Monday, 11th July 2016
Good morning, friends,
In this issue of Money Truths….
- No universal meaning….
- A cut in the base rate….
- Reaching for the defibrillator….
- Life-saving surgery….
No universal meaning….
Like politics, the financial world is largely driven by events.
Things happen. Every day. That much you can rely on….
But, in the financial world, events have no universal meaning. They don’t mean the same thing for everybody.
A single event can have a different meaning, create a different effect and produce a different consequence for different individuals, businesses, groups or interests. Each can see and experience the same event very differently.
That’s one aspect of the financial world that makes it such an interesting and compelling environment – and one so difficult to fathom. It is a mass of complexities and contradictions….
Take what might happen later this week, for example. It means different things to different groups of people….
A cut in the base rate….
Last week the Bank of England governor, Mark Carney, said that there was a prospect of‘material slowing’ in the British economy. In other words, a sharp slowdown in the rate of economic growth….
Economists took that warning as a strong hint that interest rates will be cut this week to a new low of 0.25%.
Is that good news? Is it bad news? Does it a matter? Does anybody know for sure?
There’s no definitive answer. How you feel about it will depend very much on your specific outlook and your particular circumstances.
If you are a borrower determined to sail further into the red, then the rate cut will represent good news.
That interest rate cut would see the cost of borrowing money – or getting into debt – set at an all-time low. So low it’s almost as though we are being begged to borrow money.
The rate tells you there has never been a cheaper time to borrow (at least not yet). No doubt there will be many only too happy to take up the invitation….
But the news about the rate cut is not so good if you happen to be a saver who just wants to squirrel-away a portion of their hard-earned cash in a savings account, for example….
At a skinny 0.25% – the thin end of nothing whittled away to a fine point – there is very little incentive to observe the traditional tenet of good financial husbandry and to place your money on deposit with a High Street financial institution.
Doing so at 0.25% would be akin to employing a man so that he can stand idle all day long.
Clearly, the interest rate cut being mooted would be better news for borrowers than it would be for savers. And, if it seems like the borrowers are getting preferential treatment over the savers, you wouldn’t be wrong.
But it isn’t that the planners and the pointy-heads who run the economy necessarily like borrowers better than savers. They don’t. They’re ambivalent. It’s just that they need borrowers more right now.
And, that being the case, the cost of borrowing might very well disappear altogether in the not-too-distant future. You might even get paid by banks to borrow money from them….
Reaching for the Defibrillator….
If Mr. Carney at the Bank of England does cut the base rate this week, then he will do so because he is concerned about a slowdown in the rate of growth in the economy.
He will cut the rate to help to stimulate activity – to encourage businesses and individual consumers to load up with more credit (debt), to get out there and to spend money – to keep the engines ticking over….
That’s why interest rates have been so low since 2009. They were cut close to the ground in order to encourage businesses and individuals to borrow, spend and consume. They weren’t cut out of a sense of generosity or largesse. The ultimate aim was to kick-start the economy.
But, despite the lowest interest rates of all time for the entire period since, the economy just doesn’t seem to want to play ball.
It seems the economy is a bit like Uncle Donald after he’s been at the brandy bottle on Christmas afternoon. It just wants to go to sleep and is resistant to all efforts to rouse it.
If this expected cut – all the way down to a miniscule 0.25% – does happen, the Bank of England will be hoping it has the effect of a defibrillator, the piece of equipment paramedics use to resuscitate patients whose hearts have stopped beating in the back of the ambulance.
They’ll be hoping the patient leaps straight off the gurney like a man fresh from a long holiday – a man fully invigorated with his muscles rippling and his blood pumping, a man ready and willing to get straight back to work and move mountains….
Because if the patient doesn’t leap off the gurney, then what can the good doctor do next?
Mr. Carney is already playing at the fine margins of the game. If rates are already down at 0.25% how much scope is there to cut further? How much more stimulus can be squeezed out of what remains to him to play with?
If the economy fails to respond positively and permanently to a rate cut on Thursday (which it eventually will), Mr. Carney’s options where the interest rate is concerned will be limited….
He might cut interest rates to zero – so that borrowing costs nothing at all.
Or he might go further still and introduce a negative interest rate – so that the traditional order of things is turned completely on its head and lenders actually pay borrowers to borrow money….
In that last scenario savers would be paying banks to keep their money on deposit. You would effectively be taxed for saving….
These scenarios might sound wacky. But they are already realities in one or two countries. Other countries are considering the idea. And the Bank of England has not ruled out going negative with interest rates….
Nobody knows for sure where we are headed. But things are a long way from normal when interest rates are kept so low for so long, continue to go lower still and look destined to head eventually into negative territory.
That territory is unchartered and we don’t know what we are going to find there…. But it promises to be an interesting, if turbulent, ride.
The Bank of England’s monetary policy committee meets on Thursday. All we can do is wait for their next move and see how that works out.
In the meantime, the Bank of England will be saying prayers for the patient. They will be hoping he is sleeping something off rather than dying. Because if he doesn’t stir and get back on his legs soon, there will be some pretty seismic consequences to deal with.
The Bank of England is trying desperately to avoid those consequences and to get the economy growing at a quicker rate. The Bank is making moves. And there will be more moves to come.
But here’s the rub. Sometimes consequences cannot be avoided. They can only be delayed. The Bank of England might well be engaged in a fight with forces that can be subdued temporarily but not overcome permanently.
That’s a money truth….
I’ll be back with more next Monday.
All the best