Low interest rates are doing more harm than good – quadruple them and see what happens

I’ve been boring you all for a few years now on the pernicious effects of very low interest rates. I’ve said more on the subject in my editor’s letter in the magazine this week. But I’m pleased to see that the group of people who think that low rates are now doing more harm than good is expanding fast. Here’s a quote from Blackrock’s Larry Fink that pretty much exactly reflects our thoughts on the matter.

“There has been plenty of discussion about how the extended period of low interest rates has contributed to inflation in asset prices. Investors are being forced to trade liquidity for yield by taking on more risk and investing in less liquid asset classes — a potentially dangerous combination for retirement savers.

“Not nearly enough attention has been paid to the toll these low rates — and now negative rates — are taking on the ability of investors to save and plan for the future. People need to invest more today to achieve their desired annual retirement income in the future. For example, a 35-year-old looking to generate $48,000 per year in retirement income beginning at age 65 would need to invest $178,000 today in a 5% interest rate environment. In a 2% interest rate environment, however, that individual would need to invest $563,000 (or 3.2 times as much) to achieve the same outcome in retirement.

“This reality has profound implications for economic growth: consumers saving for retirement need to reduce spending if they are going to reach their retirement income goals and retirees with lower incomes will need to cut consumption as well. A monetary policy intended to spark growth, then, in fact, risks reducing consumer spending.”

I know he is right on this one – for the very simple reason that I am doing exactly what he says people are doing. I spend much less than my income suggests I could because I am really worried about my retirement.

A decade ago when I made mental calculations about my income in my 70s I figured out how much I might save and assumed a 6% return on it. Now, with most global assets already overvalued and rates on the floor, I assume 2-3% tops. That at least doubles the amount I know has to be in my Sipp the day I put my pen down for good. I’ve got a long way to go.

Low interest rates aren’t making me borrow and spend. They are making me worry – and save.

A central bank employee said to me recently that raising rates is too dangerous a thing to do. We don’t really know what happens if we cut rates below zero, he said, but we do know what will happen if we raise them from their current levels, given our previous experience in raising interest rates (he was assuming that a rise in rates would mean a fall in economic activity as has been the case in the past). I reckon he is wrong.

We do know what will happen if we cut them more (an exaggeration of the effects above and the others I have mentioned here nad in the mag). But we really don’t know what will happen if we raise them. Rates have never been this low before – so we have no experience in raising them from these levels.

There is every chance that a quadrupling of interest rates from here would do no harm at all – instead it might do an awful lot of good. At this point it might be worth a go!

  • DemiGod

    “Low interest rates aren’t making me borrow and spend. They are making me worry – and save.” Could not agree more. However, the period of adjustment to higher rates will almost certainly bankrupt the government before the economy picks up enough to get better tax revenues. It would also drive house prices down – excellent. It is such a poison chalice now, that I cannot see rates going up until they are FORCED up, maybe when pension funds start to default.

    • Sabbie

      Driving housing down IS excellent. I can’t stimulate the economy when half of my income is going to housing. If your aim is to use your house as an ATM machine, too bad,.

  • Peter

    Completely agree. I’ve given up hoping that myopia amongst MPC members will ever be a condition precluding membership. We’re at the stage where events will overtake these wallys and they’ll be forced to put rates up. A Brexit inspired Sterling crisis seems the most obvious catalyst for change.

  • Hugh Jarsse

    Exactly – low interest rates are a signal of an economy in trouble. As we all know, central bank employees leave their brains at home in the morning so don’t expect any sense to be spoken by them. Amongst the many purposes interest rates serve an important one is as an indicator of risk. With ultra cheap money central banks are signaling there is – apparently – little risk out there – really? I think if you asked most people they’d take a diametrically opposed view. It’s a great shame that no central banker has the cojones to start – the painful – adjustment process back to sensible levels of interest rates – of course none of them want it to happen on their watch, The longer we have zero rates, the higher they will have to go eventually. Yes, raising rates will involve bankruptcies and pain for banks etc, but if they don’t start the gradual process of adjustment it will still occur – just catastrophically – another financial crisis – at some point in the not too distant future.

    • Peter

      How much pain will it really cause? Plus there’s going to be a lot of pleasure seeing feckless debt junkies eyes pop after decades of them lecturing of their largesses to others…

  • hohum

    Quadruple rates? Only an economic masochist would do that!

    The BoE will only put them up when they are forced to.

    • AAJ

      2%. Quadrupling of interest rates would just be 2%
      Has there even been a time in history before 2008 when interest rates were 2% Has there ever been an economy is history that was ruined by 2% interest rates?

      • Peter

        Exactly -who are these people who would be in trouble with base rates at 2%?

        • Steve Clarkson

          The problem is that over the last eight years, the economy has got used to the low rates so if there is suddenly a quadrupling of borrowing costs, there will be huge problems. It’s all very well for those with no mortgages or companies with no gearing saying rates should rise because it won’t affect them and they have everything to gain.

          • Peter

            Can’t you read? Savers, anyone with a pension – just some of the people who’ve been suffering due to low interest rates over the last few years. Why should we bend over backwards for a few people who’ve gorged on debt? We need to return interest rates to normal ASAP before there are more of your potential ‘victims’.

        • rory

          Mostly the Government, which is why they won’t put them up.

  • CM_discuss

    Eight years of ’emergency rates’ has ZIRP as the new ‘normal’ & the populace are now convinced the world will fall apart if rates are raised. As mentioned in another comment, quadrupling (UK) rates gives 2% – if homeowners, businesses cannot survive on this then more fool them to allow themselves to get into such a situation.

    The ’emergency rate cuts’ of 2008-09* should’ve been just that, a few months at 0.5% followed in 2010 by rises back towards normality. The weak banks and businesses would’ve died, yet the world would’ve survived – and survived without the asset bubbles we see today. This would have given CB’s an opportunity to reload their interest rate weapons for the next cyclical downturn (i.e. now), avoided this prevailing ‘woe is me if rates rise’ mentality and allowed ‘money’ to retain some value.
    The winners are government & politicians – ZIRP has allowed them to finance extraordinary debts and continue huge ongoing deficits at extraordinary rates without real austerity and thus loss of popularity. Financing new debt issues at higher rates will blow the deficit sky high and either taxpayers will have to pony up, or the populace will lose their public services. It’s not ‘the economy, stupid’, it’s all about the vote.

    Unfortunately, I believe that the only way out of this situation we now find ourselves in is a real National emergency of some sort – sovereign debt default, hyperinflation or actual (rather than proxy) WWIII etc to reset the populace’s priorities back to absolute basics and away from house prices & shiny trinkets.

    *the whole cycle of mis-priced rates probably more accurately started from the late 1990’s; 2008 was merely the blow-up of the credit-bubble journey that the world had been taking since then.

  • Big V

    I wonder what role low interest rates and the difficulty in generating a return in this market played in the pension black hole at BHS