Good reads from around the Web.

I have not been alone in wondering whether politicians and central bankers might someday look to cure the world’s debt problems via a burst of high inflation.

Paying off a massive debt with a little bit each month takes ages. Run inflation at 3-5% for a few years, however, and you’ve got a big ally in whittling away your borrowings. Inflation was the Help to Buy scheme enjoyed by our parents and grandparents.

As things have turned out though, most inflation measures have remained subdued in the wake of the financial crisis. Indeed, fears have as often turned to deflation.

Asset prices have arguably been inflated, especially government bonds. But their resultant low yields only make the little sense they do in a world in which investors believe that central bankers will at least keep inflation in its bottle, and where there’s also a fear of stagnation.

What if markets are wrong about all this? What if after years of hysterical commentary about hyper-inflation and returning to the gold standard and – each and every month for the past seven years – the bond bubble being called to burst but doing no such thing, everyone has become complacent just at the moment when central bankers finally play their hand?

What if the governor of the Bank of England just said:

“Our judgment in the summer was that we could have seen another 400,000 to 500,000 people unemployed over the course of the next few years … so we are willing to tolerate a bit of overshoot in inflation over the course of the next few years in order to avoid that situation, to cushion the blow.”

Only in the face of a persistent rise in inflation would the central bank raise interest rates, Carney reportedly went on.

Ding dong

I am definitely not saying Carney just rang the bell at the top of the UK bond market (though I’d get a lot more traffic if I did do that every three months).

For what it’s worth I spend more time warning people against second-guessing the bond market than I do predicting its reversal! People, especially over-confident blog commenters, have been wrong, wrong, and wrong again. Far better for most to invest passively with a strategy that doesn’t rely on them being right about such things.

But Carney’s aside does make me a tad nervous, and wishing I had a big, cheap mortgage. Maybe it’s time to bite the bullet, despite loony house prices and the banana skin of Brexit.

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Good reads from around the Web.

Brexit started with a bang in June. The stock market plunged and a bloodbath unfolded at the top of the major political parties. We were all hooked.

But like a TV drama with a limited budget, things tailed off as we got bogged down in turgid mid-season plot building.

Theresa May’s appointment was reassuring but hardly a thriller, as the crazy Andrea Leadsom story line went nowhere. The Bank of England did its best to liven things up by cutting interest rates and warning of a greater chance of a recession, but more positive data kept coming in.

Even I had to admit – not without some relief – that I’d been wrong about the initial impact of the Leave vote. I wondered aloud if commercial property in London was now a buy.

Many viewers began switching off.

But in the past week, Brexit got back to its barmy best.

Not so much like Game of Thrones as the early episodes, mind you. More The Man in the High Castle, as an alternative universe started to take shape around us.

The right kind of workforce

It all started when Prime Minister Theresa May announced that she would trigger Article 50 this coming March. That sent the pound falling.

Later, she made it clear that curbing immigration rather than preserving the economy was her top priority. Pandering to fear and prejudice – the fantasy and lies of the Leave campaign – was more important than trying to maintain the profits and tax revenues that might actually help address the very real inequalities that motivated a big chunk of the vote to Brexit, and that she identified in a conference speech that otherwise had much to commend it.

As a result of this posturing, a ‘hard Brexit’ now seems firmly on the table, to the dismay of business [search result]. The pound fell some more.

Then we had some sinister new plot twists. Talk from Jeremy Hunt that the UK should be “self-sufficient” in doctors set the tone, but worse were the almost unbelievable plans from Home Secretary Amber Rudd to force companies to publish the proportion of “international” staff on their books.

Rudd said she wanted to “flush out” companies that she deemed to be harbouring an inappropriate number of (entirely legal) foreign workers.

This would “nudge them into better behaviour”. (Better as defined by Amber Rudd and the new order in Britain.)

It didn’t take an LBC radio presenter to point out where we’ve heard this kind of language before. Still, James O’Brien did an excellent job of drawing the parallels.

Ukip won the war, but it’s losing the plot

Before some bold Brexiteer turns up in the comments to tell me to calm down, it does seem Rudd may row back on these plans.

But that is only because of the backlash from business and other commentators. Clearly they felt appropriate at the time her wonks drew them up.

Another sign of the times – we learned yesterday that foreign-born academics have apparently been barred from giving the government official advice on the upcoming Brexit negotiations:

It is understood up to nine LSE academics specialising in EU affairs have been briefing the Foreign Office on Brexit issues, but the school has received an email informing it that submissions from non-UK citizens would no longer be accepted.

