Super Low Interest Rates Do More Harm Than Good

[jplevene]

I agree that lower interest rates during hard times are a help, but the big mistake the Bank of England are doing today will cause damage for years to come.

The current low rate of 0.5% is damaging because of the following reasons:

Banks are not lending. Banks are actually lending, but only when loans are secured with stable capital (large companies, etc.) or at huge rates (credit cards, etc.). While rates are low the banks get a far better return lending money to their Investment division for trading than using it for loans with a lower return. It's just simple business. This lack of money to small businesses is crippling now and will damage our future.

The super low rate stops people with savings from spending, as their savings are currently making them a loss, because for the first time in history savings interest is lower than inflation. 16% of our population are aged 65 and over, this 16% has stopped spending as well as the below 65 who also depend on their savings as a source of income.

The low rate also enabled some borrowers to lower their bills, thus tempting them to borrow and spend more, which they have done, but as before they have hit a funding and repayment affordability wall and have to stop spending again, as they did before.

We are well above our inflation target and looks like with the wheat shortage, oil problems, VAT rises, etc. that are all in the pipline, infaltion over the next 2 years is looking pretty grim as well. We have had high inflation for 2 years now and not tried to correct it, instead the Bank of England are just looking at current annual figures, being now to the same time last year, what about before that where we have missed our targets and not repaired the damage. This attitude is just bad book keeping. For 18 months we have had the super low interest rate, the Bank of England say they look 2 years ahead, well in 6 months will be two years from the start and inflation will be pretty high then, so it looks like they got their figures wrong again. Do we ignore the bad previous prediction and make another optimistic one, that would be stupid, oops, that is what they have done.

We are now out of options as a 1/2% drop to 0% will now have no impact at all. If we do need another stimulus, all we have is words of encoragement from our PM or Queeen, and that won't help pay the bills.

In history only Japan lowered rates like this due to a crash caused by excessive spending and borrowing. Since then Japan has never recovered to its former glory, has a defecit and has now fallen behind China. On the other hand, another country had the same problems, was near bankrupt and did the opposite and raised rates. As a result this country became the finance capital of the world and repaid nearly all of its debts. This country was England and the rates rise done by Margrett Thatcher that was opposed by every current member of the monetary commitee. She made them look like fools as within a day the economy started to recover due to her measures. Maybe they still think they can proove her wrong and are gambling with our future out of arrogance.

For 18 months we have had these rates and all that has happened is that things have continued to get worse. If you are ill and a doctor gives you medicine that doesn't work, you don't keep taking it or increase the dosage, you change the medicine. If the doctor won't let you change the medicine, you change the doctor. We need a different medicine or a new doctor, if we have neither, investors will loose faith and if you think things are bad now!

[danlee74]

How do we get you on the MPC??

[sun n sea]

High interest rates suit the saver but don't stimulate growth... would you borrow money to expand your business and create more jobs if you were forced to pay a crippling rate of interest?

Banks are lending.... but only to good businesses with sound prospects.

Low interest rates are providing crucial life support to the economy.... it might be tough on savers but money for doing nothing is still free money... no matter how small the returns.

[easy2012]

Banks are not lending. Banks are actually lending, but only when loans are secured with stable capital (large companies, etc.) or at huge rates (credit cards, etc.). While rates are low the banks get a far better return lending money to their Investment division for trading than using it for loans with a lower return. It's just simple business. This lack of money to small businesses is crippling now and will damage our future.

Good one jplevene. Actually it is worse than that, Bank borrow 0.5% off BoE and relend it back to the government in the form of medium/long term gilts at between 1-4%. Can we actually believe this? Bank borrow from BoE (which is taxpayer/gov really), and then relend it to the government and then make a spread... This is so that BoE can pretend that it is not really monetising debt...

The super low rate stops people with savings from spending, as their savings are currently making them a loss, because for the first time in history savings interest is lower than inflation. 16% of our population are aged 65 and over, this 16% has stopped spending as well as the below 65 who also depend on their savings as a source of income.

The low rate also enabled some borrowers to lower their bills, thus tempting them to borrow and spend more, which they have done, but as before they have hit a funding and repayment affordability wall and have to stop spending again, as they did before.

