Era of cheap credit coming to an end

Allister Heath
FEW people realise it yet but the era of cheap credit is about to come to an end. I’m not talking about central banks hiking rates or bond yields going up a few notches; rather, my contention is that over the next few years, powerful economic forces will permanently and drastically push up the cost of credit. This will have significant consequences for borrowers, who will suffer, as well as savers, who will benefit.

Investment is financed out of savings, and the world is about to go on a capex binge, thanks to Asia. This increased demand for investable funds will push up the rate at which they are made available – and hence force up interest rates. This is a significant change for the world economy, albeit one which would already have become apparent by now in the absence of the recession. Since the 1970s, investment fell from 26.1 per cent of world GDP to 20.8 per cent in 2002, entirely as a result of reduced capital expenditure in rich countries. This was due to the end of the post-war reconstruction boom; a deterioration in the economic environment, with higher and more variable inflation; higher taxes on capital and incomes; a drop in the price of capital goods, especially IT; and a reduction in the share of national income made up of investment-intensive industries such as manufacturing.

But while the West was consuming more and investing less, the rest of the world was at a different phase of its development. The global rate started to increase again, hitting 23.7 per cent in 2008, led by a boom in capex in Asia, Latin America and Africa. The figure then slumped back to 21.8 per cent of the world’s GDP last year as a result of the global recession, before starting to recover this year. Cyclical issues aside, we are at the start of another enormous wave of capital expenditure as poor countries become rich and adopt modern technologies, living standards, housing and economies.

McKinsey & Co, the management consultancy, argues in Farewell to Cheap Capital?, a fascinating report published by its global institute, that this massive spending by emerging market economies means that the investment rate will keep on rising. By 2020, global investment demand could hit the sorts of levels we last saw when Europe and Japan were reconstructing themselves after the ravages of the Second World War. It could exceed 25 per cent of GDP by 2030, McKinsey predicts.

At the same time, global savings will start to fall. China’s savings rate hit 53 per cent of GDP two years ago; this won’t last, just as Japan, Korea and Taiwan saw their savings rates drop as they developed. An ageing population will also cut savings rates, as pensioners draw down reserves. All of which means that it will soon cost more to borrow. One of the drivers of the recent unsustainable boom was excessively low long-term interest rates caused by huge demand for government debt by Asian governments, which created a false market in bonds by investing a large chunk of their national savings in them. Dearer credit will make such bubbles less likely – but it also means that the rate of return required to make an investment project viable will rise, and many currently economically sound ventures will no longer happen, especially in the West.

Consumers – especially 20 and 30-somethings in the UK and the US, many of whom assume that money will remain cheap for ever – are in for a nasty shock.