Relevant departments subsequently sent notes to those in the group, telling them of the instruction.

One of the group is understood to be a dual national, with citizenship of both the UK and another EU member state.

The Foreign Office was said to be concerned about the risk of sensitive material being exposed as article 50 negotiations over Britain’s exit from the EU – and subsequent talks on its future trade and other relations with the bloc – start to get under way.

Because, you know, being born in a country is the best way to judge a person’s trustworthiness and loyalty!

It’s frightening how quickly we’ve got to a point where our vibrant economy that attracts talent from across the EU and the world has become in the language of politics a cartel of unpatriotic gangmasters, shiftily employing Johnny Foreigners who hop over the border to steal our wages as well as our benefits.

As Ian Dunt, the editor of Politics.co.uk puts it, the Conservative party is arguably morphing into Ukip and the direction is disturbing.

Take the government’s ongoing refusal to guarantee the right to remain for all EU citizens living in Britain. Dunt writes of the logical conclusion:

Mass deportations. It sounds alarmist doesn’t it?

No, it wouldn’t involve Nazi officers banging on doors. It would all be very polite and English. A very polite but firm Home Office letter would come through the letter box and it would have a deadline.

If you don’t make that deadline – or if the authorities say they have reason to believe you won’t – the immigration enforcement vans come.

The sudden exodus of three million people from the UK. That is the suggestion. That is the threat.

That is what is implicit in Fox’s card game. It might be the most shameful policy Britain has considered in living memory. It is so shameful no-one dares say it out loud. They only imply it. But that is what he is proposing. That is the reality.

This is the great and final victory of Ukip. They have taken their economically catastrophic EU agenda, their bizarre sense of thin-skinned personal victimhood, and their culture-war poison over immigration and embedded it in the guts of the Tory party.

Do I think it’s likely that millions of EU citizens will ultimately be asked to leave the UK?

No, not particularly. Not yet.

Am I ashamed and dismayed that we’ve come to this in three short months?

Absolutely.

Thankfully, there was also a comic thread running through the latest episodes to lighten things up. It also came from Ukip – the cast of characters who by giving voice to the common man (or more specifically voice to his or her bigotry and fearfulness, rather than his or her better nature) seeded the germ that’s now eating us up.

This week we saw the leader step down after 18 days at the helm and Nigel Farage come back from the political dead to resume his place as top dog. Then one of its MEPs was hospitalized after confrontations with another Ukip MEP in the European Parliament.

Yep, funny alright. Albeit like a Tarantino movie is funny.

Investment implications

The pound is around $1.24 as I type – down from $1.30 before the Conservative conference, and around $1.50 in the moments before the Leave win was confirmed.

Overnight the pound fell to $1.14 in a flash crash that was blamed on robots (there being no Romanians or Poles nearby to take the blame, presumably).

The precipitous fall in the pound is making our country and its citizens poorer. That’s true however much you personally are managing to offset the declines with your investments in a Vanguard global tracker fund, or however much you believe Blackpool and Skegness can beat anything a fancy pants foreign holiday has to offer.

The FT has a big piece on the winners and losers from the pound’s decline [search result]. So far foreign tourists are the biggest beneficiaries. Quelle ironie!

If the fall in the pound is followed by a decline in overseas investment and a widening of our current account deficit, then all bets really are off again. The least we can now expect is an inflation shock. We import far too much for sterling’s collapse not to show up in our grocery bills.

The iShares index-linked Gilt fund is 23% higher since Brexit day. That had seemed like a crazy move. Now it’s looking prescient.

It will also be interesting to see where Theresa May’s opinion that low interest rates may now be causing more problems than they’re worth fits into the picture.

Some onlookers say a political intervention to reverse low rates is being signaled. I think it’s more likely cover for a big fiscal push in the Autumn Statement.

Get with the programme

Investing aside, I hope the more reasonable end of the Brexit voting spectrum will be as dismayed as me that what was (wrongly) dismissed as a xenophobic fringe element during the EU Referendum campaign is alive and kicking in the mainstream body politic.

If I was that kind of reasonable Leave voter, then rather than downplaying every lurch to the right in the rhetoric, I would be speaking out against it.

Millions of people who came to the UK with the best of intentions – and who we welcomed in, employed, worked alongside, and enjoyed the company of for years – now find themselves the subject of a bogus political scrutiny.

