I liked a comment by Martin Wolf in the FT this morning. Making the case for the maintenance of very low interest rates in the long term (with which I would strongly agree) he said:
Our world is not normal. Get used to it.
Precisely. The hankering after 'a return to normality' which underpins the desire for increased rates from both the Fed and Bank of England is the true abnormality.
It is argued by those who favour it that such a change would deliver benefits. The most important of these would, supposedly, be better decision making on capital investment allocation because low yields supposedly distort such processes. Like almost everything said by those favouring this change that claim is misplaced, or just wrong. Rates do not as such distort investment decisions: projects deserving consideration remain subject to the same real potential future cash flows whatever the interest rate. Low rates simply mean more of them should be funded, either with cheap loan capital or equity that should be increasingly attractive for reason of the additional risk-related premium it can offer in such cases. The last thing you can say is that low rates should discourage investment.
And yet investment is low. And that is because the yield on speculation and not investment is high. So there is, after all a misallocation of capital. But this fault lies not with the low interest rate but with the nature of markets, the appetite for risk that they reveal (which is very low in the long term: if anything, anywhere reveals commitment phobia it is capital markets) and the tax system we operate.
Let me just muse on that last point. When we offer low, and on occasion no rates of tax on speculation, and when we have no effective wealth taxation and a whole raft of incentives designed to encourage corporate and personal saving via speculation is it surprising that a pre-existing market aversion to risk is exacerbated? Our tax system also retains the absurd belief that saving is the pre-condition if investment, when we know that is no longer true, and the consequence is that it reinforces the misallocation of resources that undermine effective economic management.
In that case there is, yet again, a case for rethinking economic policy across the fiscal and monetary boundaries at present. This fact reinforces, yet again, the suggestion that the artificial division of the two between the Treasury and the Bank of England is inappropriate. As the IMF is arguing, increasing interest rates at present would not just be wholly inappropriate but an act of outright folly. It could easily tip us back to recession, and very quickly. In an over leveraged world the stress this would pose on a very wide range of households could have a dramatic impact on demand and that is a risk just not worth taking, especially as the result would at best be an increase an increase in net income and wealth inequality that the IMF and OECD have both warned does also have significant negative growth impact.
Raising rates would also, by suggesting pre-2008 was normal imply an endorsement of all that went with that mentality, which should be consigned to history.
And such an increase would imply that an increasing cost of capital to deny funds to necessary investment programmes was an appropriate economic policy at this moment when such investment is so obviously needed.
But if all this is true then what is necessary now is the working out of the changes that we really need.
I dedicate some effort to the tax aspects of this in the forthcoming Joy of Tax (of which I finished the proof-reading yesterday). Suffice to say now that first of all tax incentives for saving are no longer needed: we need incentives for investment. And this means a massive overhaul of the taxation of capital in the UK. The incentive to speculate has to go. The incentive to invest must be created. We are a long, long way from that right now but deliver that together with low rates and we do create the conditions for real and sustainable growth. Right now the tax system and a monetary authority hankering after an age where it worked in ignorance of the risks it was taking are the exact opposites of what we require.
Change is essential. As Martin Wolf might have said, 'Deal with it'.
It's time we dragged regulation, economic thinking and tax into the twenty-first century. There are people out there who need us to do just that. It is the job that the government should be doing. And if it refuses to partake in it then, I suggest, it is the job a responsible Opposition must undertake. I hope whoever wins the Labour Party leadership that they will take notice.
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Our world is not normal and we certainly should not get used to it. Since bank credit became the predominant form of money in the late 1970’s, unemployment and underemployment have become normal, inequality has increased, the cost of housing has outstripped earnings, trade imbalances have escalated and the public debt has ballooned. The Labour Party, Lib Dems, Tories, Democrats and Republicans are all now Neo-Liberal which means that they believe that banks should rule unfettered. All political parties in the UK and U.S. Are now funded by banks. This is not normal and must be changed. The banks want us all (except for they and their cronies) to be poorer so that they can be richer. They have turned our homes, our higher education, our cars, our public utilities all into cash flows to themselves. My book, The Trouble with Money (2012) sets out why this has happened, why it is now up against the buffers and how it can be reversed by the adoption of Digital Cash, The People’s Money. Richard, I am also a Chartered Accountant.
Great to know I am not alone!
