Tuesday , 25 October 2016

Negative Interest Rates Will Likely Hurt, Not Help, Economic & Financial Stability – Here’s Why

There’s a view in some policy circles that easy monetary policy is goodInterest-Rates for an economy, and the more stimulus you add, the better…This latest stimulus is taking the form of negative interest rates, or charging banks to park their cash with the expectation that this will spur lending and economic growth…In my opinion, however, negative rates—or high rental costs for money storage—are excessive and more likely to hurt, rather than help, economic and financial stability. Here are a few reasons why:

[The original article, as written by Rick Rieder (blackrockblog.com), is presented below in an edited ([ ]) and abridged (…) format by the editorial team at  munKNEE.com (Your Key to Making Money!) to ensure you a fast and easy read.] [A move to] negative rates is excessive and more likely to hurt, rather than help, economic and financial stability. Here are a few reasons why:

1. Global Economy Experiencing Growth Headwinds Unlikely To Be Positively Influenced By Negative Rates

One of these headwinds is an aging population, which is likely to lower the corridor of potential economic growth for many years, especially in developed markets.

  • …In many countries and regions—including Japan, Europe and increasingly, China—higher numbers of people are drawing from their respective economies rather than contributing to it.
  • Traditional economic metrics aren’t keeping pace with the influences of rapid technological innovation, meaning the global economy is likely doing much better in reality than what economic numbers are telling us. Just one example of what traditional metrics don’t capture: Technology has dramatically brought down “bad” inflation (i.e. the cost of food, energy and rent), a fact not reflected in traditional U.S. inflation numbers.

2. Negative Interest Rates Functionally Take Money From Borrowers and Hand It To No One

Central banks initiated aggressive rate cuts in the immediate aftermath of the financial crisis in order to stabilize the system by reducing excess leverage as quickly as possible. Consequently, a short-term subsidy from savers to borrowers through the interest rate channel made a significant amount of sense at the time.

  • Now, however, moving to extreme and excessive robbing of savings through charging for storage takes money from savers but doesn’t significantly enhance demand among borrowers. In fact, businesses and consumers may have a lower marginal propensity to spend in uncertain economic times.
  • In addition, negative interest rates act on the overnight funding rate, or the front end of the yield curve, at a time when few businesses use short-term funding for their borrowing needs. Thus, negative rates seem to merely charge savers and penalize financial institutions through lower net interest margins and consequently, compressed cash flow.

3. Weak Currency Is No Longer An Effective Stimulus Strategy

One argument for negative rates is that they weaken, i.e. cheapen, a region’s currency, bringing forward demand but, while the approach of competitively devaluing a currency vs. global counterparts was effective at times historically, it’s likely to be less effective when each country is attempting to cheapen its currency.

In such a scenario, which we’re seeing today, there’s a zero-sum game at hand, only leading to aggressive retaliatory measures and economic and financial system volatility. This, in turn, can further dull corporate and consumer expenditures and economic growth.

4. Negative Interest Rates Can Have Other Unintended Consequences

In an environment of negative rates, instead of being charged for saving, savers may attempt to hold their wealth in hard assets such as gold or in large bills in vaults (or under their mattress). Such hoarding, protection and insurance dynamics could create an escalation of black markets and illicit behavior.

If Not Negative Rates, Then What’s the Solution? 

To be sure, I’m not alone in being concerned about negative rates. The market’s belief in, and tolerance for, these policies seems to be more skeptical today than in the past, as seen in the adverse market reaction to Japan’s negative rate discussion. Of course, it’s one thing to point out problems, and another to offer solutions so you’re probably wondering if I’m not a fan of negative rates, then what’s my solution instead.

I believe:

  1. fiscal policies are needed to address the structural challenges facing the economy, including ones to help workers gain the skills needed in a world of quickly-changing technologies…
  2. QE monetary policies designed to provide funding to, and dull the pressures on, financial institutions during times of instability and low confidence may also prove quite effective, not least because they target the parts of the yield curve where today’s corporate funding occurs. In recent years, QE programs have shown they can dull volatility in the system, enhancing confidence and unlocking expenditure and investment.
  3. Above all, as we are now seven years from the financial crisis, I believe markets, financial systems and economies need a chance to recalibrate to an unstimulated posture.

If central banks continue rolling out untested policies in response to cyclical economic softness and specific regional pressures, they risk doing more harm than good.

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