Richard L. Wottrich, CEO & Senior Consultant, International Services, Atlanta USA
As we step ‘Through the Looking Glass’ in Alice in Wonderland into the world of negative interest rates, I am reminded of a conversation between Alice and the King.
`I see nobody on the road,’ said Alice.
`I only wish I had such eyes,’ the King remarked in a fretful tone. `To be able to see Nobody! And at that distance, too! Why, it’s as much as I can do to see real people, by this light!’
This writer explored negative interest rates a few years ago when they were still a novelty. Suddenly they are ‘de rigueur.’ Historically Switzerland imposed a negative interest rate on non-resident deposits in 1972-1978. That ‘surcharge’ drove rates to -40% in 1978. Switzerland did this to discourage inflows of capital seeking higher yields in the face of rapidly declining interest rates in surrounding European countries. Dependent upon its exports, Switzerland felt the need to deflate the appeal (value) of its currency. This policy lasted until 1982, when the Swiss realized that inflation was too high a price to pay for a weak currency. This however remains a problem for Switzerland today. As of last April over 30 percent of EU-issued bonds traded at negative interest rates.
The Federal Reserve, Bank of Japan, Bank of England, and European Central Bank have managed interest rates since 2008 down to zero and beyond. As a result in certain cases depositors have to pay to deposit funds or buy bonds, accepting a negative interest rate. Negative interest rates have appeared on government bonds from Switzerland, Denmark, and Germany. Certain corporations have issued negative rate bonds, including Nestlé and Shell.
Japan is now easing into negative rate territory. Janet Yellen, the U.S. Federal Reserve chair (who said at her confirmation hearing in November 2013 that even a deposit rate that’s positive but close to zero could disrupt the money markets that help fund financial institutions) said this past week that a change in economic circumstances could put negative rates “on the table” in the U.S. Why is this?
The reason is simple and deceptive. Total global sovereign debt is in excess of $230 trillion. Governments have printed money for so long that rolling these bonds over into near zero rate bonds makes great economic sense. Even if the average interest rate on this pile of debt were a nominal 3.3 percent, the annual interest bill would be a staggering $7.6 trillion or 10.3% of the 2015 global GDP of $73.5 trillion. Governments just do not have this much money to spend – ergo negative interest rates.
Negative interest rates are born of desperation. What little growth there is in the world economy appears to be almost entirely dependent on rising levels of debt. The 2008 financial collapse should have exploded global credit bubbles, but instead governments have continued to print money. Rising sovereign debt has taken over where households and companies left off. Monetary policy has been substituted for fiscal policy in a massive game of three-card Monte.
Politically governments have neither the will power nor the political capital to change fiscal policy or raise taxes on disgruntled citizens. Hence governments print money and raid the capital of ordinary folks by paying them next to nothing on their savings. Private equity groups, hedge funds and investment houses pocket this ‘free’ money and flood higher risk investments in search of yields. This is a classic moral hazard of epic proportions.
What is a negative rate in practical terms? Once a Central Bank has dropped rates to zero, then the cost of a savings account deposit is zero minus the actual expenses of the bank providing the savings account and its corporate pro rata expenses per account – about negative 1 percent. In practice this ‘surcharge’ never trickles down to ordinary depositors, but rather is a surreal feature of safe asset markets and big investors across the globe.
In this distorted financial landscape, banks have defied logic and are not making more loans – central banks cannot push a rope. Very large depositors seek out non-bank alternative investments – searching for higher yields, which bring higher risks – the shadow banking system.
No one really knows how big the global shadow banking system is, but it is most certainly massive. The International Monetary Fund (IMF) estimated in 2014 that the shadow banking system holds $15 to $20 trillion in U.S. assets, which extrapolates to perhaps $75 trillion worldwide. Compare this to just $9 trillion in FDIC insured deposits in U.S. banks. Shadow banking loans in China could exceed $8 trillion, but no one really knows. China is like a deer in the headlights, as $1 trillion left its shores in 2015.
Research by Zoltan Poszar, the director of Credit Suisse’s global strategy and research department, suggests that a large share of the increase in global savings over the past couple of decades has not been from individuals, but rather from private equity groups, sovereign wealth funds and multinational corporations. Big depositors are the players in the shadow banking sector. This is the playground generating the global Wealth Gap.
Meanwhile the Federal Reserve has accumulated $4.5 trillion in assets as a result of its quantitative easing program – America’s first quasi-sovereign wealth fund. Is this a moral hazard? Who authorized the Fed’s sovereign wealth fund? Who does it hurt? Who makes the decisions? And now the ECB is following in the FED’s foot prints.
What is the end game for the world’s central banks? The simple answer is no one knows. This has never been done before. The debt loads are staggering and, much as black holes throw off invisible gravitational waves that distort space and time, these massive debts distort global markets in countless ways – most not yet understood.
And the ‘existential threat’ in the room? Deflation? Perhaps the derivative symptom of deflation is negative interest rates. “Once you have carpet bombed the global economy with debt and littered its landscape with negative interest rate bomblets, how do you clear the minefield?”
“Curiouser and curiouser!” Alice, Alice in Wonderland
Richard L. Wottrich, CEO & Senior Consultant, International Services