Richard
There are thousands of Chartered Accountants but very few Professors. Congratulations.
When it comes to investment in long-lived, specific assets (which characterise the utility and infrastructure services sectors) is there some mix of incentives (in most cases, a polite word for bribery) and compulsion that may be applied? Or is it necessary to secure some state control and go down the PQE route? My preference would be Teddy Roosevelt’s approach of “speaking softly” initially, but also “carrying a big stick”, i.e., PQE.
The return on equity the corporate capitalists (shareholders and C-suite) gouge both in the utility sectors that are subject to faux competition and in the utility and infrastructure sectors that are governed by what is laughably called “economic regulation” is extortionate – particularly when it is related to any objective assessment of the risk-related cost of capital in these sectors. But the drive to secure these extortionate returns is perfectly understandable. If they’re not secured, enough shareholders will switch from shares in these sectors to ones where even more extortionate returns may be secured in the short-term.
To its credit, the Competition and Markets Authority (CMA) has tried to rein in these returns in the network and infrastructure service sectors. Last year in a case referred by the Northern Ireland Utility Regulator (UR) on the cost of capital and allowed revenues for Northern Ireland Electricity (NIE) it reduced the Weighted Average Cost of Capital (WACC) awarded by the UR — and this has had a knock-on effect on regulators in Britain. (There is an interesting story behind this reference. Previously the state-owned Electricity Supply Board (ESB) in the Republic had acquired NIE. It had been used to the energy regulator in the Republic, the CER, awarding it whatever revenue it desired — for example, in 2010 it forced the CER to award it a higher WACC to help finance its acquisition of NIE. So it foolishly thought the UR in NI would also be a pushover like its counterpart in the Republic. But the UR wasn’t and reduced the WACC and the allowed revenue for NIE the ESB demanded. The case was eventually referred to the Competition Commission, now the CMA. Another interesting snippet is that the chairman of the Irish CER prior to 2014 is now the CEO of Ofgem.)
Similarly, in its current investigation of the energy market, the CMA is trying to reduce the gouging of consumers primarily by the Big 6 energy suppliers. But its principal proposed remedy — a regulated safeguard tariff for some consumers — not surprisingly, is meeting forceful opposition from the Big 6. I wouldn’t bet against the CMA being rolled over. If they’re not allowed to gouge consumers, the Big 6 will refuse to invest — or will invest only when they are awarded extortionate rates of return and almost absolute guarantees of investment recovery with no-penalty exit arrangements. And the extent to which they have suborned governing politicians, policy-makers and regulators is frightening.
Both to protect consumers and to restore the link between the almost indefinite and absolute guarantee of investment recovery final consumers provide I am proposing the establishment of a statutory national energy buyers’ collective to supply retail consumers who refuse to opt-out of being supplied by this collective. I would commend it to Mr. Corbyn and his team.
Mr Corbyn might, of course, still be a backbencher next week
If he is not, I am sure he will have a team wanting to listen
Thank you, Richard. I take your point about Mr. Corbyn, but I would be interested in your take on the questions I posed in the first para. of my comment. There is a very clear difference between, one side, seeking to restructure the current electricity and gas sector arrangements to make them work in the interests of consumers in terms of efficient and sustainable service, prices and long-term investments and, on the other side, imposing public control of the sector. Corbynomics seems to favour the latter; but these options should not be seen as being mutually exclusive. As I indicate, they could be pursued sequentially if necessary.
There is, of course, a totally vacuous, but damaging, ‘Third Way’. The residues of the New Labour tendency, not surprisingly, favour the potentially unimplementable ‘regulated safeguard tariff’ being proposed by the CMA. Patrick Wintour is giving Caroline Flint a final puff of publicity in her deputy leadership campaign by giving this nonsense some air:
http://www.theguardian.com/business/2015/sep/09/carolione-flint-protected-energy-tariff-vulnerable-customers
It will prove necessary to thrash out these issues in the very near future.
I suspect you are right
The inflationistas crying out for rate rises ought to heed the graph in the linked blog by Paul Krugman:
http://krugman.blogs.nytimes.com/2015/09/01/the-triumph-of-backward-looking-economics/?module=BlogPost-Title&version=Blog Main&contentCollection=Opinion&action=Click&pgtype=Blogs®ion=Body
Going by that model without a move away from neo-liberal economic orthodoxy it appears there will never be another rate rise.