Negative interest rates are gradually enveloping the developed world with the US also likely to experience this rather counterintuitive economic feat.
In a recent interview, former Federal Reserve chairman Alan Greenspan explained it’s only a matter of time before the US slips into negative interest rates with long-term government bond yields (the return investors receive for lending to the government) slowly-but-surely sinking below zero.
“An ageing population is driving demand for bonds, pushing their yields lower,” said Mr Greenspan.
“We’re so used to the idea that we don’t have negative interest rates, but if you get a significant change in the attitude of the population, they look for coupon. As a result of that, there’s a tendency to disregard the fact this has an effect on the net interest rate that they receive,” Greenspan explained.
However, the former Fed chairman doesn’t see the world being enveloped in negative rates as particularly problematic.
Mr Greenspan declared that “there is no barrier for US Treasury yields going below zero. Zero has no meaning, besides being a certain level.”
Greenspan and the greenback
The esteemed central banker who famously coined the term “irrational exuberance” to describe overvalued stock markets also warned investors to keep a watchful eye on ultra-long-term government debt, specifically 10-year and 30-year Treasury bond yields.
Treasuries are securities issued by the US Treasury to finance government spending as an alternative to taxation. In the US, this asset class has been continually yielding lower multiplies to the point of becoming negative. In other words, investors receive less capital than what they originally lent.
The highly important 30 and 10-year Treasury yields are therefore seen as bellwethers that set a benchmark for the rest of the financial markets, both in the US and globally.
The 30-year yield fell to an all-time low of 1.95% last week. This means that when investors lend $100 to the US Government for a 30-year period, they can expect to receive $101.95 in return. In comparison to other asset classes such as stocks, property and commodities, this is derisory.
The currently low level of interest rates across the entire G20 is a rather historic first.
Never before in history have so many nations experienced such low-interest rates collectively, at the same time.
There are already four countries with negative interest rates: Japan, Sweden, Denmark and Switzerland with a further 21 countries currently on zero.
To further demonstrate the sprawling problem of negative rates, European central bankers are set to meet next week to decide ongoing monetary policy.
The European Central Bank (ECB) is expected to debate the prospect of a “fresh economic stimulus package” that will maintain low rates and compound negative rates. One of the key issues on the table is whether their own measures are doing more harm than good.
The primary reason why central bankers find themselves in a pickle today is due to policy decisions taken around eight years ago that began the “era of unprecedented monetary policy” enacted in response to the global financial crisis (GFC) back in 2007-2009. The GFC was originally triggered by ineffective lending practises and the sub-prime mortgage market in the US.
The ECB’s chief at the time, Mario Draghi, (in combination with all other major economies) declared that they would do “whatever it takes” to support the single currency as all major economies were being whiplashed by high short-term funding rates.
This concerted move towards ultra-low rates has not been reversed since.
If anything, quite the opposite has transpired with a plethora of monetary policies such as quantitative easing (QE) being rolled out to create what some economic commentators have dubbed “the new normal” including hundreds of billions in asset purchases to support the banking industry.
Some banks were bailed out to prevent insolvency as part of a “too big to fail” mantra aimed at resolving moral hazard in the financial markets.
The ECB’s main deposit rate hit zero in 2012 and successive cuts have left it at -0.4% since 2016.
But as the ECB prepares to debate cutting rates further, questions are growing about whether the downside outweighs the positive effects.
Critics say that negative rates weaken the eurozone’s already struggling banking system, discouraging lending and motivating insurers, banks and savers to hoard capital.
The effect of negative rates
The ECB officially introduced its negative interest rate policy in 2014, and in January of 2016, the Bank of Japan unexpectedly followed suit, cutting its benchmark rates below zero in a bold move to stimulate its economy and overcome persistent deflationary pressures.
Research published last month by economists from the US Treasury Department, the University of Bath, the University of Sharjah and Bangor University found robust evidence that bank lending growth was weaker in countries with negative rates.
The research declared that negative interest policies were “backfiring” and “stifling domestic demand”.
For investors, negative rates are counterintuitive and indicate severe imbalances are festering behind the scenes in the economy including overvalued assets and the need for drastic deflation.
In a negative rate environment, banks must pay to hold loans and securities and are effectively punished for providing credit, which is the lifeblood of an economy.
Not only that, but negative rates also punish savers because they disincentivise prudent saving (which some economists claim leads to long-term prosperity) while simultaneously incentivising risk-taking in search of above-average returns. However, investors’ risk appetite remains low because they expect future deflation.
As a partial proof for these knock-on effects, gold prices have been rising steadily alongside the parallel decrease and inversion of interest rates around the world.
According to market analysts, there is currently more than US$16 trillion (A$23 trillion) in negative-yielding debt instruments across all countries.
This is partly because central banks are desperate to maintain loose monetary policy in a bid to maintain record-high stock markets and to prevent funding issues for companies that require low levels of interest to maintain operations.
As it stands, 10-year sovereign bonds in Belgium, Germany, France and Japan to name a few are trading with a negative rate, although, there many less economically developed countries also facing the same inversion.
According to Bloomberg, the EU and Japan “account for 87% of the negative rates worldwide”. As it stands, Europe is effectively in recession with negative GDP in Italy, Germany and elsewhere. Meanwhile, European banks are trading at the lowest levels in more than 30 years.
Without flying the Commonwealth flag too high, it is worth noting that the US, UK, Canada, Australia and New Zealand are the only developed bond markets that do not have negative rates.