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.
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 mean 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 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.
Because politicians in advanced economies have been too chicken to increase taxes and undertake structural reforms since the global financial crisis, we are in the uncomfortable position of relying on easy monetary policy, aka printing money.
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.
Since 2008, global debt had grown to US$184 trillion or 225 per cent of GDP by 2017, with the top three countries – the US, China and Japan – accounting for more than half, significantly higher than their share of global output.
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.
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 bad news is that applied for 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 is not sustainable, but it is the only tool they have to prevent recession if politicians are still unwilling to act.
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.
Will interest rates ever get back to normal? In the short term, it’s unlikely. Last month’s International Monetary Fund 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 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.
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.
Even more worrying is that the US is pressuring its allies, including Japan, South Korea and the Nato countries, to increase defence expenditures. In the 1930s, an arms race led to the second world war. The world has now come full circle, with the US again looking inward, reminiscent of the Smoot-Hawley protectionist measures that led eventually to the Great Depression.
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