There's one book that every central banker should read. It's not by Friedrich Hayek or John Maynard Keynes.
It's Mary Shelley's Frankenstein.
In it, Dr Frankenstein has the hubris to believe he can use science to short-circuit nature, and re-animate something that should be dead. The creature he creates goes on to destroy him.
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The parallels are striking. Our own central bankers thought that their audacious experiments in monetary policy could revive dying economic models.
Now Britain is being eaten alive by the monsters they have created.
Unfortunately, we suspect that rather like Frankenstein this story won't have a happy ending
Why zombies are taking over Britain
It's easy to understand why the Bank of England acted as it did after the financial crisis.
The autumn of 2008 was crazy. I'd spend my day in the office, running between my desk and the Bloomberg terminal, waiting to see which bank would collapse next. I'd read so many politicians and City boys shrieking about meltdowns that I'd get off the train home at night and emerge blinking into the street, marvelling that all the buildings were still standing.
You can see why the Bank might have thought that cutting interest rates to zero seemed like a good idea.
The trouble is, every action has consequences. Britain is now crawling with zombies, reports this morning's Financial Times.
Low rates and quantitative easing (QE) have delayed or prevented the process of creative destruction from taking place. As a result, firms that should have gone out of business are grimly clinging on to a twilight existence, neither bust nor solvent.
One in ten companies are only paying the interest on their debt, according to the insolvency industry's trade body, R3. They are unable to repay any of the actual loan. So the firm sits there consuming resources inefficiently, dragging on the economy. And the zombies are spreading. Their numbers have grown by 10% over the last four months.
Now R3is hardly a disinterested observer. It'd be very good for business if someone were to come along and decapitate all these undead companies.
Yet, it's not just R3 who believes the zombie plague is bad for business.
The Bank of England warned last week that these zombie' companies were part of the reason why the economy is so weak.
The trouble is, a zombie company doesn't just take up physical space. It takes up valuable bank lending capacity too. Zombies are only just able to pay the interest on their debts. If the banking system were healthier, they'd be put out of their misery.
But as it stands, notes the FT, "banks are reluctant to write off those loans because, among other things, the banks might need to raise additional capital. And because those loans to zombies remain outstanding, banks do not have enough capital to extend to new, viable companies".
So they indulge in what's called forbearance'. That is, they allow borrowers more slack than they normally would. And that creates the zombies.
Mervyn King's sick sense of humour
I've always suspected Mervyn King of having a droll sense of humour, but this really is jet-black comedy.
It's not that I disagree with him far from it, at MoneyWeek we've been talking about the zombie problem for years.
But for our central bank to complain about zombie companies cluttering up the economy is a bit like a James Bond baddie moaning about all the sharks in his swimming pool. Who put them there in the first place?!
Worse still, it's not as though this plague of zombies is going to change the Bank's policy. King is still trying to dismiss inflation fears and continues to talk up the prospects for more QE.
You can see why. If interest rates were to rise now, it would inflict an awful lot of pain on the economy. King isn't the only one worrying that perhaps banks have been a little too forgiving.
The other day, trade magazine Money Marketing reported that one of the Financial Services Authority's risk specialists had warned that "lenders may have left hundreds of thousands' of [mortgage] borrowers in a worse position by providing forbearance when they have experienced money problems."
The point is that if you move someone onto an interest-only loan, you may leave them in a position in the future where they have no hope of ever paying back the original capital. Better to repossess now rather than leave people hanging on as zombie' households.
Of course, this is exactly what will happen once bank balance sheets have improved enough. Everyone who found their lender nice and accommodating when it was in trouble, will get a nasty shock when its balance sheet has been healed by sufficient injections of QE. It's only a matter of time.
Unfortunately, this has left us all in rather an unfortunate position. We're reliant on low interest rates to get by. But the low rate cure is also killing us. One way or another, it's going to end badly.
We have more on why the UK economy is in far worse trouble than anyone believes in the latest issue of MoneyWeek magazine (if you're not already a subscriber, subscribe to MoneyWeek magazine), and some ideas on how you can protect your portfolio against it. We've also been working on a report on the topic which we'll be releasing in the next couple of weeks keep an eye out for it.
This article is taken from the free investment email Money Morning. Sign up to Money Morning here .
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