Imminent challenges are delivered by negative interest rate environment

Chen Gong

Their appearance in the United States is just a matter of time, says former Federal Reserve Chairman Alan Greenspan

After the Federal Reserve cut the interest rates in July, as expected the European Central Bank recently launched a monetary easing policy and lowered the deposit interest rate by 10 basis points to -0.5%.

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The financing rate and loan interest rate remained unchanged at current levels.

At the same time as the interest rate cut, the European Central Bank announced the restart of quantitative easing (QE) – printing more money – and will begin implementing the interest rate grading system.

From Nov 1, the asset purchase plan will be restarted at a scale of 20 billion euros per month. As ANBOUND had expected, the European Central Bank’s resumption of monetary easing has also meant that the world has entered a “monetary re-loosening” policy environment.

Unprecedented low interest

But the difference between the global monetary easing this time with the global financial crisis a decade ago is that the current global economy is facing an unprecedented low interest rate and even negative interest rate monetary environment.

This will inevitably bring great challenges to the global economy.

In order to be free from the economic downturn and the debt crisis, in June 2014, the European Central Bank became the first major central bank to announce negative interest rates on commercial banks.

This was followed by several European central banks including the Swiss National Bank.

Japan, which has long been on the verge of deflationary dangers, followed the policy of “Abenomics” – named after Prime Minister Shinzo Abe – in 2016, hoping to encourage commercial banks to lend funds through negative interest rates to promote domestic consumption, corporate investment and stimulate inflation.

‘Negative rates spreading’

Although the United States has yet to adopt “negative interest rates”, the former Federal Reserve Chairman Alan Greenspan also pointed out that “negative interest rates” are spreading globally and their appearance in the United States is just a matter of time before they become a reality.

Bank of America even believes that in 2020, and that is just a few months away, the world will usher in an era of low interest rates.

Stimulating the economy

Compared with low interest rates, what is more worthy of attention is the negative interest rates.

Theoretically, negative interest rate monetary policy aims to encourage people to increase borrowing and spending, as well as reduce savings to stimulate the economy.

After five years of implementation of the negative interest rate policy, the eurozone economy has yet to be free from downturn, but it only manages to ease the sovereign debt crisis in the eurozone to some extent.

At the same time, Japan also achieved economic growth with continued monetary easing.

Controllable costs

Former Federal Reserve Chairman Ben Bernanke once thought that people’s concerns about negative interest rates were exaggerated and the negative interest rate policy has certain benefits and controllable costs.

US President Donald Trump is also constantly putting pressure on the Federal Reserve as he believes that Germany, the largest economy in Europe, as well as so many other countries have implemented negative interest rates.

These countries are able to obtain money because they lend money and he criticised the Fed for not taking similar actions.

With the increasingly normalisation of unconventional monetary policies of negative interest rates and the gradual slowdown of the global economy, there is the growing controversy over negative interest rate policies.

Becoming a bubble

Many seem to think that the prosperity of the capital market brought by negative interest rates is increasingly becoming a bubble.

In practice, it has not become an immediate booster for economic recovery and that it acts more like a placebo. At present, negative interest rates are spreading all over the world.

Sovereign bonds with negative yields are about $17 trillion worldwide, twice as large as at the beginning of the year.

As the global economy deteriorates, central banks around the world continue to promote monetary easing.

There are even home loans with negative interest rates in Europe.

More and more people are calling for the issue of low interest rates to be re-considered because this will have a negative impact on the financial system and the economy.

There is an increasing fear that the actual effects of such policy will do more harm than good.

As ANBOUND has previously warned, even with the global monetary loosening, the effects are limited in the case of excess liquidity.

Recently, many economists and financial practitioners pointed out that the US economy is also facing the possibility of adopting “negative interest rates”, which will bring risks to the financial system.

Harvard University economics professor and former US Treasury Secretary Lawrence Summers said there is little evidence that further interest rate cuts will have a significant effect on economic activity.

The United States has relied on monetary policy to maintain economic stability in the past decade, but he is worried that this move will no longer work.

Federal Reserve Chairman Jerome Powell also warned that the closer the interest rate is to zero, the more limited the ability of monetary policy to stimulate the economy will be.

This is the greatest challenge faced by the central bank.

Concerning the loose monetary environment under low and negative interest rates, ANBOUND warns that in the future the global financial market will be in a huge bubble.

This means that, in the long run, the larger the degree of the bubble process, the greater the intensity of the eruption of the economic crisis will be.

It is becoming more and more obvious to see that the world is heading in this direction now.

According to a report by The Wall Street Journal, “negative interest rates” will drive down the bank loan interest rate, but in order to compete for depositors, it is difficult for banks to lower the deposit interest rate, thereby weakening the gap between deposits and loans upon which the banks rely on for their profits.

In a world of negative interest rates, people would hold on to cash.

If financial institutions suffer from a deterioration in earnings and shrink the loans, then the economy may fall into long-term stagnation and we may even see the repetition of the “trap” that Japan has fallen into.

Summers also pointed out that when the interest rate is close to zero, it is like facing a “black hole”.

Once fallen into such a predicament, it would be difficult to escape.

In such a “black hole”, weak economic growth and low inflation will lead to low interest rates, then the decline in confidence will make it harder for people to escape low interest rates.

The United States seems to be being pulled into such “black hole”.

Many analysts believe that Europe’s entry into the negative interest rate period means that there are investment opportunities in the market with a return on investment close to zero.

The US financial market also has a very important indicator, namely the inverted yield curve, which indicates that recession is imminent.Currently, the US three-month government bond yield is 1.984%, while the 10-year government bond rate is only 1.798%. After the two were downsized on March 22 this year, they have not recovered to normal levels.

The funds generated by borrowing went to the capital market idling and many listed companies also issued debt financing to buy back their own stocks and maintain the already high stock prices.

We believe that this approach has basically had no effect on economic growth and it may only delay the bursting of the capital market bubble.

Therefore, as the negative interest rate monetary environment spreads globally, the probability of an “economic crisis” in Europe and the United States is increasing. With the predictable “crash” of high-end US stocks, this will exacerbate the severity of the crisis and its spread to the whole world.

Of course, the loosening globally with negative and low interest rates will also have an impact on China.

As China’s interest rates and economic growth rate are still relatively high, it will inevitably bring in the inflow of low-cost international capital, which is beneficial to China’s yuan exchange rate and China’s capital market in the short term.

This will also bring space and opportunities to China, as the Chinese central bank adopts countercyclical adjustment.

However, as China’s capital market becomes more open, the Chinese economy will unavoidably be affected by capital flows, the bubble in the real estate market and capital market will then become larger and larger.

At the same time, the downside of interest rates does not mean that investors will increase their investments.

In the absence of improvement in the real economy, liquidity and credit stratification will still occur, bringing new risks to small and medium-sized financial institutions and enterprises.

This environment also means that there is an urgent need to address the problem of obstruction in the monetary transmission mechanism.

Final analysis conclusion:

The European Central Bank has restarted monetary easing, which means that the monetary environment of low and negative interest rates will spread further globally. The world of negative interest rates has no precedent in history and this spells new challenges for central banks around the world. In this case, the world needs to be prepared in advance for that.

Chen Gong founded ANBOUND Think Tank in 1993. He is now ANBOUND chief researcher and is one of China’s mostrenowned experts in information analysis. Most of Chen Gong’s outstanding academic research activities are in economic information analysis, particularly in the area of public policy

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