Even if it all comes to nothing, damage has been done on a personal level, and perhaps soon enough on an economic one.

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You probably don’t need me to tell you that interest rates are very low right now. In fact, interest rates are around 5,000-year lows:

That graph was devised by Andy Haldane, chief economist at the Bank of England, and circulated in October 2015. Since then both the red and blue lines have dived even closer towards (or in some countries below) the 0% flat line.

Such extremely low interest rates across the developed world are due to a number of factors, most directly the near-zero benchmark rates set by central banks.

In August the Bank of England cut its Bank Rate to just 0.25% in response to the UK’s vote to Brexit. An unimaginably low rate got even lower.

Central bank policy plays a huge role in setting wider interest rates by influencing what’s called the yield curve – strictly a representation of the yield you’ll get for holding bonds of lengthening maturities, but often applied to the returns from other asset classes, too.

You can see a central bank’s influence in the lower interest rates on mortgages, savings bonds, and even Santander’s popular 1-2-3 account that followed in the days and weeks after the Bank of England’s cut.

But the Bank of England had its reasons for further cutting rates, of course, and for having held its rate so low for so long in the first place.

And these reasons give us a clue as to some of the fundamental drivers of today’s very low interest rates.

The interest rate merry-go-round

This is not a Phd thesis on rates, so I will have to be necessarily brief.

Indeed I am writing this article at the request of a few readers who have asked for a super-straightforward summary of the problems potentially caused by low interest rates.

I don’t want to go off into the weeds!

So with a bird’s eye view, other factors that influence the market interest rates that we as consumers and businesses see (and that feedback into the benchmark rate-setting of central banks) include the state of the economy, inflation and deflation, currency moves, what other countries’ central banks are doing, demographics, and – I’d argue – the emotional state of savers, borrowers, and investors, and the impact of such emotions on asset prices.

There are also more contemporary or controversial causes of low interest rates. These might currently include globalization pulling down wages worldwide and boosting the supply of global savings, or the rise of robot workers. However these factors still manifest themselves as, say, deflation or as low government bond yields.

In fact all these factors interact with each other.

For instance, the economy may take a hit, confidence falter, the stock market plunge, and demand by borrowers for credit slump. A central bank might then cut interest rates to try to stimulate the economy by making money cheaper, and so encourage more borrowing.

Similarly, when the economy is very strong, investors are going crazy, borrowing is at all-time highs, and the central bank fears excess demand could provoke inflation, it might raise its benchmark rate to try to dampen all those factors.

By raising and lowering interest rates like this, the central bank is aiming to dampen the extremes of the economic cycle.

A key thing to remember though is that central banks do not set market interest rates; rather their own reference rate and any associated monetary operations influence market rates, and are influenced by them.

The great rate debate

So how do we square those dynamics with today’s economic picture?

Bank Rate in the UK is at an all-time low, yet few would say the economy is the worst it’s ever been, or investors at their most depressed.

Well readers, that is the $10 trillion question.

People have been arguing about near-zero interest rates ever since the financial crisis ushered them in for the UK, the US, and Europe (with Japan having had very low interest rates long before then).

Central banks initially slashed rates in direct response to the value destruction of the financial crisis, which wiped trillions off asset prices and caused a surge in unemployment and fearfulness that threatened to submerge the world in an economic depression.

Supporters of the extremely low interest rate strategy – and its bedfellow, quantitative easing – claim lackluster economic growth and the absence of high inflation since the near-zero rate era began shows that continuing with such low rates has been appropriate, that things would have been much worse without them, and that fears of an inflationary spiral have proven groundless.

Critics respond with three main lines of attack.

Firstly, they say inflation has been caused by low interest rates, only it’s shown up in asset prices rather than in shopping baskets, with the price of everything from bonds, shares, and property to art and collectibles soaring.

Secondly, they argue a broader inflationary shock has been stored up for the future. It’s like shaking a ketchup bottle, where nothing comes for ages and then it all splurges out at once. Just wait, they say.

Thirdly, many contend near-zero interest rates may have become part of the problem, rather than the solution.

The theory here is that because there’s little penalty now for being a poorly run and indebted business – because you can limp along thanks to cheap financing – low interest rates may be gumming up efficiency and productivity growth, and inhibiting the creative destruction that enables superior companies to grow at the expense of their weaker rivals.

In addition, we might ask what kind of a signal do super low interest rates really send?

If your doctor told you after a heart operation that you needed to trundle around with a bleeping heart monitor next to you all day, you may well feel more nervous – even if the pattern of bleeping suggested you were actually returning to health.

