The big zero

By Buttonwood

ONE of the most remarkable things about the modern economy is how quickly we have got used to rates of near-zero per cent. This is unprecedented in history. The Bank of England did not cut rates below 2% for 300 years and the old saying was "John Bull will stand many things but not 2 per cent". Savers want some return on their money.

Now of course the Fed has indicated that rates may stay at this level until 2014. But what will be the impact? In a Wall Street Journal piece yesterday, Charles Schwab argued that

the Fed's actions, rather than helping, are having the perverse effect of destroying the confidence of businesses and individuals to invest and the willingness of banks to loan to anyone but those whose credit is so strong they don't need loans

Meanwhile Bill Gross of Pimco writes on Ft.com that "zero-based money risks trapping recovery" arguing that the Fed has driven rates too low

A flat yield curve is a disincentive for lenders to extend intermediate or long-term credit unless there is sufficient downside room for yields to fall and bond prices to rise, resulting in capital gain opportunities.

It is an interesting argument. I've suggested before that, for anyone saving for retirement, the logical response to low rates is to save more, not less. The pot needed to generate a given income is higher and the expected return on your savings is lower so it takes more work to get there.

But what if the Fed took Mr Schwab's advice and pushed up rates? The economy has not delevered much, even in the US. Higher rates would lead to more defaults and the potential return of the downward spiral of 2008 with debtors selling assets, pushing down prices and hurting confidence even further. This is a classic "I wouldn't start from here" problem and one has to have some sympathy for central bankers, even though (in my view) they dropped the ball during the boom.