I have also reached this conclusion on other threads/blog post. Worse still, those borrowers will negative balance sheet won't be able to borrow / won't borrow at any rate.

However, I need to point out that negative interest rate (aka saving < inflation) is the norm since WWII rather than exception. In the 1970, the real rate of interest was like -5% or so (inflation 20%, rate 15%) and that is when this house price can ever go up thinking was formed. Now we are at maybe -3% or so.

In history only Japan lowered rates like this due to a crash caused by excessive spending and borrowing. Since then Japan has never recovered to its former glory, has a defecit and has now fallen behind China. On the other hand, another country had the same problems, was near bankrupt and did the opposite and raised rates. As a result this country became the finance capital of the world and repaid nearly all of its debts. This country was England and the rates rise done by Margrett Thatcher that was opposed by every current member of the monetary commitee. She made them look like fools as within a day the economy started to recover due to her measures. Maybe they still think they can proove her wrong and are gambling with our future out of arrogance.

Therefore I expect UK to be just like Japan - another loss decade.

[exiges]

The government needs low interest rates to breed inflation. Inflation cuts their debt in real terms.

Of course it's a tightrope, they can't let it go too high, just "a fair bit above target" will do them.

The BoE knows this and is complicit.

[easy2012]

High interest rates suit the saver but don't stimulate growth... would you borrow money to expand your business and create more jobs if you were forced to pay a crippling rate of interest?

Banks are lending.... but only to good businesses with sound prospects.

Low interest rates are providing crucial life support to the economy.... it might be tough on savers but money for doing nothing is still free money... no matter how small the returns.

Define 'crippling rate'? 4-5% isn't crippling in any sense and prevent the money from being borrowed to finance pointless Private Equity takeover etc.

Banks are lending at a big fat margin that requires no great skills whatsoever and then pays the banker big bonus.

Too low an interest rate prevent the zombies who ties up society resources from liquidating and freeing up the resources.

Money is a store of value, it is not supposed to be a paper that depreciates in real purchasing power over time. Real interest rate should only be very smallish positive indeed (like +0.5%), but -3% interest rate is another sotry..

[exiges]

Don't forget low rates does encourage spending, sure people aren't apble to spend the interest on their money, but they figure they may as well spend it because it's doing sod all in the bank. (See: recent inflating of house prices)

[SleepyHead]

High interest rates suit the saver but don't stimulate growth... would you borrow money to expand your business and create more jobs if you were forced to pay a crippling rate of interest?

Banks are lending.... but only to good businesses with sound prospects.

Low interest rates are providing crucial life support to the economy.... it might be tough on savers but money for doing nothing is still free money... no matter how small the returns.

Sorry, but I disagree.

Low interest rates destroy the capital base. They reduce the capital available to business for capital investment, with which they could grow their business and create jobs.

Eventually the savers will run out of money. Then what do we do? IR's will sky rocket to unimaginable levels because there is so little money available for lending.

Low interest rates are killing the economy. As are high house prices.

[Bruce Banner]

High interest rates suit the saver but don't stimulate growth... would you borrow money to expand your business and create more jobs if you were forced to pay a crippling rate of interest?

Banks are lending.... but only to good businesses with sound prospects.

Low interest rates are providing crucial life support to the economy.... it might be tough on savers but money for doing nothing is still free money... no matter how small the returns.

I never did borrow money to expand my business. Apart from an initial loan, backed by a personal guarantee, growth was always financed by retained profit. The initial loan was repaid during the first two years and the personal guarantee withdrawn. Old fashioned? Perhaps, but I always slept well at night. The banks always wanted to lend me money, in fact they still do, even though I'm retired .

A properly run business doesn't need to borrow loads of money, a small overdraft to cover the odd late payer is all you need, and to be truthful, during my last ten years in business, I didn't need the overdraft facility.

[billybong]

These days low interest rates are fundamental in exporting jobs overseas.

If your house is earning more than your wage and you can borrow against it there's no need to improve skills too much.

At a certain level your wage and job becomes almost irrelevant. And if overseas they have the skills or capability to create those skills (which they now do have) in order to do your job more cheaply then that's what will happen i.e. they'll do what was your job and UK people will actually help fund that process through borrowing and the cheaper (low interest rates) the better.

