ZERO inflation may be fine, but zero interest rates? Actually it is not quite zero inflation, because if you allow for higher housing costs, UK consumer prices are still nosing up. But the bigger point stands: here, across Europe, in the US, in Japan, indeed throughout the developed world, inflation is moribund.
Or at least current inflation is. If instead you look at the price of assets – shares, property, bonds, whatever – there is huge inflation. Our own share market has been a bit of a latecomer to the global party, only just going through its previous peak at the end of 1999 and up only 12 percent on a year ago. German shares are up nearly 30 percent on a year ago, Japanese shares by nearly 40 percent. But the star of the show has been the US, for – though shares are up only 16 percent on a year earlier – the dollar is up more than a quarter on its weighted index, giving foreign investors a theoretical profit of around 40 percent.
If you look at property there is a similar pattern, with prime property everywhere soaring in price. We all know what has happened to high-end homes in London, but the same phenomenon is evident in most global cities: Singapore, Berlin, New York and so on.
It is the very top of the market that is experiencing the greatest gains. There is one place where you can actually see it: midtown Manhattan. In October last year, they topped out 432 Park Avenue, a pencil-thin 430m tower apartment block, the third tallest building in the US. Another three super-tall, super-thin buildings are scheduled to be finished in the next year or so. More are planned. This is a game of “mine’s taller than yours”, with the height of the mast of the tallest of all, the Nordstrom Tower, planned at 540m.
The buyers come from all over the world. Naturally, most are Americans, but many are other nationalities seeking somewhere safe to park money. The top price so far is $100 million (R1.18 billion), reportedly paid by a former prime minister of Qatar for a duplex apartment just south of Central Park. At a rather different end of the scale, there is a sweet story of a Chinese mother who paid $6.5m for a flat for her two-year-old daughter, on the grounds that she might want to go to university in New York when she grew up. But apparently the largest group of non-native purchasers in New York are Brits, including Sting, who bought into a particularly classy limestone block overlooking Central Park.
The point about all this is that the world is awash with money. We have had five years of near-zero interest rates. The Federal Reserve, followed by the Bank of England and more recently by the Bank of Japan and the European Central Bank (ECB), has backed up very low interest rates with quantitative easing (QE), pumping money into the global economy.
But weak demand for goods and services has helped hold down current inflation, an effect reinforced by the collapse in the oil price. The money has not inflated current prices; instead it has inflated asset prices. Initially the main effect was on bond prices, but the effect has spread much more widely. QE has probably helped nudge countries to greater growth, certainly in its early stages. But it has unquestionably been great for people who already have assets – the rich.
You might imagine the asset boom would sound warning bells, but central banks have as their mandate the requirement to control, or at least target, current prices. In the case of the Bank of England, it is to keep the consumer price index within half a percentage point, plus or minus, of 2 percent; in the case of the ECB, it is to keep inflation below but close to 2 percent. There is a subsidiary target, most explicit in the case of the US, to reduce unemployment to its long-term stable levels, and the high levels of unemployment have been cited as a justification for the ultra-easy money policy in both the US and UK.
But unemployment has plunged in both countries and rates have not yet risen. Meanwhile, the impact on asset prices, including flats in Manhattan, has been largely disregarded.
At last this is beginning to change. Just this week James Bullard, the head of the Federal Reserve Bank of St Louis – one of the constituent banks in the Federal Reserve System – warned that the US was risking an asset bubble which could burst with devastating consequences. Speaking this week at a panel discussion in London he said: “Zero is no longer the appropriate interest rate for the US.”
There is, however, a string of obvious problems. One is how to justify a rise in rates when consumer inflation is so low. It is impractical to change the mandate of central banks, so it will be a public relations challenge for them to justify higher rates despite low inflation. One way of doing so would be to focus on the need for long-term stability, and the fact that the plunge in the consumer price index is a temporary phenomenon. But it does require confidence and clarity.
Another problem is that the country that goes first in the interest-raising cycle will push up its currency. That has already happened to the dollar, particularly vis-à-vis the euro, so maybe the increase is so anticipated that it will not have much effect when it happens.
Another difficulty is that people have become so used to ultra-low interest rates that any increase has to be carefully signposted. You don’t want to hit home-buyers with the double whammy of higher mortgage costs and falling house prices. Millionaires in Manhattan and Mayfair can probably look after themselves, but the broad mass of middle-class homebuyers could be in trouble. Similarly, while you may want to curb stock market excess, you do not want a share price collapse either.
So the world faces a tricky period ahead. We all know policy has to change, but we do not know when the first move will come from the Fed, and what will follow. We should however recognise that zero interest rates, like zero inflation, will not stick much longer. – The Independent