Negative interest rates don’t make sense. Yet, nearly US$16 trillion of the world’s bond market yields are in negative interest rate territory. Can this continue forever?
Negative interest rates mean that if you lend money to someone, you have to pay the borrower rather than receive interest from him. It pays to borrow and it does not pay to be a lender. No wonder bank shares are not doing well.
Technically, if it does not pay to save, you should be spending, but why is there lack of global aggregate demand (consumption plus investment)?
The answer is no one is confident about the future. With negative rates, it does not pay to save, but if we spend too much, we will end up in bankruptcy sooner or later. Furthermore, with markets at record highs, we don’t even know how to invest!
How did we get into this ridiculous state of affairs? Interest rates are supposed to be in the hands of professional and independent experts like central bankers.
But central banks went into negative territory with their eyes wide open. They had no choice politically, because it all has to do with exchange rates, whoops, I meant jobs.
The first central bank to experiment with negative interest rates was the Riksbank, the Swedish central bank in 2009. Sweden was facing high domestic savings, which meant that if the surplus funds do not flow out, there will be pressure on the exchange rate to appreciate, especially against the neighbouring eurozone.
As all policy-makers discovered, especially with the experience with Japan in the 1980s, very large exchange rate appreciations with no capital controls can end up with huge asset bubbles and also deflation on the real economy.
This was what the Swedish government wanted to avoid. So to keep the exchange rate against the euro stable, nominal interest rates went negative and Sweden avoided a massive recession.
In practice, Sweden learnt that households need not pay negative interest rates, because the negative interest rates mostly showed up in bond yields.
Banks did not mind holding such paper as they were liquid assets that could be used as collateral to obtain repo funds from the central bank. Insurance companies and pension funds had no choice except to diversify out of the local currency, creating exactly the capital outflow that would keep the exchange rate from appreciating.
Very quickly, the Swiss, Japanese and European central banks also learnt how to use negative interest rates in order to combat deflation.
Since advanced country politicians were too chicken to apply the tough pains of fiscal policy (increase tax) and structural reforms since the global financial crisis, we are in the uncomfortable place of relying on easy monetary policy, aka printing money.
Central bank balance sheets world wide grew by over US$20 trillion since 2008 and stock markets rise and fall whenever central banks expand or shrink their balance sheets.
Since 2008, global debt has grown to US$184 trillion or 225% of GDP in 2017, with the top three countries, United States, China and Japan, accounting for more than half of global debt, significantly higher than their share of global output. Advanced countries have an average debt of 266% of GDP, emerging markets 168% and low-income countries 77% (IMF 2019).
The elephant in the room is the United States, with US$21 trillion or 31% of global government debt of US$69 trillion (2018 data) and still growing at roughly 3% per year, with no sign how this is going to be addressed.
The bad news is that applied too long, negative or very low real interest rates are not only affecting long-term productivity, but also fuelling social inequality. Hence, central bankers are in a pickle. They know that excessive quantitative easing (QE) is not sustainable, but it is the only tool that they have to prevent recession, if politicians are still unwilling to act.
The primary task of Christine Lagarde, the new ECB President, is to persuade her European ministers of finance to use fiscal reflation more to deal with sluggish European growth.
Will interest rates ever get back to normal? In the short run, unlikely.
Last month’s IMF World Economic Outlook concluded that the world is in a synchronised slowdown. With geopolitical tensions higher than ever, there is no sign that global leaders can agree on how to address this problem.
The more immediate problem is that Germany and Japan will become the largest surplus economies in the world, with current account surpluses running at 7.3% and 3.5% of GDP in 2018. IMF projections suggest that by 2024, the US current account deficit of 2.3% of GDP would be almost 100% financed by Germany, Japan and China But by then, China’s current account surplus would be essentially balanced at 0.4% of GDP.
We are thus in an uncomfortable slow train wreck, whereby the world is lurching towards recession because the key powers refuse to address the structural imbalances, which causes the private sector to lose confidence and neither invest nor consume. Meanwhile, climate change, terrorism and populist protests make everyone insecure, with no one in charge in G7 or G20.
The scary part is when the US is pressuring its allies, including Japan, South Korea and NATO to increase defence expenditure. In the 1930s, it was the arms race between rivals that led to the Second World War. The world has now moved full circle, with the US again looking inward, like the 1930 Smoot-Hawley protectionist measures that led eventually to the Great Depression.
Negative interest rates are therefore a symptom of our times. No leadership and all news are negative, spun as great victories. Political leaders are hiding behind central bankers who hide behind technical jargon. Negative interest rates are not the cure for depression.
