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The stagnation threat

Secular stagnation is the idea that real interest rates are low around the world because desired savings exceed desired capital spending. This predates the financial crisis; real interest rates have been falling since the 90s.

That fall, though, poses a big question here: why haven't falling real interest rates triggered a rise in capital spending sufficiently big to stabilise interest rates?

One reason, says Dr Thwaites, is that the relative price of capital goods has fallen so that a given quantity of savings now buys more capital goods: for example, in the last 15 years the price of UK investment goods has risen by less than half as much as consumer prices - 17 per cent against 38.9 per cent. However, because there are limits (for now at least) on how far machines can replace human workers this fall in the relative price of capital goods hasn't unleashed a big rise in the volume of investment; the price elasticity of demand for capital goods is less than one. This means that, in current prices, the share of business investment in GDP has fallen; it's now 10.1 per cent in the UK compared with over 13 per cent in the late 90s.

Others, however, see another reason for weak investment - that there is, as former Fed chairman Ben Bernanke said 10 years ago, a dearth of investment opportunities in the west. Some, such as Northwestern University's Robert Gordon, attribute this to a slower rate of technical progress. Others, though, see a more benign process. Erik Brynjolfsson at the MIT says progress has shifted from the measured part of the economy to the unmeasured. Wikipedia, for example, has replaced the Encyclopedia Britannica. But the voluntary work that creates Wikipedia isn't measured in national accounts whereas the paid labour that created the Encyclopedia Britannica was. That has tended to depress GDP. In this sense, what looks like economic stagnation is actually the result of technical progress.

Yet others see a third reason why investment hasn't responded to low interest rates - confidence. Biagio Bossone, chairman of the Group of Lecce, says that since the recession firms have wanted to hold liquid assets rather than invest in capital. And the UCLA's Roger Farmer has shown how depressed confidence can lead to sustained weak growth and high unemployment.

All this suggests that ultra-low gilt yields are not a sign of a bubble or of the effect of quantitative easing. Instead, they reflect fundamental long-term forces.

Which poses the question: what could change to reverse the long-term downtrend in yields?

Economists agree that one thing would raise yields - looser fiscal policy around the world. However, this is not on the cards, so we must look for other forces.

One of these, says Dennis Yang of the University of Virginia, is that Asia's savings glut will diminish as China rebalances away from exports towards consumer spending and as the creation of a welfare state reduces the need for individuals to save for old age or ill-health. And Barry Eichengreen at the University of California Berkeley adds that some new technologies - such as 3D printing, graphene or robots - might have so many possible applications that they will cause investment generally to rise.

However, these are long-term forces. They won't much raise gilt yields this year. There are, though, also some near-term possibilities. Economists expect a cyclical upturn in capital spending, at least in the UK and US this year. And the slump in oil prices will reduce oil producers' savings; in effect, it shifts incomes from savers to spenders. The IMF foresees the combined current account surpluses of oil exporting nations falling from $414bn last year to $223bn by 2019.

On the other hand, though, it's possible that savings in the UK and US will rise, putting downward pressure on yields. Gauti Eggertson and Neil Mehrota at Brown University show how secular stagnation can result from an ageing population - because middle-aged folk save more than youngsters - and from increased inequality (as the rich save more than the poor). So far, these haven't been a factor in the UK and US - savings ratios are lower than they were in the 1990s - but they might become important in future.

In truth, the gilt market is pricing in continued secular stagnation. The index-linked yield curve is quite flat, which implies that the market expects real interest rates to remain negative for a long time. Which means savers face many years of negative real returns on safe assets.

We have, however, been here before. The phrase "secular stagnation" was coined by the American economist Alvin Hansen in 1938 to describe the low interest rates and weak growth of the 1930s. Those problems were solved - at a high cost - by World War II. It caused a huge rise in government spending and then a surge in capital spending as countries rebuilt their economies after being wrecked by war. Perhaps what we're seeing now is a return to normal conditions after that long hiatus.