The economic factor that I believe is going to change political realities is the movement of interest rates. For the last ten years interest rates have been exceptionally low. When inflation has been taken into account savers have been paying the banks to look after their money. Interest rates of around one per cent a year have been well below price rises.
That is a historically rare situation that has persisted for an astonishingly long period of time. This decade long strange state of affairs was produced by central banks printing trillions of dollars, billions of pounds and billions of Euros of money and pumping it into the banking system in a deliberate attempt to help the banking system to get back on its feet. Those days are now over. Central bankers know that if they continue to create money from thin air during a boom that it will simply fuel that boom and cause inflation.
We are therefore moving to a new era. Instead of trying desperately to apply the accelerator, central banks know that they now need to apply the brakes. They are going to encourage interest rates to rise to more natural levels. That means that we can expect interest rates to approximately double and to be slightly above the inflation rate sometime soon.
This isn’t just going to happen in the UK. Something similar or slightly more dramatic is likely to happen in the States as the Fed tries to juggle with the impact of Donald Trump releasing huge unfunded tax cuts onto a market that was already entering a period of boom.
A couple of percentage points on interest rates doesn’t sound that dramatic. It is. Start with the impact on anyone with a mortgage. If you have borrowed 100,000 this puts your bills up by £2,000 a year or around £40 a week. That kind of change in the amount of income you’ve got at your disposal has a real and immediate impact. It means you have to cut back on spending and tighten your belt. Not exactly what most people would describe as an end to austerity but exactly the kind of impact on real lives that changes political opinions. The middle classes rarely vote for a government that puts up their mortgage bill. Nor do they like talking at dinner parties about how much their house has declined in value because the cost of mortgages has put people off borrowing.
Much the same is going to happen to governments. They are huge borrowers and when the cost of borrowing goes up they have less money to spend. Despite the tendency for government revenues to rise at the top of a boom there isn’t going to be much money for ending austerity once the bill on the national debt starts going up significantly.
Then consider the impact on industry and commerce. Very few companies don’t have debts. A slow down in sales at the same time as an increase in debt payments is bound to cause difficulties for quite a few companies. The ones with costs that are hard to control like rental agreements on large premises are the most likely to go bust. So expect a series of major high street retailers to hit problems. There will, of course, be plenty of winners if the upswing lasts but that may not be enough to swamp the effect of panics as the losers go bankrupt. Is the economy strong enough to carry on growing now that central bankers have had to turn off the tap of free money? Will enough businesses continue to be confident enough to invest and grow when the main group of spenders start to feel the pinch of high mortgage payments?
This leads me to the real heart of the question. What is the impact on the financial services industry and on economic speculators of a rise in interest rates? The last time people struggled to pay for their mortgages was in 2007-8. Very quickly we discovered that money had been lent out to people for a long period of time who were struggling to pay the interest and incapable of paying back what they had borrowed even if they lost their home. We also discovered that the banks had borrowed very little money from regular savers and a great deal of it for very short periods of time on financial markets. Borrowing day by day is usually cheap whereas lending for months and years usually brings in a healthy income so the firms like Northern Rock that did this made enormous profits and paid their Chief Executives huge bonuses for being so clever. When the credit crunch hit banks like this were forced to pay a fortune to borrow overnight and couldn’t quickly get their money back from mortgage borrowers so they went bankrupt. At the same time it was discovered that almost the entire banking and finance system had allowed itself to be seduced into buying complex packets of mixed types of borrowing such as car loans, mortgages and company debts. Those financial derivatives quickly became every bit as toxic as overnight loans and drove even more banks and finance houses to the wall.
If interest rates start to rise, if the middle classes start to struggle to pay mortgages on homes of declining value, if money starts to be tight, how confident can we be that a new round of financial panics cannot possibly take place? If you listen to governments then you will be told that banks are back under firm control and a repeat of the 2008 market crash is impossible. If you look at history all the evidence is that free markets always go through periods of boom and bust and that when we entered the period of the global financial economy those booms and busts have been more frequent and bigger. In 1997 the crunch hit Asia hard. In 2008 it was Europe and America. No one can put an accurate date on when the next one will arrive. It would, however, be a foolish and an over-confident politician who would rule out the possibility. Or underestimate the likely impact of another disaster.
Since most central bankers can see that possibility they are going to work hard to choke off the excesses of the boom. The main way they will seek to do that will be to gradually increase interest rates just enough to prevent the boom from roaring away without provoking the shocks to the system that I have described. The central concerns of the next few years are therefore likley to be:
- Are central bankers clever enough to raise interest rates at the right speed to control and manage a recovery?
- How will people react politically to steady increases in the bills on their credit cards and mortgages?
- How long will it be before the next financial crash and what form will it take?
- Why are people’s lives being controlled by economic forces instead of those forces being properly managed by governments?
- How long will it take before people decide to use their political power to try and control events instead of being at the mercy of them?
- How long will it be before we change our lifestyles and organise ourselves in a secure and sustainable way instead of lurching from one crisis to the next?