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Blow, winds…

27 June 2014

Mark Carney, unabashed by the hopeless confusion sown by his previous attempts at “forward guidance”, now tells us that interest rates of 2.5% are the “new normal” and could be achieved by 2017. He’s welcome to disagree with Thomas Piketty’s policy recommendations, but the weight of historical evidence that “normal” interest rates are around 5% seems to me worth more than Carney’s observation.

What he may mean, I fear, is that the government will continue its policy of keeping interest rates artificially low indefinitely – just not quite so severely as for the last five years. He’s right to note (as I’ve been saying for all of that period) that it really makes very little difference to investment decisions whether rates are at 0.5% or 2.5% – although of course it makes a huge difference to savers (who might perhaps spend a little more).

The sad point is that the government has no sensible policy to restore growth. Rather it has a variety of methods of continuing to squander taxpayers’ money in supporting the banks (but without any concern as to how much of that support goes straight into employees’ pockets) and helping people to overstretch themselves in support of a housing bubble.

Behind the sticking-plaster of these measures lies the real gaping wound: serious inflation, not yet reaching Weimar levels, but still operating insidiously to allow the government to escape its obligations at the expense of its citizens.

But, you will say, inflation is running below 2%? Below the Bank of England’s target? How can there be a problem?

The fact is that inflation is a much broader concept than is measured either by RPI or CPI. And for all the attention that economist have devoted to technical discussions about the “formula effect” (whether prices of 105 and 106 combine to 105.5 or 105.499), the far graver problem has so far escaped voters, journalists and it seems most economists: house prices just aren’t dealt with correctly in either formula. CPI (which for obvious reasons the government would like to switch to for pegging wages and pensions) simply excludes them, while RPI includes some level of mortgage interest payments and “housing depreciation” – i.e. the cost of periodic renovation. But if mortgage interest rates are kept artificially low, mortgage interest payments will be too, and the real inflation which government policy now deliberately focuses on house prices is virtually invisible to these formulae.

Another little-known fact is that RPI specifically excludes the top 4% of households…who of course hold an increasing amount of the country’s wealth. That’s why tickets to Covent Garden, paintings, private medical bills and taxis can rise astronomically with virtually no impact on newspaper headlines.

Furthermore there is no simple way to hedge against this risk. Inflation-linked bonds are linked to … RPI! In fact the only thing one can do is buy houses, which will of course perpetuate Osborne’s Ponzi scheme. Brilliant.

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