In 2008 the central banks reacted to a massive crisis they had completely failed to foresee by cutting rates to record lows and embarking on “quantitative easing” – pumping trillions of dollars into their economies by buying up the assets of commercial banks. The trouble is that eight years later they are, to varying degrees, still doing it. Like doctors keeping their patients on a drip many years after an operation, they are losing credibility and producing very dangerous side effects.  

There are at least 10 serious drawbacks to this – all of which can be accepted for a short period but become either politically explosive or economically unwise if continued indefinitely. 

1. Savers find it impossible to earn a worthwhile return, which drives them into riskier assets thus causing the price of houses and shares to be inflated ever higher. 
2. Higher asset prices make people who own them much richer, while leaving out many others, seriously exacerbating social and political divides and fuelling the anger behind “populist” campaigns. 
3. Pension funds have poor returns and therefore suffer huge deficits, causing businesses to have to put more money into them rather than use it for expansion. 
4. Banks find it harder to run a viable business, contributing to the banking crisis now visibly widespread in Italy and Germany in particular. 
5. Those people who are able to save more do so, because they need a bigger pot of savings to get an equivalent return, so low interest rates cause those people to spend less, not more. 
6. Companies have an incentive to use borrowed money to buy back shares – which they are doing on a big scale – rather than spend the money on new and productive investments. 
7. Central banks are starting to buy up corporate bonds, not just government bonds, to keep the system inflated – so they are acquiring risky assets themselves and giving preference to some companies over others. 
8. “Zombie companies”, which can only stay in business because they can borrow so cheaply, are kept going even though they would not normally be successful – dragging down long-term productivity. 
9. Pumping up the prices of stock markets and houses without an underlying improvement in economic performance becomes ever more difficult to unwind and ultimately threatens an almighty crash whenever it does come to an end – wiping out business and home buyers who got used to ultra-low rates for too long. 
10. People are not stupid; when they see emergency measures going on for nearly a decade it undermines their confidence in authorities, who they think have lost the plot. 

I am not an economist but I have come to the conclusion that central banks collectively have now indeed lost the plot. The whole point of their independence was that they could be brave enough to make people confront reality. Yet in reality they are blowing up a bubble of make-believe money to avoid immediate pain, except for penalising the poor and the prudent. 

Earlier this year I put this view to the top staff at the central bank of a major Far East economy, thinking they might set my mind at rest and explain why everything made sense. But, far more alarmingly, they said they agreed with me: their problem was that no single authority can opt out of these policies because they might cause a recession for their own country unless there was a global, co-ordinated move gently to raise interest rates. 

David Fuller's view

I think most economically savvy people would now concur with William Hague’s article.  I also think a coordinated global response led by the USA and other developed economies would be the least disruptive.  The problem is that the US economy, while somewhat firmer than others due mainly to its technology lead, significant energy production and healthier banking sector, is clearly leading the economic recovery cycle among major nations.

Consequently, a unilateral rate hike, even if only 25-basis points, could push the US Dollar Index up out of its current trading range.  If so, this would be a headwind for not only the US economy, in proportion to additional USD strength, but also for emerging markets which borrowed in the highly liquid currency at lower levels.  In other words, a too strong Dollar could further delay the next global economic recovery which is sorely needed.

It has been hard enough for the Fed to agree tentatively to a quarter-point rate hike in December, with at least two more increases planned in 2017.  It would be much more difficult to persuade Japan, Germany or China to raise rates anytime soon, so the US is virtually on its own in terms of December and 1Q 2017.  Nevertheless, unilaterally higher US rates are worth the risk, especially if the Treasury and Fed agree to intervene in forex once again, anonymously of course, to keep the Dollar Index below 100.

I have long maintained that normalisation of global interest rates, albeit at lower levels than seen in previous cycles, would lead to some volatility in stock markets.  We should keep that risk in mind, although it is probably much lower than the risk in bond markets.  UK 10-Yr Gilts have recently been amongst those most vulnerable to profit erosion, due to Brexit / currency risk.         

Here is a PDF of William Hague’s article.