In that sense low interest rates are evil.

Edited August 6, 2010 by billybong

[Injin]

I never did borrow money to expand my business. Apart from an initial loan, backed by a personal guarantee, growth was always financed by retained profit. The initial loan was repaid during the first two years and the personal guarantee withdrawn. Old fashioned? Perhaps, but I always slept well at night. The banks always wanted to lend me money, in fact they still do, even though I'm retired .

A properly run business doesn't need to borrow loads of money, a small overdraft to cover the odd late payer is all you need, and to be truthful, during my last ten years in business, I didn't need the overdraft facility.

Someone had to borrow the money you got.

And somebody else had to go bankrupt instead of yourself.

That's how the system works.

As to interest rates - they are irrelevent without a fixed supply of money.

[billybong]

I agree that lower interest rates during hard times are a help, but the big mistake the Bank of England are doing today will cause damage for years to come.

....

The super low rate stops people with savings from spending,..

....

Exactly. And a lot of savers still don't really like it when they do spend having to always buy goods made as a result of jobs being exported overseas to the extent it is these days.

Of course some people will say but that's all been replaced in the UK by the financial sector but what they fail to say is that sector only benefits a relative few and it's already been officially shown to be crooked and corrupt.

Edited August 6, 2010 by billybong

[crouch]

The government needs low interest rates to breed inflation. Inflation cuts their debt in real terms.

Of course it's a tightrope, they can't let it go too high, just "a fair bit above target" will do them.

The BoE knows this and is complicit.

This is exactly my suspicion.

[scepticus]

Low interest rates destroy the capital base. They reduce the capital available to business for capital investment, with which they could grow their business and create jobs.

that may be the case by sun n sea's point is valid. Raise rates and people won't borrow, or at least, not enough.

under these circumstances in order to stay solvent with an diminishing asset base banks must charge borrowers a high rate and pay savers a low rate, otherwise they go bust.

it seems a paradox of sorts but in fact its just because people assume growth just happens and interest grows on trees.

[Once in a lifetime]

Banks borrow from the BoE at 0.5% and lend (at a higher rate) to responsible people like you & me.

and because of this they are getting their books balanced (slowly)

low interest rates also help people/businesses/Governments/[enter noun here], that... like everyone else, borrowed too much.

if you think they're going up by a substantial amount soon, you're going to be disappointed... (sorry)

[SleepyHead]

that may be the case by sun n sea's point is valid. Raise rates and people won't borrow, or at least, not enough.

under these circumstances in order to stay solvent with an diminishing asset base banks must charge borrowers a high rate and pay savers a low rate, otherwise they go bust.

it seems a paradox of sorts but in fact its just because people assume growth just happens and interest grows on trees.

Why do we want people to borrow? There's too much debt in the system. Trying to get out of this by everyone spending again is not going to work.

The days of society being full of "consumers" making up "70% of the economy" are over. We restructure, or we die.

banks must charge borrowers a high rate and pay savers a low rate, otherwise they go bust.

Yeah, so the low interest rates are not working then. Right? They're not "stimulating" spending, because the banks can't pass the low IRs on to borrowers. Hence the problem. The benefit you're talking of is not being felt, and the drawback is being felt. So why do it?

Edited August 6, 2010 by wtb

[LuckyOne]

The best way to stimulate spending is for central banks to play mind games with borrowers and lenders.

They need to raise the fear of rising rates so that people feel the need to borrow more now while at the same time increase their inflation fighting credentials with lenders to keep market rates low. They also give savers hope that rates will rise soon which lets them spend a bit of capital as they become less uncertain about the future income that their savings will generate.

I think that this is the game that Trichet and Sentance (sp?) are playing at the moment when they talk about normailising emergency rates and conditions. I think that Bernanke is missing a trick here.

[easy2012]

that may be the case by sun n sea's point is valid. Raise rates and people won't borrow, or at least, not enough.

under these circumstances in order to stay solvent with an diminishing asset base banks must charge borrowers a high rate and pay savers a low rate, otherwise they go bust.

it seems a paradox of sorts but in fact its just because people assume growth just happens and interest grows on trees.

