Friday, 12 February 2016

Where is the economy going?

There is much doom and gloom in the media at the moment. People seem to be fearing the worst. The banks seem to be taking the biggest hits with the majors losing up to 5% in market cap per day. The underlying reason is not because they are doing so badly but because the QE taps are being turned off and the free money going away. The world economy has about twelve trillion US dollars of QE money in it and has become addicted. The money is not being withdrawn yet but just the lack of new money is causing a slump.

Two obvious symptoms are the fall in oil prices and a slow down in the Chinese economy. In fact, for the UK these are not bad things: we burn more oil than we dig up so the cheap fill-ups at the gas station is a net positive for our economy, and China sells way more to us than we to them so the tat gets cheaper. But our big banks are global and no-one can see where their future profits are coming from, so the shares fall and the markets get gloomy.

Governments would normally offset these doldrums by lowering interest rates to give the economy a shot in the arm. However base rates are already so low that there is really no more medicine left to give out. The UK base rate is 0.5%, the USA is 0.25%, and the Eurozone a staggering 0.05%. The UK may have a little leeway, but the rest of the big players have nothing left to give.

So we come to the new territories of ZIRP and NIRP - Zero Interest Rate Policy, and Negative Interest Rate Policy. As far as most people are concerned ZIRP is what we already have. The halcyon days of the early 2000's when you could deposit some cash and get a 7% or 8% return are just a wistful memory and not coming back. But NIRP changes the whole landscape. Most people are resigned to getting next to nothing on their savings and are consoled by the fact that the cost of living is pretty much static as well, but when you deposit £100 and only get £99 back - that's a whole different ball game. Why would you bother? Sweden (-0.5%) and Japan (-0.1%) are already in ZIRP. Sweden announced they were going negative just this week. The market effect is not yet apparent because the new rate does not apply until the middle of next week. A cash flight seemly likely though.
 
The powers-that-be are cornered. They need to lower interest rates to stimulate the economy but they know that while people will put up with a low return they will not tolerate a negative return. They will take their money out of the banking system and so push the banks even closer to the edge. And these days all governments know that they have to bail out the banks; banks are dominoes - one falls they all fall, which is the way they like it. Everyone would like a government guarantee for their business.

Past form indicates that when the powers-that-be don't know what to do, they do nothing. So we will see a strong reluctance to cross the zero boundary on interest rates, with perhaps some very delicate toe dipping starting in the US later this year.

Doing nothing while Rome gently smolders means the economy will continue its gentle slide for much time to come. Cash will be king (again.)

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