The end of growth in the West?

HM Treasury Image copyright Getty Images

Depending on which central banker I bump into, or what day of the week it is, those charged with providing some kind of momentum to our economies and maintaining financial stability tell me either that the rich world is at long last at the beginning of an economic recovery strong enough to require a rise in interest rates or is doomed to decades of stagnation.

This apparent contradiction hangs on the disjunction between the resumption of growth in the US and UK, on the one hand, and the much more dour and downbeat message contained in the 25-year yield curve for government bonds of the developed economies (sorry if this sounds tediously technical but, cross-my-heart-hope-to-die, this stuff matters to you).

You can see the UK chart of the long term yield curve for British government debt or gilts here.

It is a representation of the implied cost of borrowing for the UK government for different loan maturities, or the length of time it wishes to borrow, ranging from nought to 25 years.


Now the chart to focus on is the "real" yield curve, or the one adjusted for inflation expectations.

What this shows is that the real cost of borrowing for the government is negative or zero for any length of time the government would wish to borrow, up to 25 years.

Or to put it another way, investors are prepared to incur a loss when lending to the public sector - which implies that money for the Treasury is better than free.

Now conventional theory says this ultra-cheap-debt phenomenon is a manifestation of a conviction among investors that the rich developed economies will stagnate, that they will enjoy no growth, for decades.

How so?

Well, investors see governments as the safest place to lend. And when they are prepared to lend to governments at a loss, that implies they don't see anywhere else they can confidently lend at a risk-adjusted profit.

Or to put it another way, they don't expect the economies of the developed world to grow fast enough for it to be wise to concentrate investment on the private sector.

This is a restatement of the famous or notorious hypothesis made a few months back by the former US Treasury Secretary, Larry Summers, to the effect that for the rich west, the so-called "equilibrium" interest rate that generates growth necessary for full employment may be negative - which is another way of saying our economies are seriously crocked.

Now it is important to note that the UK is not anomalous: investors are equally prepared to lose money when lending to the US and to most of the eurozone.

And the second thing of importance is that this curve has flattened and shifted downward by about one percentage point this year. Or to translate, as the evidence accumulated that we are enjoying quite a rapid recovery, investors became more pessimistic about the long term.

Record debts

Strikingly therefore, investors reduced the implied long-term interest rate they charge rich governments, just as the top central bankers of the US and UK, Janet Yellen and Mark Carney, signalled that the momentum of renewed growth means it may not be long till they increase the short term interest rates under their control.


Investors seem to be saying, in how they place their money, that the UK's and USA's current reasonably rapid growth will turn out to be a short-lived period of catch-up, following the deep recession of 2008-9.

Why might they fear that?

One reason, which I have been banging on about for years, is that in Britain (though less so in America) the private sector, especially households, remains hobbled by record debts incurred during the boom years - whose burden, at a time of low inflation, remains oppressive.

Other possible apocalyptic jockeys - with a nod to the influential US economist Bob Gordon - include our ageing populations, inequality which channels the fruits of whatever economic success we see to low-spending rich people, inadequate education for an intensely competitive global economy and the putative end of the West's capacity to make society-transforming innovations.

So far so gloomy.

But it might not be as dour and depressing as all that. Or at least it might be differently dour and depressing.

Investors might be taking a much shorter-term view in their gloom and preference for chucking cheap money at Western governments.

They may simply be saying that the world remains a hairy and uncertain place, such that they want their cash placed with those they are certain will and can repay it - viz the governments of strong stable countries - till the hairiness abates.

Safe haven

What makes investors anxious right now is:

1) a Middle East on the brink of total chaos, thanks to the caliphate-building ambitions of Islamic State,

2) a China awkwardly and belatedly recognising the risk of a crash as it tries to wean itself off its addiction to debt-fuelled investment and growth,

3) a Russia under Putin seemingly intent on provocative territorial expansion,

4) and a eurozone seemingly constitutionally unable to make the structural economic reforms that could end its remorseless economic decline.

If any of these dramas went from hairy to horrendous, the economic implications for the world would be nasty. So buying supposedly high-quality government bonds might be sensible insurance.

On this view, investors are not taking any long-term view about the supposedly dire prospects for the US, UK and other developed economies, but simply want a safe haven for their cash till the immediate uncertainties blow over.

Which would be less dismal, except for one thing.

In making these supposedly safe bets with their cash, investors are not putting enough of their money where it might help make us more prosperous - namely in the productive, wealth-generating private sector.

So their preference for supposedly safe government debt might not be a statement that they anticipate long-term secular economic stagnation. But it might end up causing such economic stagnation, by starving those who create our prosperity - small businesses in particular - of risk capital.

Which suggests that the brilliant thing for the British government to do, for example, would be to take advantage of its ability to borrow for 25 years at less than zero cost to throw money at investment in infrastructure - to generate both short-term growth and enhance long-term productive potential.

That would mean Labour's ambition to balance the current budget, but still borrow for investment, might be more sensible than the Tories' plan to create a surplus on the overall budget.

Except for one thing. None of us can know for sure if fickle investors would continue to give the government free money if the government were to elongate the timetable for deficit reduction by doing something economically useful with the money it borrows.