Perhaps something similar is happening in our minds due to seeing low interest rates for years on end? We’re told things are improving, but maybe we’re skeptical because of the low rates themselves, and so we don’t borrow and spend as much as theory would predict.

If that’s true then low rates could actually be dampening the economy rather than helping spark it into life.

There are other potential downsides to very low interest rates, such as if they encourage people to chase higher returns through unsuitable investments.

But then that is partly what central banks are trying to achieve – by trying to get crisis-scarred savers out of cash and into more productive assets, others out of bonds and into equities, and so on.

To an extent it’s not a flaw so much as a feature.

Right and wrong

These debates have been swirling for years in the business media and among sophisticated investors.

For example, CNBC’s recent Delivering Alpha conference was pretty much a procession of hedge fund managers saying a bond and equity crash was imminent because of all the problems caused by low interest rates.

Such comments are also voiced beneath almost any article we publish on Monevator that’s to do with bonds or cash.

And newsletters and rent-a-doomster media pundits have been warning of an imminent market implosion or inflationary shock for years.

I understand where such sentiments come from. The rally that has sent the yields on trillions of dollars worth of government bonds into value-destroying negative territory is hard to square with good financial governance, or even a nodding acquaintance with economic reality.

Yet you have to remember most such warnings have proven wide of the mark for years.

In reality, inflation has stayed low, bond and equity prices have continued to rise, and the UK and US economies have grown and seen unemployment steadily fall (albeit with little in the way of wage or productivity growth).

Yet in spite of such progress, many hedge funds have delivered lousy returns since the financial crisis. One reason is they were too timid because of their disquiet at the low interest rate policy of central banks.

I’m not immune to this. While I spend much of my time warning passive investors in our comments not to suddenly start thinking they’re fortune tellers and dumping all their bonds and whatnot, I’ve had my own hunches.

I thought quantitative easing would cause inflation, and so far it hasn’t. I suspected interest rates would fall back in 2008, but I never thought they’d still be so low eight years later. I also thought bonds were finally topping out in 2015, and was wrong. (Worse, I’d had doubts years before that).

None of which is to say the dire warnings won’t eventually come true.

Markets always crash eventually, that’s nailed-on – it’s the timing that’s difficult – and I also think it’s very hard to believe that a growing global population on a finite planet will never see inflation again, even with all those robots doing jobs at slave labour rates.

But I would add that nearly ten years of seeing doomsters confounded should, at the least, be a reminder to the rest of us to stay humble and avoid hubris.

Everyone has been wrong about this stuff for years.

The optimists thought the economy would respond more quickly to low interest rates and that rates would be back to more normal levels by now.

The pessimists predicted we’d be using a wheelbarrow to take our shopping money to Tesco.

I think pragmatic investors who admitted they didn’t know how things would pan out and so stuck to their plans – and their diversified multi-asset portfolios – have carried the day on points.

Sure, they were never going to make the headlines.

But they’ve quietly achieved good gains, suffered lower levels of angst, and had less need to wipe egg off their faces every six months.

Is the tide turning for the low interest rate strategy?

The readers who suggested this as an article topic said they hadn’t seen much comment about the downsides of low interest rates.

I presume they’ve only been reading personal finance blogs and otherwise getting on with their life (and I applaud them for it) because I have read literally hundreds of thousands of words on the subject over the past few years.

I’m tempted to do a bit of post-crisis doomster bingo (hot words and phrases including the likes of manipulation, confiscation, helicopter money, Fiat currencies, ZIRP, the monetary laboratory, John Law, and gold, gold, gold) but I want to keep things simple and succinct, to honour that reader request.

So having set the scene as to why we have low interest rates, next week we’ll consider what specific potential problems such low rates may be causing that we as armchair investors need to worry about.

After all, there seem to be increasing signs that even central bankers fear we’re running out of road when it comes to very low rates.

The politicians who have hitherto been happy to let central banks carry the load are also showing signs of changing their tune.

Consider these recent words from Prime Minister Theresa May:

“While monetary policy – with super-low interest rates and quantitative easing – provided the necessary emergency medicine after the financial crash, we have to acknowledge there have been some bad side effects.

People with assets have got richer. People without them have suffered. People with mortgages have found their debts cheaper. People with savings have found themselves poorer.

A change has got to come. And we are going to deliver it.“

• Update: See part two for a look at the potential problems caused by low interest rates.