By John Richardson
WE are entering an almost surreal world where Western central bankers, rather than admit they are wrong, have either already opted for, are in the case of the Fed are openly discussing, negative lending rates.
If the Fed and other central banks followed the examples of the likes of European Central Bank, the Bank of Japan (BOJ) and the Riksbank – Sweden’s central bank, this would be the result:
- The individual banks would be forced to charge negative interest rates on deposits to cover the costs of paying lenders to borrow money. These individual banks would also need to generate revenues to the cover the costs levied on them of storing their money with the central banks. This is another aspect of negative interest rate policies.
- These negative rates on deposits would result in customers withdrawing money to place their cash in warehouses. A whole new industry would spring up of super-secure warehouses, which would charge less than the negative rates applied to deposits.
- Gift vouchers, long-term subscriptions, urban-transport cards and mobile-phone SIM cards would also gain greater popularity as a way of avoiding paying fees to banks to store money. Virtual currencies, such as BitCoin, would gain extra momentum.
- This flight to hard cash and other stores of value, such as also gold bars or art work, might create the effect of reducing the viability of banks to the point where they look to be at risk of going bust. This would encourage more withdrawal of deposits and so the vicious circle would continue.
- Or at the very best, the deposit outflow from the banks would reduce their reserves to the point where their capital adequacy would be insufficient to allow them to lend more money.
Most seriously of all, which is why it is worth separate mention, is the subsequent “race to the bottom”. If the Fed opted for negative rates then the dollar would weaken. Other central banks would follow suit as they attempted to weaken their own currencies, particularly the economies that are heavily reliant on exports.
We would then be involved in a war of tit-for-tat lower rates, in an effort to weaken currencies as major exporting countries tried to export their way out of trouble. This would worsen today’s global deflationary problems and quite likely result in trade wars. A repeat of the Great Depression, perhaps.
How would China respond in this scenario? China might, even without more widespread negative interest rates, be forced into a major devaluation of the Yuan because of its existing capital outflow problems.
A significant competitive devaluation of the Yuan would the biggest single trigger of a global trade war, and so the last thing we need is the extra pressure on China that would result from an increase in the popularity of negative interest rates. I will look at China’s current capital flight problems in more detail on Wednesday and discuss the various scenarios.
Back to this issue. Why negative interest rates cannot possibly work is because of the global demand deficit resulting from ageing populations.
People won’t want or need to borrow more money, no matter what the cost, and will instead want to save their money. Hence, they will not tolerate negative rates on bank deposits.
You don’t even have to look into the future to see the effect of ageing populations, but can instead turn to Japan as historical evidence. Its 20 years of weak GDP growth and deflation are the result of its rapidly rising army of retirees versus a falling number of working people. This is why the BOJ’s January decision to opt for negative interest rates cannot possibly work.
You can also think about it from this perspective: No economy is an island, we are all interconnected.
Ever since the Abenomics quantitative easing programme was launched in December 2012, the weakening of the Yen has put huge pressure on other export-focused countries such as South Korea.
The South Korean Won has strengthened relative to the Yen, making it obviously much harder for South Korea to export its away out of its own very serious demographic problems. It, too, confronts a rapidly ageing population. It is at risk of going the same way as Japan.
Look at it from this perspective as well: How can export-based growth work for any economy when everywhere you turn the demographic issues are the same?
If your population is ageing, retirees already have most of what they need, and are in more straitened economic circumstances because they are living on pensions. They will thus buy less, rather than more, of both imported and locally-made goods.
The two maps at the beginning of this blog post, from BrilliantMaps.com show the extent of global population ageing.
They highlight the dramatic collapse in fertility rates since 1970, which have nearly halved from a global average of 4.85 babies/woman to just 2.5 babies per woman today:
- Dark blue covers countries where rates are 1 – 2 babies/woman.
- Light blue is 2 – 3 babies/woman.
- Green is 3 – 4 babies/woman.
- Yellow is 4 – 5 babies/woman.
- Red is 5 – 6 babies/woman.
- Pink is 6 – 7 babies/woman
The maps show 72 countries now have fertility rates below replacement levels of 2.1 babies/woman, compared to just two countries in 1970 (Finland and Sweden).
Until the consensus shifted, you would have been able to easily counter this demographic argument with claims that the rise of the middle classes in emerging markets would provide more than sufficient replacement demand for all the lost demand in the developed world.
But this argument never stood up because as everyone should have long known, China faces its own ageing issue as a result of the One Child Policy.
And in countries such as India, and across the African continent, the failure to satisfy the basic needs of decent water, sanitation and electricity supply etc. risks turning their demographic dividends of youthful populations into demographic deficits.
It was also wrong to ever claim that people in the developing world were rapidly becoming middle class by Western standards. Serious analysis of income data has always told us that this conclusion was nonsense.
And finally, we need to turn back to China. China doesn’t just confront a demographics crisis, but also debt and environmental crises. It needs an entirely new growth model, which, if it can be successfully built at all, will take many years to build. This is the single biggest drag on global growth and is thus another reason why negative interest rates will fail.
Because of the collapse in global growth resulting from China’s reforms, once again: How can attempting to force people to borrow more money that they simply don’t need possibly work? Think of Germany and the loss of export revenues as China continues to slow down.
I just hope that policymakers will wise-up before it’s too late. But the chances of that happening seem incredibly slim, I am afraid.