Britain is sliding into a deflationary death spiral

Negative interest rates on government debt are a harbinger of economic destruction on a vast scale

The most important news from the Covid front line this week was not the grimly stillmounting death toll, the row between the UK’S four nations on how and when to lift the lockdown, the standoff with unions on reopening schools, or even the more encouraging revelation of a zero new-infection rate in the capital. Political recriminations aside, all this will be quickly forgotten as incidental detail once the pandemic is over.

Rather, it was two pieces of Covidrelated economic news – that Rollsroyce, Britain’s world-leading aerospace manufacturer, is shedding 9,000 jobs, mostly in the UK, and that the interest rate on an auction of new UK government debt had fallen below zero for the first time.

The first of these announcements is indicative of a corporate sector that has given up on the idea of a rapid bounce-back in the economy, and has instead determined to use the outbreak as an excuse for massive operational restructuring.

This is about survival, says Rollsroyce’s chief executive, Warren East, which is no doubt true – he’s being driven by global forces beyond his control. But it is also because Covid has highlighted deep flaws in Rollsroyce’s business model. Nobody could have predicted the sudden stop in air travel, but to have bet the farm on wide-bodied aircraft, and to have linked payment to air miles flown – Rolls-royce makes its money from servicing its engines, rather than selling them as such – has left the company particularly exposed. Both bets may have been permanently damaged by Covid.

Wherever the blame lies, the resulting cull is utterly disastrous for the UK economy. Many of these jobs, some of the most skilled in British manufacturing, will never return to these shores. Once demand for jet engines recovers, production will progressively shift to the growth markets of Asia and the Americas.

Negative interest rates, meanwhile, make a once unimaginable world of investors having to pay for the “privilege” of lending to the Government into an Alice-inwonderland reality. On one level this might seem quite reassuring – a vote of confidence in UK solvency as it were. It seems that investors still want to park their money in Government debt regardless of the ruinous fiscal costs of the pandemic and the lack of any return.

But benign this is not – quite the contrary, it is indicative of an economy sliding into a deflationary death spiral. Start by thinking of Government debt as essentially just cash, or with interest rates across the so-called “yield curve” at close to zero, much the same thing as the physical commodity itself, which also carries no return.

The reason why demand for it is high, despite record levels of issuance, is that spending in the wider economy has collapsed. UK consumer spending was down a stomach-churning third in April as the lockdown hit home. The closure of restaurants, shops, offices, pubs and airlines has meant that even those with the money to splurge have been struggling to spend it.

It is a similar story in the corporate sector, where investment has been largely suspended for the duration of the crisis. Money that would otherwise have been spent instead lies idle and unproductive. Nil return cash or Government debt would indeed have seemed like a bad use for this surplus but for the perception that a tanking economy makes the alternatives look even worse. Instead it gets lent to the Government, which uses it as best it can to support demand in an economy where perhaps as much as a third of the workforce is no longer working.

Rationing during the Second World War and its immediate aftermath was motivated not just by shortages of food and petrol, but also as a way of forcing households to save so as to create the surplus needed to fund the war effort. We are seeing a similar phenomenon today. It’s better than the surplus being left entirely fallow, but it is the reverse of what you would want in a properly functioning economy.

The imposed collapse in demand is feeding through into job losses of the type we are seeing at Rolls-royce. Many furloughed workers will find themselves properly unemployed the moment the scheme ends. Even those companies not directly impacted by the shutdown are finding they can exist perfectly well with fewer staff, less office space, less travel and much reduced business expenses.

From the perspective of the individual firm, it makes perfect sense to rationalise, automate and work from home. Yet if everyone does it at the same time, it will damage aggregate demand, leave vast tracts of commercial property empty, and lead to a permanently smaller and poorer economy.

So no, the fact that the Government can borrow at a negative interest rate should not be seen as a vote of confidence in UK plc, but as a sign of economic destruction on an increasingly catastrophic scale. Someday this war’s gonna end, as Boris Johnson is fond of saying, after Colonel Bill Kilgore in Apocalypse Now. What will be left of the economy when it does is another matter entirely.

Jeremy Warner on Twitter @ Jeremywarneruk; read more at telegraph.co.uk/opinion