Richard Murphy – Interest, profits, savings and growth, and why the Bank of England is trashing the economy by pushing rates up

If you are not an economist or an economics student being fed a solitary diet of neo-classical dogma, here is a good piece to understand some of what is going on in Western economies

Richard Murphy is an economic justice campaigner. Professor of Accounting, Sheffield University Management School. Chartered accountant. Co-founder of the Green New Deal as well as blogging at Funding the Future

Cross-posted from Funding the Future



The following comment was posted on the blog last night. The person posting it used what was, very obviously, a false name and email address and I would normally have deleted it. However, whoever the troll might be they raise points that reflect real economic confusion, and for that reason I thought it might be worth addressing the question that they posed. This is what they asked:

I must admit I don’t understand your criticism of positive interest real rates – surely if we want corporations and individuals to invest and grow the economy, they need to achieve a return ahead of inflation, otherwise they are net worse off?

Why do you want to discourage investment AND make people worse off? What have I missed?

This person has made a number of false assumptions.

Most fundamentally this person has made the mistake of assuming that people who save in  cash want to invest and grow the economy. That is not true. People save in cash accounts because they wish for financial security, and to get their money back. The essence of cash-based saving is to seek security. As a consequence, the last thing that those who save in this way want is that their money be put at risk.

Investing to grow the economy does, inevitably, require that risk be taken. The goal of this activity is to make a profit. The pursuit of profit is an inevitably uncertain activity. It is undertaken by those who want to take a risk. They are willing to face the possibility that they might get less than they saved back, or nothing at all.

The return to the person who saves to invest in growing the economy is, then, fundamentally different from the return paid to the person who saves in cash, whose sole goal is to set their money aside for future use with minimal risk arising in the intervening period. One gets a return, which is a share of profit, which is called a dividend, and the other is paid interest.

A dividend is paid because a profit has been earned, which is an uncertain outcome. Interest is paid because of the passing of time, which is a certain outcome. The first involves risk. The second involves very little risk. This is the first, and fundamental, difference between the two.

The second fundamental difference is the way in which the funds are used. The funds intended to grow the economy have to be invested in a very particular way. A person investing in this way has to either become a partner in a business, and so accept the unlimited liability consequences of doing so, or buy new shares issued by a company that is seeking to raise capital to invest in its growth, and so in the growth of the economy.

LAs a matter of fact, very few people commit any serious funds to the first of these activities. Most partnership businesses in the UK have very low capital intensity, and are largely engaged in the supply of services. When significant capital is involved very few people wish for the risk of unlimited liability. In that case, we can pretty much dismiss this option.

The flow of significant capital funds into new share capital in the UK is also very small. New share capital issues by quoted companies are rare. Those that do take place are usually associated with merger and acquisition activity, or the original placement of shares on a stock exchange, and neither usually provides funds for growth or investment, but do instead replace existing owners with new ones. The vast majority of small companies have tiny share capitals in proportion to their funding requirements. Those companies that fall between groups are either funded by private individuals, who are called angel investors, or by venture capital funds. However, together, they represent a very small proportion of the UK savings market. In other words, this type of saving activity is notable by its scarcity.

Saying this, I do not deny that people save in shares. As a matter of fact, they do. However, the vast majority of people who do so are not providing funds to promote investment in, or the growth of, the economy. Instead they acquire secondhand shares on the stock exchange, i.e. they buy shares previously issued by a company that are now owned by a third-party who is entirely unrelated to it, which that third-party now wishes to make available for sale. The company that originally issued this share gets precisely no benefit from its sale, whatsoever. As importantly, not a single penny of the money saved in this way is, as a result, used to invest in or grow the economy. All that actually happens is that a gamble is made on the future direction of the value of the shares of the company that have been acquired.

Importantly, that change in the value of the shares in question may also have nothing whatsoever to do with the generation of a return on investment. Fashion and whim, plus irrational sentiment, are as likely to impact this. For example, almost all the gains arising on stock exchanges at present are attributable to a very few, very large, tech companies. It is presumed that these will become very much more profitable because of AI, but no one really knows if this is true, or how it might happen. That increase in value could vapourise as quickly as it has appeared. The point is, this return should not be considered to be related to investment, or growth, let alone to any activity in the trading of the shares of the company in question. And quite emphatically, it has nothing to do with the interest rate.

In fact, the only thing that a high interest rate does is reduce the rate of growth in the economy. There are four reasons.

Firstly, consumers have less to spend on goods and services, meaning that demand within the economy is reduced, as is growth. The higher the real rate of interest, i.e. when adjusted for inflation, the stronger is this effect.

Secondly, the higher the rate of interest, the lower will be the rate of profit within the economy. This is because most companies borrow and the more that they have to pay in interest, the less that there will be available to the shareholders. As a result, the already limited incentives to invest for growth are reduced even further.

Thirdly, this also means that the amount of funds that can be retained by a company for reinvestment within it will be reduced, and this is by far the most common source of investment for growth in the UK economy.

Fourthly, the incentive to take a risk by investing for growth is reduced if a real rate of return is available within the economy by taking no risk it all. Once again, the funds available for investment will fall.

It is, therefore, readily apparent that if growth is to be the objective (and I question that), then positive rates of interest provide a massive disincentive for that to happen.

And all this is, of course, before the social consequences of positive rates of interest are considered. These relate, most especially to the redistribution of wealth upwards within the economy, and the strain placed upon households with regard to housing cost, in particular, so that this upward redistribution of wealth might take place.

Then you have to stand back and realise that all this interest is paid for the use of money which literally costs nothing for a bank to produce, and what you then appreciate is that this whole hierarchy of charging for a wholly artificial commodity created as a human construct to exercise power within an economy is morally repugnant. Hardly surprisingly, the great, wisdom traditions all condemned the charging of interest. They were right to do so. We have, however, let those with power ignore this at cost to all the rest of us. The price for doing so has already been far too high. It looks as if it will get much higher still because the Bank England wants us to have long term high positive interest rates, and that is economic madness.

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