Zombie Britain desperately needs a way out of this dangerous debt bubble
Inexorably, markets are moving, even if the Bank of England isn’t. Governor Andrew Bailey had teased them by suggesting recently the Bank would “have to act” to curb inflation. Then, despite its inflation forecasts going up, he found that the Bank didn’t really have to act after all. But markets still expect interest rates to rise soon. Surely they can’t stay at these extraordinary levels forever?
Well, not quite, but nor can they go up much either. The Bank’s reasoning for doing nothing this time was that the post-covid bounce-back is already slowing and it still expects inflation to come down on its own after the winter. What it didn’t say explicitly is that we are too weak to risk undoing the latest expansion of the great credit bubble. The bubble is so fragile that even trying to shrink it marginally is too risky. We are stuck.
Even before Covid struck, we had long ago passed through the interest rates looking glass. Several major governments around the world were able to get away with paying such low interest rates on slices of their debt, they were in real terms being paid to borrow. And for decades, we have borrowed more and more for each pound of GDP growth we get in return. This trend had already set in across the developed world before 2008, but after the financial crisis, it spread to China, too. Whereas China had been getting rich from returns on huge investments, it was forced to switch to the model more prevalent in the West: borrow to spend and spend to push up GDP.
Government responses to the pandemic kicked this system into overdrive. The splurge of spending on emergency support during lockdowns effectively transferred enormous chunks of private debt onto government balance sheets. Rather than letting households and businesses get into debt or go bust, the Treasury borrowed for them and then granted or loaned the money out. Since the Government can borrow much more cheaply than individuals can, this was an enormous reduction in the economy’s overall borrowing costs. Forget the Bank of Mum and Dad. This was the Bank of Nana State.
This was especially true because it was facilitated by a substantial cut in the Bank of England’s interest rate and the launching of a fresh quantitative easing programme. From already low levels, government borrowing costs fell even further as the Government essentially created money and lent it to itself via the Bank of England.
The policy was more successful than its architects ever imagined. Unemployment has stayed low. Company bankruptcies actually went down early last year and then rose to only slightly elevated levels. Households wound up with more cash to burn than they have had for years, resulting in a surge in demand that has overwhelmed global supply chains.
It was both fair and sensible to protect the economy while the Government and the virus were forcing it into stasis, but now we face a problem. How on earth do we unwind this gargantuan debt fest? The Government doesn’t want to keep paying our wages. It wants its money back. But the governing party also wants to keep winning elections. These things are not compatible.
Raising interest rates from their extraordinarily low level of 0.1 per cent would be one tiny step on the path back to limited borrowing. Unfortunately, we are so reliant on cheap credit that even this tiny step is painful. The best example of this is housing.
It is abundantly clear that there is an acute shortage of housing in certain regions of the UK. The average house price has risen tenfold since the late Seventies, and this has generally been put down to insufficient housebuilding. But recently, the Government abandoned planning reforms that might have fixed this problem and began to focus on another culprit for the price rises: unlimited credit.
The expansion of mortgage availability, low interest rates, tax incentives and a whole series of complicated regulatory tweaks that push banks to fund mortgages over almost everything else have funnelled more and more borrowing towards property. This is certainly a problem, but it now seems to have become an excuse, from the Government’s point of view, not to get more houses built. It’s not supply, you see. It’s the credit system.
If that is true (and it is only partially true), the solution is obvious: choke off the supply of credit. Yet this seems to be the one policy more difficult to implement than planning reform. If the Bank of England, which is meant to operate on the basis of a sober, independent assessment of economic risks, doesn’t even dare raise interest rates by a smidgeon when inflation and GDP are growing, what are the chances that politicians will dare to raise the cost of mortgages to the point where they stop inflating house prices? As for the notion that the elderly might be asked to use their housing wealth to pay for their own old-age care, rather than turning the public finances upside-down just to protect this particular type of asset, forget it.
But it isn’t just housing. Across the whole economy, the boundless extension of cheap credit is keeping resources tied up in activities that may no longer be worth our while. The think tank Onward estimates that the pandemic substantially increased the number of British companies that are now “zombies”– firms that can only make ends meet due to the extremely low cost of borrowing. These companies now make up more than a fifth of British enterprises, Onward calculates, and they are stopping their employees from retraining and moving to other, more productive jobs and tying up capital that could be better deployed elsewhere. Yet calling in their loans is too painful to contemplate.
The only force that could change this calculation is inflation. Inflation never spiralled out of control after the financial crisis despite low interest rates and large amounts of quantitative easing. But the amount of money printed and pumped into economies globally over the past two years is fourfold the amount released in 2009 – and rather than getting stuck inside struggling banks, as it did then, it has gone straight onto household balance sheets via government spending.
So while we might be seeing temporary inflation now from energy prices and supply chain problems, long-term inflation could easily take hold next year. At that point, to quote an authority, the Bank of England would “have to act”.
The Bank of England might be an “independent” body, but there is no “independent” way out of this mess. Our bureaucrats and politicians have set up a system that endlessly puts off the reckoning. That is not prudent economic management. It is cowardice.
Authorities must stop being cowardly and end this long era of ultra-low interest rates