Perhaps people won't borrow because the price isn't right? (and in Japan, people still won't borrow because the price still isn't right for the solvent/debt free borrowers. A small house in tokyo still cost about $1m).

Also, is it really beneficial to the economy in the medium run keep the weakest of the zoombies alive as opposed to liquidating them so that they can start over?

The real issue is because BoE is a monoply producer of 'sterling'. Say if the government runs a farm that sells milk at very low price so that no other farmer can sell their milk, a revolt would have occurred. I think in world trade, this is called dumping ? Basically, BoE is selling money below cost (less than rate of inflation) and in the same time destroy the marketability of any saver's saving (their product).

To quote Jim Rogers, to take resources from those who are competent and give it to the incompetent is pure madness.

Edited August 6, 2010 by easybetman

[scepticus]

Why do we want people to borrow? There's too much debt in the system. Trying to get out of this by everyone spending again is not going to work.

I agree, but if people are not borrowing all the money that is being saved savers can't be paid any interest can they?

Interest comes from borrowers you know, not the tooth fairy.

Perhaps you are thinking along the lines of barclays 'grow money with bonds' ad, you know - where the man burries a gold coin and then magically digs up a whole load more after a bit?

[easy2012]

Interest comes from borrowers you know, not the tooth fairy.

Indeed. But what would be the IR without BoE monopoly action with all the banks and building society scrambling for money ?

[LuckyOne]

Indeed. But what would be the IR without BoE monopoly action with all the banks and building society scrambling for money ?

Short term rates should be about inflation + 2.5%. Something like 6% would be the policy neutral rate.

[scepticus]

Indeed. But what would be the IR without BoE monopoly action with all the banks and building society scrambling for money ?

if there are more savers than borrowers and without the action of the BoE then savers would be getting 0%, and perhaps even being charged fees. anything else would bankrupt the banks.

given the likely state of the economy that would result, banks would be charging borrowers very high rates or simply not offering credit.

this is what happened in the great depression. savers got zilch and money couldn't be borrowed, unless you were a AAAA borrowerin which case you could be borrow at very low rates indeed.

[SleepyHead]

I agree, but if people are not borrowing all the money that is being saved savers can't be paid any interest can they?

Interest comes from borrowers you know, not the tooth fairy.

Perhaps you are thinking along the lines of barclays 'grow money with bonds' ad, you know - where the man burries a gold coin and then magically digs up a whole load more after a bit?

My point is this. Some people argue that low IRs encourage lending, and that lent money "stimulates" the economy when its spent.

But this is a futile endeavour. If you want to encourage lending you should RAISE interest rates!! Because it then pays the banks to take the risk and lend!! Would you lend to someone for 0.5% interest? Particularly if its a risky borrower?

Moreover, the banks won't lend at 0.5% today. Yet they pay 0.5% to savers. So we aren't getting the "stimulation" of lent money being spent, and at the same time the capital base is being eroded, and will soon prevent people from borrowing at all.

You say interest comes from the borrowers. true. (if they can keep servicing their debts) .. ... but the money they borrow comes from other people "under-consuming" or "saving" as its more commonly known. If you wipe out one, you wipe out the other.

Edited August 6, 2010 by wtb

[winkie]

Don't forget low rates does encourage spending, sure people aren't apble to spend the interest on their money, but they figure they may as well spend it because it's doing sod all in the bank. (See: recent inflating of house prices)

Low interest rates together with growing inflation and tax rises encourages people to spend what they have before they lose it....what incentive is there to save, when it is gone it is gone, either spend as you go or invest in a place where you can see the value of today's hard work is at least maintained over time until it is required for spending.

Low interest rates are fine when inflation is low and stable...

[LuckyOne]

Low interest rates together with growing inflation and tax rises encourages people to spend what they have before they lose it....what incentive is there to save, when it is gone it is gone, either spend as you go or invest in a place where you can see the value of today's hard work is at least maintained over time until it is required for spending.

Low interest rates are fine when inflation is low and stable...

For some, what you have said is true.

For others, particularly those who value personal financial self sufficiency, the effect is the opposite. When they see negative real returns on their savings, they understand that they need to save even more to fund their retirement etc so they spend even less to-day.