There is such a thing as a free lunch, at least if you are a bank. Imagine this: I offer to lend you as much money as you like at 0.5 per cent interest and then I will immediately borrow it back at 4.5 per cent. Not a bad deal, eh? Just borrow £10mi from me and you pocket £400,000. Borrow £10bn, and you earn £400m. Now I am neither so flush nor so stupid as to make that offer—but that is precisely what our governments are doing right now, and that is why banks and financiers are returning to profitability while the rest of us are still struggling.
It is called the yield curve, and right now it is unusually steep. If you don’t work in finance you probably don’t know what a yield curve is but if you do it is your bread and butter. It works like this: generally lenders demand a higher interest rate the longer they lock up their money. A ten-year bond will normally yield more than an overnight loan. Historically the spread between the 20-year US treasury and its three-month bill is around 2 per cent. Today it is almost double that, not because long-term rates are high (they are not) but because the central banks have driven the short term rates (the only rates they control) very very low.
Standard economic theory tells central banks to set interest rates low during a recession in order to stimulate lending, and consequently investment and economic activity. If banks can secure funding cheaply, they should be able to lend at lower rates, which creates incentives for firms to invest in capital projects, for households to borrow and spend, allowing the economy to return to its normal growth rate. But banks are not lending vigorously right now. In part this is because they are hoarding cash. During the boom optimism reigned and banks would lend to anyone. Now fear is king, and even qualified borrowers find it difficult to obtain funds. But also banks have little reason to lend to you and me when they can make a risk free 4 per cent buying government bonds (and using government money to do it).
Now one can argue, that considering the…