The Price Of Money: My thoughts on 2023

Jan 07, 2024 6:05 am


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So: Nine months on from publication, what's been going on in the world of money?

These are what I consider to be the three things worth thinking about – plus at the end, my views about the coming year.

1: The banking crisis that wasn't

Back in March, just as The Price Of Money was released, three US banks collapsed. 

For a moment, it looked like the book was at risk of being instantly outdated: was this the beginning of the collapse of the financial system that I'd written was inevitable but somewhat distant?

No. It turned out not to be a big deal in the grand scheme of things, but it still provided useful information that we can apply to other events.

Those lessons are coming up – but first, the background about what happened…

In short, a few banks (the biggest being Silicon Valley Bank) had taken customer deposits and invested them in long-term US bonds.

As you'll know from reading the book, government bonds are super-safe in terms of getting your money back at the end... but their value if you want to sell them before their “maturity” date can fall dramatically if interest rates rise.

These banks had made these long-term investments when interest rates were at pretty much all-time lows, which of course exposed them to the risk that rates would rise.

(Does that sound like something they should have thought of? Amazingly, Silicon Valley Bank's Chief Risk Officer had left in April 2022, and wasn't replaced until shortly before its collapse.)

And what was the big macro theme of 2022-2023? Yep – interest rates rising. A lot.

As long as customers didn't want to withdraw their deposits en masse, this wouldn't have been a problem. But unfortunately, the startups that made up the majority of Silicon Valley Bank's customers were struggling to raise funding, so they started to run down their bank balances to cover their own expenses.

Result: the bank had to sell its government bonds at a loss to repay depositors. If this had been allowed to carry on, they would eventually have run out of money.

So, that’s the background. And as I said, there are some points we can take from this to use in the future:

  • Just like in 2007/8, the central bank came to the rescue: the Federal Reserve pledged to buy back bonds at face value (rather than their depressed market value) in exchange for cash, allowing depositors to be repaid. Clearly, the consequences of even a relatively small collapse were seen to be too damaging for the system as a whole.

  • There's now far more social media shoutiness and general "noise" around than there was in 2008. Chaos and collapse get clicks, which is why a disproportionate amount of attention was given to these bank failures. In general, anything that happens is now amped up to the max, which means it's becoming increasingly hard to tell when something is genuinely important rather than just hyperbole.

  • The Silicon Valley Bank run happened at tremendous speed, in part because it's now so easy to make withdrawals: no more lining up outside Northern Rock like in 2007. Digitisation and network effects make banks more vulnerable to "runs".

  • The whole fiasco resulted from the sudden increase in interest rates that no one was prepared for – as were the UK pension problems of November 2022, which I covered in the book. In a way, it's surprising that more things haven't "broken" in the face of such a rapid adjustment. Will there be more to come? It seems likely.

2: Shock: "real" rates are positive

For the first time in 14 years in the UK, "real" interest rates are positive – meaning the rate of interest is higher than the rate of inflation.

The base rate is standing at 5.25%, and CPI inflation has fallen to 3.9% in the latest (November) figures.

Result: it's possible to come out ahead by keeping savings in the bank, even after inflation.

In Chapter 10 of the book I said that we were in for a continued era of negative real rates: interest rates would be higher than we're used to, but inflation would be higher still. As a result, one of the principles I laid out was to "forget about growing your wealth with savings".

Was I wrong? Well, conveniently I didn't specify a timeframe – so if I am, it'll be years before you can conclusively say so.

But trying to put face-saving motives aside, I really don't think so. With inflation at 3.1% in the US, the Federal Reserve has dramatically changed its language and hinted strongly at rate cuts next year. The Bank of England will be late to adapt (as they've been late to do everything), but it seems likely that they'll follow.

This could bring interest rates down into the ~4% range. Is inflation likely to average less than that over the coming years? It seems unlikely, given that the average over the past ten years – when the world has been gripped by deflationary forces – has been 3.8%.

In short, I believe everything I wrote in the book still stands. Not least because it's the only mathematical option for governments...

3: No shock: government borrowing has grown rapidly

In the 2023/2024 financial year, the UK government is projected to borrow an additional £152 billion. This has nothing to do with war, Covid or recession: it's at a time when nothing is unusually "wrong".

Because the need for this borrowing arises from the sheer gap between tax revenue and the cost of providing services, they'll need to continue borrowing large amounts forever. The only alternative is to dramatically raise taxes (which are already at an all-time high), cut services and entitlements (not going to happen), or increase productivity (more on this in a minute).

Indeed, the Institute for Fiscal Studies writes that: "Official projections suggest that, under current policies, debt as a share of GDP is projected to increase exponentially in the long run."

Inflation is a tool that can be used to moderate this inevitable increase.

With the total national debt now standing at £2.5 trillion, the extra £152 billion represents an increase of 6.5%. GDP would therefore need to grow by 6.5% to keep the debt steady as a proportion.

Is that likely to happen? Well, if you mean as a result of actual productivity growth, no: the current forecast is 0.5% real (that is, after inflation) growth in 2023. 

If you don't adjust for inflation though, GDP has increased by 8.5% over the last 12 months. 

So based on those numbers, despite adding 6.5% to the debt pile, debt as a proportion of GDP has fallen. Neat, huh?

(These figures might not end up being quite right because different numbers are released at different times, some are projections that are subsequently revised, and so on – but you get the idea.)

You can see how from the government's point of view, inflation that's higher than the official target – yet not high enough to upset people – is the ideal scenario here.

(BTW: I ran this section past ChatGPT, which pointed out that it “contains oversimplifications and generalisations about complex economic relationships and policy strategies”. It’s not wrong: this is highly simplified, but I think the general point stands.)

What next?

So nothing has changed from the situation I described in the book: our economic system is unsustainable, but unsustainable situations can persist for much longer than you expect.

It's pretty mad, when you think about it, that the Western world can only finance its day-to-day operations by taking on debt – with no possibility of a way out. 

What happens if the amount of debt governments need to issue outstrips the demand from investors? Then I guess they’ll have to offer a higher yield to encourage demand, which will only hasten the spiral because they'll then need to borrow even more money to finance their higher debt payments.

Or if no one else wants the debt, the central bank can buy it, financed by printing money – which is basically QE again, so adds inflationary pressure to a world that already has more inflationary characteristics than it did in 2008.

Anyway. I'm getting myself down now.

What about the year ahead? Well, the consensus seems to be that inflation has been conquered and we're gliding in for a soft landing: inflation back under control, without causing a recession.

There's no reason to disbelieve the "soft landing" narrative. Except that, as we've seen repeatedly, the consensus is often wrong. 

So, helpfully, my prediction for 2024 is "anything could happen". Inflation could spike again – or more likely, the economy could be tipped into recession by the impact of previous rate rises that haven't been fully felt yet.

And, like with the 2022 gilt crisis and 2023 banking crisis, something totally unexpected could happen. As I mentioned earlier, it still feels like not enough has broken as a result of the speed and magnitude of rate rises we've seen. Nobody foresaw either of those problems, so I think it'd be wise to expect the unexpected.

What should you do in the face of this uncertainty? Nothing has changed from the position I outlined in the book: diversify, favour real assets, and optionally use debt as a tool responsibly.

And also: it’ll be to your benefit if you don’t worry about any of this stuff too much. It's extremely interesting (if you ask me), and worth understanding – but you'll ultimately do far better by focusing on controlling what you can control.

Thank you for reading! If you fancy doing me a favour and you haven't left a rating for The Price Of Money on Amazon yet, I'd really appreciate you doing so.

Happy new year!