Heroes: Now This is Interest(ing)

“Every night before I rest my head 

See those dollar bills go swirling ’round my bed” 

Interest rates are topical; for borrowers nothing is too low, for investors nothing is to high. As we move away from “zero” interest rates everyone talks about the new norm, and with UK now at 5.25%, there have been some hysterical comments about “high” interest rates. 

By historical standards todays rates are not unusually high. Data from Tradingeconomics.com shows that UK interest rates averaged 7.11% from 1971 until 2023, reaching an all-time high of 17.00 percent in November of 1979, see chart 1, below. 

Chart 1 

As a reminder,  “zero” interest rates were introduced by central banks in 2009 to help economies recover from the GFC. The policy was extended to help global economies deal with the Covid pandemic. 

Both these events were global, not based on government policy, although it might be argued that loose monetary policy and light-touch regulation helped bring about the GFC.  

The first question I pose, is, “were “zero” interest rates of benefit? 

As both the BoE and US Fed had identical interest rate policy immediately after the GFC, it interesting to see the divergence between the two economies from 2009-2012. See Chart 2, below. 

In my opinion the key date is 11th May 2010, the day the Tories, led by David Cameron, took office. As the chart shows the economies divergence starts to grow. Why? 

Whilst Obama sought to reflate the US economy, the Tories inflicted a policy of austerity on the UK, telling us we all needed to “tighten our belts”. Not only did austerity not deliver prosperity, it delivered unnecessary suffering on much of the population, from which many have yet to recover. 

Austerity had one more gift to give; Brexit. Whilst not the sole driver, austerity played a key part in people’s disquiet, and provided “vote leave” with yet more ammunition.  

Chart 3, below, consider the impact of Covid, and how economies have recovered. Or, in our case, are still waiting for recovery. Why then have others fared better?

Covid was a global pandemic, and the two follow-on factors were also global. Namely, slow to recover supply lines and war in Ukraine, both of which have driven the supply-side inflation that has driven interest rate rises. 

As with the self-inflicted harm caused by austerity, post 2020 the UK economy had to deal with yet another Tory disaster, Brexit.  

As with austerity, Brexit was championed as being the answer to all our problems, unfortunately it turned out to be the cause of virtually all of them! 

Were they any winners from “zero interest rate policy? 

Government debt issuance has been distorted by the cost of bailing-out banks, and supporting economies through the pandemic. 

Putting countries to one side, the sectors I will consider are business and individuals. 

Post-2009 there was an explosion in corporate borrowing, as business sought to benefit from historically low interest rates. 

Unfortunately, all too often the borrowing was for all the wrong reasons; rather than additional hiring or investment in plant and equipment, it was largely used for stock buy backs. This had the short-term effect of increasing the share price enabling management to hit their bonus target, whilst long-term it left the business saddled with a mountain of debt. 

Whilst there was little change in household debt, it did enable borrowers the benefit of lower rates for their existing commitments. 

The big winner were rentiers, asset owners who were able to leverage off these, borrowing more at advantageous rates. Research by Investec shows that, “in the low interest rate environment following the Global Financial Crisis (GFC), the value of buy-to-let lending increased. It rose from £9.6bn in 2010 to £37.9bn in 2015.” 

The net result in the UK was that austerity meant the poor stayed poor, whilst the rich (rentiers) got richer. The top-20% continue to dominate the income spectrum, taking almost half the income before and after the crisis. (1) 

Whilst focusing on income inequality is one measure, it misses the growing economic dividing line – wealth – which is central to concerns about the relative wellbeing of different generations, and social mobility. 

Whilst people across the income distribution have seen their incomes stagnate in recent years, continued growth in asset prices has increased the wealth of those who already hold it. These two facts make it increasingly difficult for working families to climb the wealth distribution, as the rungs on the ladder grow wider apart.  

In 2008, it took 10 years’ worth of typical full-time gross earnings to move from the middle to the top of the wealth distribution. By 2018, this had increased to almost 16 years. Significant growth in asset prices during Covid, as well as higher rates of saving during lockdown amongst richer people, may well have made the gaps between the steps wider still. 

This has especially impacted the housing market, where the young generations are much less likely to get on the housing ladder than their predecessors.  

For example, only 36% of those born in the 1980s were homeowners by age 30, compared to 55% of those born in the 1970s and over 60% of those born in the 1950s and 1960s. A natural consequence is that wealth is becoming increasingly concentrated amongst older people, whilst half of working-age adults are now renting. 

Another example of top-earners feathering their own nests was seen this week, as bosses of FSE100 companies collected an average £500,000 pay rise last year, while many of the millions of people working for them saw their pay growth fail to keep up with soaring inflation. 

FTSE 100 CEO’s received an average pay rise of 16% last year, taking their median pay to £3.9m, up from £3.4m in 2021, according to research by the High Pay Centre thinktank published on Tuesday. 

The median FTSE 100 CEO is now paid 118 times the median UK full-time worker, an increase from 108 times in 2021 and 79 times in 2020. The average salary for full-time UK workers is £33,000, according to Office for National Statistics figures. 

Luke Hildyard, the director of the High Pay Centre, said: “At a time when so many households are struggling with living costs, an economic model that prioritises a half-a-million-pound pay rise for executives who are already multimillionaires is surely going wrong somewhere.” 

