John Daniels discusses interest rates and why they remain so low.
Remember the good old days? When you could put money in a deposit account and discover, a year later, that some more had magically appeared in there? And not just a bit more. A sum in excess of the rate of inflation, so that you really were a bit better off than you were before.
The good old days. We took them for granted, didn’t we? But now – my Nationwide ISA is paying the royal sum of 0.5%, while the Consumer Prices Index says that my money’s losing value to the tune of 1.5% per annum.
What the heck’s going on? Just look at this graph showing the Bank of England’s base rate since the Bank was founded in 1694:
300+ years during which the rate never dropped below 2%; but now 10 whole years during which it’s not got above 1%, with no sign of things changing soon. Welcome to the new normal!
So what is going on? One way of seeing the interest rate is as the price of money. And if we regard money as just another commodity, then you’d expect it to obey the laws of supply and demand: if there’s lots of demand (lots of people wanting to borrow) then you’d expect the price to be high, i.e. a high interest rate.
But what we see is exactly the opposite. Never has money been so cheap, but it turns out you can’t give the stuff away.
Why aren’t people wanting to borrow? Because you borrow in order to invest and so make more money. If you don’t reckon there’s money to be made, well then – there’s no point borrowing in the first place.
And why do people feel that there’s no money to make? Maybe because the underlying cause of money’s fecundity – cheap energy – has dried up. The golden age of post-war growth coincided with a period of rock-bottom (less than $20 per barrel today) oil prices. As I write this it’s hit $70. Insofar as our prosperity depends on the alchemy of transforming the chemical order of abundant hydrocarbons into increasing economic abundance, then that’s a big problem.
Of course you could also borrow money in order to have a flutter with it. But that’s what – in effect – led to the 2007-8 crash. And people’s memories aren’t that short.
Like the man once said, “Do not lay up for yourselves treasures on earth, where moth and rust destroy and where thieves break in and steal, but lay up for yourselves treasures in heaven, where neither moth nor rust destroys and where thieves do not break in and steal. For where your treasure is, there your heart will be also.” (Matthew 6: 19-21)
Two thousand years on, looking at my ISA rate those words still seem all too relevant.