Last year, the ECB cut deposit rates on reserves into negative territory, the first major central bank to do so. So far other major central banks have not followed suit, but smaller ones have: in January the Swiss National Bank slashed deposit rates to -0.7%, and the Danish central bank has now cut deposit rates further into negative territory at -0.75%. Both moves were prompted by the ECB’s QE programme, which by putting downwards pressure on Eurozone interest rates forced satellite countries to cut interest rates in response or face sharply appreciating currencies. Unfortunately neither rate cut has had much effect: the Swiss franc, freed from its Euro exchange rate cap, has soared and the
Danish krone is struggling to stay in its ERM II narrow band despite the Danish central bank intervening directly in the market.
A similar story is happening on the other side of the world. Japanese QE is forcing South East Asian countries to cut interest rates in order to prevent their currencies appreciating, damaging their export-led growth models.
In fact interest rates are tumbling everywhere, as a quick look at this summary of rate decisions shows. India, Pakistan, Australia, Canada, Turkey, Egypt and Peru have all cut rates within the last month, and China cut rates in December. Even Russia, which unwisely raised rates in December in response to a precipitate fall in the ruble, has now cut them again. These are financing rates, of course, not deposit rates: not all central banks are dealing with banking systems awash with reserves. Of these cuts are in response to the deflationary effect of oil and commodity price falls. Just as an inflationary shock causes global interest rates to rise, so a deflationary shock causes them to fall. Central banks with an inflation-targeting mandate are supposed to protect their economies from the effects of external price shocks. The argument is, therefore, that central banks should cut rates in response to a deflationary shock. Those central banks that do not cut rates risk allowing their economies to become uncompetitive, with serious impact on both current and future growth: competitiveness, once lost, is hard to recover. Although there are strong arguments for NOT responding to a short-term supply-side shock, the fear of deflation is very powerful: not surprisingly, most central banks are choosing to cut. The problem is that because the world has not recovered from the 2008 and 2012 shocks, interest rates are already very low, so some central banks are having to cut rates into negative territory – even though this means some people may hoard physical cash, as the Swiss central bank seems to have accepted.
But there are some countries that are raising interest rates because of high domestic inflation and a falling currency. These are mostly countries experiencing capital flight due to raised political risk and/or severe economic distress. Ukraine – unsurprisingly – is the latest to raise rates, but others that have raised rates recently include Belarus, Armenia, Nigeria, Ghana and Brazil.
To me, the antics of central banks all look like attempts to hold back the tide. If investors wish to remove their money from a country experiencing political uncertainty and economic distress, they will do so, however high the central bank pushes interest rates. In 1998 Russian interest rates rose to 160%, but it was still forced into default and currency collapse. And the same applies in the opposite direction, too. Investors removing capital from troubled areas will put that money somewhere safe even if they have to pay to do so.
The rise in the Swiss franc, along with negative yields in Swiss and other “safe” government debt such as German bunds, JGBs, USTs and even UK gilts, is due not to falling oil and commodity prices but to elevated political risk, particularly within the Eurozone, along the EU border and in the Middle East.
But…. falling oil and commodity prices, elevated geopolitical risks, the resurgent Greek crisis. Aren’t all of these transient shocks? Surely central banks should be looking at the medium-term – and isn’t the medium-term trend for interest rates to rise gradually as growth recovers?
That’s what Western central banks say. But I fear they are wrong. Far from rising, global interest rates will fall in the medium term. And since global interest rates are already on the floor, that means that they will eventually turn negative everywhere. The long-term trend of interest rates has been evident for many years: yields on government debt in all developed countries have been falling since the early 1980s. A key driver of this is demographics. The “baby boom” of the 1950s & 60s gave way in most countries (with the notable exceptions of India and countries in sub-Saharan Africa) to gently falling fertility. China’s one-child policy caused a much faster drop in fertility, and fertility also fell precipitately in the former Soviet Union and its satellites after its collapse in 1989. Meanwhile, improvements in nutrition and healthcare meant that average lifespans gradually extended. Putting it bluntly, we now live longer and produce fewer children than we did half a century ago.
Consequently, the age profile in most countries is rising.
And nowhere more so than in Europe. We are used to thinking of Japan as an aging society: but Germany’s median age is actually higher than Japan’s, and many other countries in Europe are fast heading for similar levels. Indeed with the exception of Japan, the countries with the highest proportion of over-65s are all in Europe. Many argue that the current economic stagnation and political tension in the EU can largely be laid at the door of its unfavourable demographics.
I don’t buy the argument that households in the US, UK and European countries such as Spain and Italy have low saving ratios. They have low levels of liquid savings, yes – but they invest hugely in illiquid assets, particularly property, usually as a leveraged investment. Even after the recent crisis, over 60% of UK households own the property they live in, and the majority of them have mortgages. The cost of servicing that debt takes up on average a third of their income. That is, by any standard, a very large amount of saving. Households also invest in corporate and private pension schemes, which also are not included in liquid “savings”: increasingly, such investments are mandated by governments seeking to reduce the pressure on fiscal finances from future unfunded public pension commitments. It speaks volumes about the beliefs of some economists that they choose to ignore households’ investments in property and pensions when talking about “savings”, and complain that households don’t save enough. The fact is that there has never in the history of the world been so much saving by households – and so little productive use made of that capital.
The lack of productive uses for the considerable saving of households not only in the Western world but also in emerging markets depresses long-term interest rates. It also blows up asset bubbles: while an asset bubble is growing, interest rates start to rise, but they then fall precipitately when it bursts, ending up lower than they were before the bubble burst. The most recent asset bubble is not in property, but in oil and commodities: the oil and commodity price bubbles of 2009-13 are bursting, causing precipitate falls in prices and in exchange rates tied to those prices (hence the collapsing currencies of oil and commodity exporting countries), and further downwards pressure on global interest rates.
But will the growing proportion of elderly in the global population cause interest rates to start rising, as those people dis-save? Well, no. After retirement, people switch to dis-saving – but as their resources are limited, they have no prospect of earning more and they do not know how long they will live (and they like to pass money on to their children), elderly people tend to live frugally in order to preserve capital. It is very sad that the expectations of the elderly that they will be able to live on the returns from their savings, rather than drawing on capital, are being dashed, but it is an inevitable consequence of their own saving behaviour. And it is in my view very wrong of governments to give the elderly false hope by paying them above-market interest rates on their holdings of public debt, as the UK’s government is currently doing. The fact is that the savings of the elderly will never give the returns that they budgeted for. They should not be fooled into thinking that they might.
If the elderly actually spent their savings, rather than living frugally to preserve capital, the release of that money into the economy would be a demand stimulus that would both raise inflation and arrest falling interest rates. And if those saving for retirement risked their money in young, growing enterprises rather than seeking low-risk passive investments in mature industries, property and government debt, it might dampen the cycle of asset price booms and busts and reverse the long-term trend of interest rates. But while governments buy votes by supporting unproductive investments and promising the elderly returns on their savings that they have no right to expect, and while we remain unable to find a more productive use for those savings than blowing up asset bubbles, interest rates will continue to fall.
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