Advanced economies swallowing negative interest rates with glee must remember this is not a cure for depression
- Negative interest rates have not encouraged spending and have fuelled inequality. Instead of relying on central bankers to tweak monetary policy, governments must initiate structural reforms. However, with a global slowdown in the offing, this is unlikely to happen
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 a lack of global aggregate demand (consumption plus investment)? The answer is that 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.
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 did not flow out, there would be pressure on the currency to appreciate, especially against the neighbouring euro zone.
As all policymakers discovered, especially after Japan’s experience in the 1980s, very large exchange rate appreciations with no capital controls can end up in huge asset bubbles and also deflation on the real economy. The Swedish government wanted to avoid this. 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 these 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 (short-term) funds from the central bank.
Insurance companies and pension funds had no choice but 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 learned how to use negative interest rates to combat deflation.
Central bank balance sheets worldwide have grown by over US$20 trillion since 2008 and stock markets rise and fall whenever central banks expand or shrink their balance sheets.
Advanced countries have an average debt of 266 per cent of gross domestic product, emerging markets 168 per cent and low-income countries 77 per cent.
Why the US deficit is much larger than you think
The elephant in the room is the US, with US$21 trillion, or 31 per cent of the US$69 trillion in global government debt in 2018. US debt is still growing at roughly 3 per cent a year, with no sign how this is going to be addressed.
The primary task of Christine Lagarde, the new European Central Bank president, is to persuade European finance ministers to use fiscal reflation (measures involving taxes and spending) more to deal with sluggish European growth.
The more immediate concern is that Germany and Japan will become the largest surplus economies in the world, with current account surpluses running at, respectively, 7.3 per cent and 3.5 per cent of GDP in 2018. IMF projections suggest that, by 2024, the US current account deficit of 2.3 per cent of GDP would be almost entirely financed by Germany, Japan and China. But by then, China’s current account surplus would be essentially balanced, at 0.4 per cent of GDP.
Japan surpasses China as the biggest creditor to the US government
We are thus in an uncomfortable slow train wreck, whereby the world is lurching towards recession because the key powers refuse to address their 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.
Negative interest rates are a symptom of our times. We are faced with a lack of global leadership and negative news 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.
Andrew Sheng writes on global issues from an Asian perspective