Interest rate hikes, what’s really going on?
If you’ve studied the subject at any level, or read a few books, you will undoubtedly have com away with the usual guilt that its all your fault and interest rate punishment is the only salvation of people who just spend too much. I never bought that explanation and here I'm presenting some basic evidence more than sufficient I believe, to reopen the case on central banks and interest rates. It would be possible to build a good model of the data involved and provide evidence stronger than certainly the underling theory ever relied upon, but I’m not paid to write and surely the onus is on those who earn a living as economists.
The pain caused for ordinary mortals is very significant and given that it is mostly all for nothing or worse than that, maybe a great lie, just cant be left unchallenged.
The background
Maynard Keynes is often blamed for the beginnings of Monetarism. Back then, he and contemporaries said that if a man ( women didn’t have money or make decisions) had money to spare, he’d look to see what interest rates were available and if they were high he’d save his money, but if they were low, he’d spend his money.
The magic formula, therefore to stop inflation was not to deal with supply shortages or control prices, but to play with interest rates in the belief that this would reduce money supply and that would reduce inflation. Imagine seeking approval for a new drug based on that many unprovable assumptions. Imagine placing a tax on matches to prevent forest fires.
Well, I remember my dad, uncle and their contemporaries many of whom had a great deal of the stuff and comfortable farmers who would come in to chat to dad and I never met anyone who would think about money in this manner even back in the 70s. You were a saver or a spender and that hasn’t changed a jot.
If you are a low to medium salary/wage earner, you never have enough money for things you need and stopping you from dressing the kids and eating is not going to happen whatever the interest rates do other than to destitute you, but food, clothes and heating are the very things going up in price the fastest now and every time we have inflation. Oh, did I mention the mortgage, the roof over your head? That goes up too once the medicine is dished out.
Savers in western economies are hooked on the Chicago school property bubble. They think that prices going up is making them wealthy as well as bequeathing poverty to their children. We dont talk about the latter aspect. Apart from a work pension, few of these people save and their pension investment decisions won’t be impacted by interest rates.
What items do you think might see a little extra demand via the credit card if interest rates were very low and cards weren’t a rip-off at all times irrelevant of central bank rates? Beer, wine, holidays, fashion, makeup, illuminous teeth? Have you ever seen a pub run out of beer? Do you expect a shortage of fashion one day soon? I dont think so either.
These things don’t go up in price because of increased demand even on the odd occasion when it does happen.
When these guys put the price up its because their supplier had to hike prices usually driven by costs, maybe the business loan has become expensive. Occasionally they just get greedy. Tariffs, Oil prices, war etc are the other suspects.
What this suggests is that, the Monetarists, themselves on big salaries, are plying their trade to influence those earning above say £150k p.a. but the hotspot is probably much higher.
I won’t research it for you, but just how many of these high earners do you reckon there are? Is their activity really enough to drive prices up for Ferraris, Rolex, private Jets, Yachts,? Do you think rich people eat two dinners?
Keynes’ notion of inflation management is as daft today as it was back then.
Now lets briefly tackle Quantitative theory, the notion that money supply itself is the problem.
What are the drivers of money supply?
To a degree, people are keener to borrow when rates are low and that helps to increase money supply, but as we discussed above, little of it ends up in a position to drive inflation.
The reality is that money supply is driven mostly by two debt cycles, a long term cycle and a short term cycle e,g credit cards etc and the things that define when they have reached their limit are: unencumbered assets and credit limits (risk appetite).
Long terms debt cycles are dominated by mortgage lending and business finance.
Money is debt, remember that however odd it may sound. It is printed from thin air and lent either against assets in the case of long-term debt or reputation in the case of credit cards. Thats how money comes into being, no other way.
Based on your spending and earning patterns, banks know how much they can risk lending to you in the short term. Don’t be fooled though, they can still grab assets if you default. Who needs a gold standard I hear you say if the banks hold all these assets. Read on.
When the population reach the end of their short-term limits, all unplanned buying must stop until this economic fiasco is fixed by paying down debt and that usually drives a nasty recession over a number of years.
You may be interested to know that this happened in US just before Covid and all the QE and Covid handouts fixed it.
Long term cycles are currently enslaved to the asset bubble that has outgrown its scope and is highly likely to correct, leaving banks in a very precarious position having lent against assets mostly peoples homes that are now considerably smaller in value than the debt on the opposite side of the sheet.
Its going to be very hard to sell a house if you have to clear the oversized mortgage first. Its hard to see how a massive crash can be avoided and that of course includes the banks crashing.
Does the Fed, or ECB or B of E really believe that farting around with interest rates that causes children to go to school without breakfast is going to somehow pick the right spot at the right time and stop greedy Joe with the *opoly from putting up the price of Gas, Bread, Butter, Meat, vegetables, all of which are as much as 300% more expensive than 5 years ago? Do us all a favour kindly.
As the results have been coming in, the Utilities are showing enormous profits, the same applies to the supermarkets etc. Joseph Stiglitz reported the same in US as mark-ups soared during Covid.
Who else benefits from high interest rates?
Well, central banks get some nice income. Commercial banks make a fortune. Debt collectors see a big jump in orders. It all depends on just how long the little game runs before it collapses.
‘Lloyds Banking Group — which owns Halifax — reported a 46% leap in pretax profit for the first three months of the year. NatWest’s first-quarter profits rose 50%.’ The guardian.
I’m not saying that it’s a scam run by the banks, though they wouldn’t turn down the opportunity, its more likely to be the central banks, covertly sending some revenue to commercial banks to strengthen them for a fight for survival. Sometimes, governments ability to borrow is damaged by a weakening currency and the only way to save it is hiking interest rates to encourage holding of the currency. Unless you are the petrodollar, you have to either buy it yourself, or hike interest rates and encourage others to buy it in order to defend your currency.
Finally, my years consulting in government and Quangos tells me that a good secure salary and a nice prestigious title is reason enough to look the other way and let a convenient little misconception go unnoticed.
