Plagued by a persistent lack of demand for loans in economies that refuse to respond to more conventional stimulus attempts, several of Europe’s central bankers have cut key interest rates below zero for more than a year.
Japan now has caught the disease in an economy that has not responded to any of Abe’s arrows, including the one he has never had the nerve to fire, which is restructuring. The idea has spread to Sweden to Denmark to Switzerland and Janet Yellen, who leads the US Fed, has said if the US economy worsens, negative rates “could be on the table.”
By now, it should be obvious that we are not friends of this abhorrent creation of excess money supply. By flushing the system with cash, Central Banks enable politicians to continue their profligacy. Why implement structural reforms if Central Banks keep providing more and more liquidity band aids? That welfare museum, Europe, is one result; that protectionist mausoleum, Japan, is another. Local politicians have killed their respective business cycles, thanks to the ECB and Bank of Japan.
Artificially low rates are akin to Hong Kong parents spoiling their third-generation brats: these enfants terribles know the price of everything but the value of nothing. In plain text, low rates mean that everyone gets to borrow cheaply, so the wrong people get rich for the wrong reasons. Risk cannot be priced any longer by the market, thanks to the Central Bank.
In the Financial Times on March 22, Morgan Stanley’s Huw van Steenis acerbically attacked the direct effects of distorted lending via fake, low interest rates: “Conventional thinking is that negative rates are just a natural continuation of quantitative easing, like dialing down the air conditioning. This, though, underestimates how financial intermediaries may actually respond. They erode banks’ margins. They give lenders an incentive to shrink, not grow. They encourage banks to seek out opportunities overseas rather than in their home markets. They also risk disruptions to bank funding. All go against the grain of the central banks’ desire to ease credit conditions and support financial stability.”
Here is what van Steenis comes up with: “For banks, the indirect consequences of negative rates may matter more than the direct effect. There is a risk that market liquidity will be reduced, as negative rates mean financial intermediaries hoard high-yielding assets. There is also a question of how money market funds, which help many corporates manage their finances, will navigate negative rates. In Japan, all 11 companies running money market funds have stopped accepting new investments. Negative rates, if passed on by banks, could also start to erode consumer trust in banks as the right place for their cash. Sales of safes have risen in German and Japan since they [i.e. negative rates, the author] were implemented.”
Given these dangers, it’s hard to believe investors would buy banks. They are too risky and offer patchy rewards and returns. Instead, low-cost beacons such as financial technology companies – “fintechs” – companies that are harnessing technology to make financial services more efficient – are coming to the fore. They are generally startups founded on the theory that they disrupt incumbent financial systems and corporations that are falling behind in the race for technology.
Enzio von Pfeil is the investment strategist for Private Capital Limited, a commission-free Hong Kong financial advisory firm