By John Richardson
THE world’s top 50 central banks have cut interest rates at least 672 times since the Lehman Bros crisis – perhaps 673 if you include yesterday’s decision by the Bank of England to lower the UK’s cost of borrowing (it is very hard to keep track of the exact number, as interest rates have on average been cut every three trading days).
It therefore seems fair to conduct an assessment of the effectiveness of these policies:
- In a desperate search for yield, insurance companies and pension funds have been forced to put greater amounts of their money into riskier assets. But some life insurance and pension companies are still at risk of being unable to meet their obligations. The negative wealth effect could thus be huge, as consumers spend less money in an attempt to compensate for these shortfalls.
- This search for higher yields has led to asset-price bubbles in real estate and commodities, including oil and iron ore. These bubbles have led to overinvestment in physical assets on the ground because high prices were falsely seen as indicating that supply and demand fundamentals were strong. Now that the oil bubble has burst, some $2trn of debt has been left behind. And in polyethylene, too, the next bubble might be about to go pop. The bubbles that have already burst have created further substantial negative wealth effects. Think of the job losses in Australia as a result of the end of the iron-ore boom.
- Financial speculators have done amazingly well out of these bubbles, whereas average middle-class incomes in the US and elsewhere continue to stagnate. This tells us that despite the glut of cheap money, companies have been reluctant to invest in enough new manufacturing and services capacity capable of adequately addressing the long-term problem of income stagnation. Here is another effect of the continued problem with middle-class income levels: The rise of populist politics. What happens if some of these politicians are elected? Will global free-trade unravel? And what about the geopolitical implications.
Governments should have spent money on encouraging companies to make the products and services of the future necessary to tackle the world’s biggest challenges: Ageing populations, provision of adequate food, water, sanitation and other basic needs – and climate change.
Politicians have instead side-stepped their responsibilities, handing them over to central bankers who don’t understand that the core of the problem is demographics.
China got it as wrong as the West in 2009-2013. But the great news is that it now has the potential to get it right. It is the “stand out performer” in that it has identified and is trying to address many of the same challenges that face the rest of the world.
But China cannot carry the global economy. Neither can the rest of the emerging world, which is decades behind China in terms of the size of its demand.
What happens next then? Eventually, and it is only a question of and if not when, we will enter a new, and very severe, global recession.
The question will then become: “How do we pay back all the debt left over from central bank policies? The answer is “we cannot”.