There has been much controversy over whether rising pay or profiteering is now driving inflation. Whilst the headline rate, CPI, now stands at 6.8%, this doesn’t take into account is the increases in rent and mortgage costs. For this we need to refer to the broader measure, the retail prices index (“RPI”), which stands at 9%. 

Based on RPI, real wages have fallen by 5.7% since the start of 2022. For many, wages are lower than they were at the start of the GFC 15 years ago. 

Research by Unite has revealed that food prices are up by 23% and energy bills up by 57% since the start of 2022, companies in these sectors are flush with cash. 

Tesco has made £3bn in profits in the last two years alone, and our research has shown that UK energy companies made £45bn in profits in 2022. Meanwhile, the big four banks have made combined profits of £29bn for just the first six months of 2023 – up 77% on last year, according to our investigation. 

Figures released last week by the Office for National Statistics showed UK business profits increased in the first quarter of 2023. 

Manufacturing firms increased their net rate of return to 8.8% in Q1, from 8.4% in Q4 of 2022. Services companies, which account for about three-quarters of economic activity, increased their net rate of return to 16.1%, an increase of 0.4 percentage points from Q4 of 2022. (2) 

Overall, the net rate of return for all non-financial businesses increased from 9.8% in Q4 of 2022 to 9.9% in Q1 this year., meaning that margins remained consistent through one of the worst winters for cost of living rises and cuts in disposable incomes for several generations. 

Philip King, a former government adviser and small business commissioner until 2021, said  it was clear from the figures that “companies are maintaining their profitability despite the difficult trading conditions they have faced”, and it was large businesses that would be to blame. These “typically have more flexibility when it comes to increasing prices and cutting costs”, he said. 

An OECD report last month found average profit margins in the UK increased by almost a quarter between the end of 2019 and early 2023. Stefano Scarpetta, a director of the OECD, said it was “somewhat unusual that in a period of slowdown in economic activity we see profit picking up”. 

George Dibb, an economist at the IPPR thinktank, said the Bank of England was “plain wrong” to consider steady profit margins a non-story. 

Clearly something is very wrong. 

One key problem is that post-GFC there has been little, or no monetary and fiscal coordination, with  neither the BoE nor the government being willing to shoulder the responsibility. Today, we have Conservative MPs criticising the BoE for hiking rates, whilst ignoring calls from the wider society for the Treasury to support households and tackle inflation. 

Herein lies the problem; the Treasury is in charge of both short-term fiscal and budgetary restraints and long-term economic strategy. The results show that Treasury orthodoxy is the barrier to investment.  

Our public-investment levels are the lowest of the G7, which explains why we have a weak economic model. Investment requires committing money now, likely by increasing the national debt for future economic gain. Whereas the Treasury’s prioritisation of the immediate public finances often leads it to restricting spending on basic public services, vetoing any long-term investment and selling off public assets to bring in a quick buck. 

This, in part, is due to the myth of “there’s no money left” post-, which both parties are guilty of perpetuating. Which is where we got earlier in this piece with the implementation of austerity, which we were told, would bring the public debt back into line. It didn’t. 

The Treasury remains commitment to the private sector and reducing public debt through arbitrary fiscal rules has resulted in Britain having one of the worst levels of income inequality in the developed world, one in four children live in poverty, and it is failing on its climate commitments. 

Strangely, the Treasury can step-up when required, E.G., during the pandemic, when the furlough scheme and the action to stop the global economy collapsing during the financial crisis were successful in part because we saw the day-to-day Treasury orthodoxy dispensed with. Rather than being a platform for the private sector to innovate, it was trying to protect people’s livelihoods. 

Even this government is capable of thinking differently, as was demonstrated with Jaguar Land Rover deal, which will see the company construct an electric-vehicle battery plant in Somerset in exchange for about £500m in subsidies.  This is also an example of how Brexit imposed handicaps can be overcome. 

This shouldn’t be a one-off, but the beginning of new approach to industrial strategy based on a broader, joined-up plan to align investments with commitments to decarbonise transport and supply chains across the economy. 

There are examples of how this can succeed. 

 Germany provided funding to the steel sector via KfW, a state-owned bank, which were conditional on the sector working to help reduce carbon emissions. In the US, Biden’s Chips Act aims to definancialise manufacturing by setting conditions on funding that limit the recipients’ ability to buy back their own shares. In France, Covid-19-related bailouts were conditional on five-year targets to lower domestic carbon-dioxide emissions. By contrast, the UK government lent £600m to easyJet with no strings attached. 

From where we are currently, the only way is up, but it requires someone to break the existing mould. Just like Thatcher did in 1979! 

We’ve been broken down” 

To the lowest turn” 

Bein on the bottom line” 

Sure ain’t no fun” 

Notes: 

1. The Equality Trust 

1. The rate of return is a measure of profitability that shows the margin between operating profits and the cost of assets used to generate those profits.  

Philip Gilbert is a city-based corporate financier, and former investment

banker.

Philip is a great believer in meritocracy, and in the belief that if you want something enough you can make it happen. These beliefs were formed in his formative years, of the late 1970s and 80s

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