Tan Sri Andrew Sheng comments on global economics from an Asian perspective. The views expressed are the writer’s own.
Negative interest rates mean that if you lend money to someone, you have to pay the borrower rather than receive interest from him. It pays to borrow and it does not pay to be a lender. No wonder bank shares are not doing well.
Technically, if it does not pay to save, you should be spending, but why is there lack of global aggregate demand (consumption plus investment)?
The answer is no one is confident about the future. With negative rates, it does not pay to save, but if we spend too much, we will end up in bankruptcy sooner or later. Furthermore, with markets at record highs, we don’t even know how to invest!
How did we get into this ridiculous state of affairs? Interest rates are supposed to be in the hands of professional and independent experts like central bankers.
But central banks went into negative territory with their eyes wide open. They had no choice politically, because it all has to do with exchange rates, whoops, I meant jobs.
The first central bank to experiment with negative interest rates was the Riksbank, the Swedish central bank in 2009. Sweden was facing high domestic savings, which meant that if the surplus funds do not flow out, there will be pressure on the exchange rate to appreciate, especially against the neighbouring eurozone.
As all policy-makers discovered, especially with the experience with Japan in the 1980s, very large exchange rate appreciations with no capital controls can end up with huge asset bubbles and also deflation on the real economy.
This was what the Swedish government wanted to avoid. So to keep the exchange rate against the euro stable, nominal interest rates went negative and Sweden avoided a massive recession.
In practice, Sweden learnt that households need not pay negative interest rates, because the negative interest rates mostly showed up in bond yields.
Banks did not mind holding such paper as they were liquid assets that could be used as collateral to obtain repo funds from the central bank. Insurance companies and pension funds had no choice except to diversify out of the local currency, creating exactly the capital outflow that would keep the exchange rate from appreciating.
Very quickly, the Swiss, Japanese and European central banks also learnt how to use negative interest rates in order to combat deflation.
Since advanced country politicians were too chicken to apply the tough pains of fiscal policy (increase tax) and structural reforms since the global financial crisis, we are in the uncomfortable place of relying on easy monetary policy, aka printing money.
Central bank balance sheets world wide grew by over US$20 trillion since 2008 and stock markets rise and fall whenever central banks expand or shrink their balance sheets.
Since 2008, global debt has grown to US$184 trillion or 225% of GDP in 2017, with the top three countries, United States, China and Japan, accounting for more than half of global debt, significantly higher than their share of global output. Advanced countries have an average debt of 266% of GDP, emerging markets 168% and low-income countries 77% (IMF 2019).
The elephant in the room is the United States, with US$21 trillion or 31% of global government debt of US$69 trillion (2018 data) and still growing at roughly 3% per year, with no sign how this is going to be addressed.
The bad news is that applied too long, negative or very low real interest rates are not only affecting long-term productivity, but also fuelling social inequality. Hence, central bankers are in a pickle. They know that excessive quantitative easing (QE) is not sustainable, but it is the only tool that they have to prevent recession, if politicians are still unwilling to act.
The primary task of Christine Lagarde, the new ECB President, is to persuade her European ministers of finance to use fiscal reflation more to deal with sluggish European growth.
Will interest rates ever get back to normal? In the short run, unlikely.
Last month’s IMF World Economic Outlook concluded that the world is in a synchronised slowdown. With geopolitical tensions higher than ever, there is no sign that global leaders can agree on how to address this problem.
The more immediate problem is that Germany and Japan will become the largest surplus economies in the world, with current account surpluses running at 7.3% and 3.5% of GDP in 2018. IMF projections suggest that by 2024, the US current account deficit of 2.3% of GDP would be almost 100% financed by Germany, Japan and China But by then, China’s current account surplus would be essentially balanced at 0.4% of GDP.
We are thus in an uncomfortable slow train wreck, whereby the world is lurching towards recession because the key powers refuse to address the structural imbalances, which causes the private sector to lose confidence and neither invest nor consume. Meanwhile, climate change, terrorism and populist protests make everyone insecure, with no one in charge in G7 or G20.
The scary part is when the US is pressuring its allies, including Japan, South Korea and NATO to increase defence expenditure. In the 1930s, it was the arms race between rivals that led to the Second World War. The world has now moved full circle, with the US again looking inward, like the 1930 Smoot-Hawley protectionist measures that led eventually to the Great Depression.
Negative interest rates are therefore a symptom of our times. No leadership and all news are negative, spun as great victories. Political leaders are hiding behind central bankers who hide behind technical jargon. Negative interest rates are not the cure for depression.
Tan Sri Andrew Sheng comments on global economics from an Asian perspective. The views expressed are the writer’s own.
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