04 Sep 2019
Like climate change, negative interest rates represent a modern enactment of the tragedy of the commons: the whole world is affected but no one accepts direct responsibility.
Like climate change, human activity is the cause. Unlike climate change however, where the necessary actions are evident even if the will is weak, there is no clear understanding of why the economic ecosystem is so out of whack and what can be done about it.
"Even as research continues into what negative rates mean, the corporate world is preparing for a new era where money essentially costs nothing.”
In both cases however, even as accountability remains mired in controversy, action is possible. And being taken.
On the climate front, regulators, investors, companies and communities are preparing for a less carbon-intensive world and one with a heightened risk of catastrophic weather events amplified by global warming.
On interest rates, even as research continues into what negative rates mean, the corporate world is preparing for a new era where money essentially costs nothing. If long-term interest rates are pretty much the same - or lower than - short-term rates, then there is no discount for the time value of cash nor penalties for riskier activity.
Preparing for zero
Even as global interest rates have trended towards zero in recent years (or 20 years ago in Japan), financial markets and their participants have focused more on preparing for when interest rates start to go up.
Now more and more are preparing for the potential for no rate rises in the foreseeable future.
JP Morgan chief executive Jamie Dimon said his bank was beginning to plan for zero rates in the US (even as Donald Trump ramps up pressure on the US central bank to cut rates to negative as the economy wains in the run up to his re-election campaign).
More and more banks are more formally looking at their operations in a zero rate world. For example, at a high level, pricing for risk becomes more difficult in such a world, spreads (and hence margins) between borrowing and lending rates are squeezed, cost cutting becomes more important while pressure to increase fee income rises.
Last year the US Federal Reserve was looking to “normalise” (raise rates) but Trump’s trade war with China, the continued regression of globalisation, broader global uncertainty and higher debt levels have reversed that outlook.
At the Fed's annual central banker gabfest last month, Fed president Jerome Powell acknowledged not only the rising risks to the economy but the declining effectiveness of monetary policy in the context of a more unpredictable world.
He said Fed officials "have much experience in addressing typical macroeconomic developments” but “there are, however, no recent precedents to guide any policy response to the current situation”.
Australian Prudential Regulation Authority (APRA) chairman Wayne Byres has warned of under-appreciated risks from an extended era of ultra-low rates. He said neither larger nor smaller financial institutions would welcome even lower rates but smaller banks would be more affected. Meanwhile, prudential risks - for example from mortgage market speculation - would rise.
Central bankers globally have increasingly drawn attention to the lower effectiveness of monetary policy - the cost of money - and the growing importance of fiscal policy - taxing and spending - as interest rates tend towards zero.
As the time value of money diminishes, governments must do more with fiscal policy to stimulate consumer and business confidence and set the policy frameworks for investment.
And rates are heading inexorably down: last week the European Central Bank (ECB) announced a new campaign to stave off recession in the euro area. The bank cut its deposit rate - “charged” on bank deposits held in the ECB - from -0.4 per cent to -0.5per cent. Yet another record low…
Meanwhile, abnormal monetary policy, such as quantitative easing (QE), is once again becoming prominent. Initially launched as an emergency response to the global financial crisis, central banks now see such measures (effectively printing money) as a part of their everyday tool kit.
The ECB said it will restart quantitative easing and buy €20 billion of bonds each month from November.
Such abnormal activities bring their own threats and central banks are looking to address some historic concerns - such as these strategies generating runaway inflation - and some new ones - such as the policies punishing savers and hence causing too much collateral damage.
In Australia, the Reserve Bank (RBA) released a research paper arguing only a “single digit” percentage of people over 60 rely significantly on interest income - with many of them well off.
“A very small share of households earn more than 20 per cent of household income as interest,” the RBA said in published answers to parliamentary questions. The bank said households have “around twice as much” in debt as deposits, in aggregate.
In a 17-page response note, the bank outlined its options for non-monetary policy measures including quantitative easing.
“If circumstances were to warrant it, the board would consider unconventional monetary policy options,” the RBA said, stressing they remained “unlikely”.
The RBA also considered the economic implications of QE which many have argued has resulted in more benefit for wealthy, asset-owning cohorts than the broader economy.
“The first-order effect of QE is to increase incomes for households who would otherwise be unemployed,” the bank said. “In Australia, as well as in those other countries, the households that benefit most from lower unemployment are young, low-income and have few assets.
“Asset prices are also supported by this policy, but the effect of this on asset-owners’ incomes and wealth is smaller than the effect of reducing unemployment on lower-income households.”
Nor, the bank argued, are abnormal policy measures unprecedented: “The RBA already purchases government securities for liquidity management purposes… central banks implemented monetary policy a few decades ago largely by purchasing and selling government bonds.”
This, and other debates, demonstrate a shift into a new era where the fact of zero or negative interest rates is no longer just a curiosity to be debated but a new world order.
That has implications. One is central bank independence, a relatively recent construct but one considered a shibboleth in many spheres.
As the Financial Times’ Gillian Tett argued in her Moral Money newsletter, central bank independence was fine when monetary policy did most of the heaving lifting in an economy but as it reaches its limits it becomes more necessary for all the different levers of economic influence to be used coherently.
She notes a speech by Philipp Hildebrand, the former Swiss central bank governor who now works at money manager BlackRock. Hildebrand’s argument is central bank policy is impotent in a world where $US17 trillion in bonds now carry negative yields.
In the next recession, a different policy framework will be required, Hildebrand argues, and this will involve efforts to “put central bank money into the hands of public and private sector spenders rather than relying on the incentives of lower rates”.
This kind of direct handout or fiscal support would “certainly require closer co-ordination between fiscal and monetary authorities.”
Tett goes on to detail the history of central bank independence and the logic of better government/policy maker cooperation.
Of course, this doesn’t mean caving into populist self-interest or Trump’s illogical hectoring of the US Fed. However, in a world of increasing political populism, a new era of cooperation is hardly straight forward.
Good then that banks and policy makers are starting to plan for an abnormal future. It’s not just climate change coming.
Andrew Cornell is Managing Editor of bluenotes
The views and opinions expressed in this communication are those of the author and may not necessarily state or reflect those of ANZ.
04 Sep 2019
09 Sep 2019