 percentage points of GDP after five years, or nearly £10 billion annually in today’s money.
Nevermind overly indebted mortgage holders, the Government has got itself into a position where it can no longer afford any appreciable rise in interest rates.
The supposed justification for negative rates is that they force savers to invest, keeping the economy afloat during periods of crisis and bringing inflation back to target. But invest in what? Stock markets, Bitcoin? There is scant evidence of QE bringing about past levels of investment in the productive economy.
A report by the Bank of England’s “Independent Evaluation Office” this week concluded that the Bank had not done enough to understand and explain the workings of QE, risking a loss of policy legitimacy with the public.
Call a spade a spade; what we are seeing is not so much the laboured machinations of formally mandated inflation targeting, but what used to be referred to as “financial repression” and “fiscal dominance”, or the subjugation of market-based, investment decision-making and monetary policy to government funding requirements.
Banks, pension funds, and insurers are all required by solvency regulation to lend to governments by loading up on public debt, regardless of the medium-term inflationary risks involved. The central bank, meanwhile, eases the path by deliberately suppressing real interest rates into negative territory.
This is what happened on both sides of the Atlantic in the 1970s. It didn’t end well.