Imagine your bank paying you to buy a house
A foreign concept? For South Africans, most likely. While the South African Reserve Bank (Sarb) kept interest rates on hold in May, the local economy is still firmly in a rate hiking cycle.
Yet, according to Fitch Ratings, global sovereign debt with negative yields topped $10 trillion in May. These bonds have mainly been issued in Japan, Europe and Scandinavia – not in the US.
Ray Wallace, chief investment officer at Taquanta Asset Managers, says all global banking systems have been built on positive interest rates. The current situation is somewhat of an oddity.
“I can’t recall doing any of this at university,” he quips.
Why there are negative interest rates
The main reason Central Banks use negative interest rate policies is due to the flexibility it provides.
“You’ve had the quantitative easing over the last few years since 2008 and in a lot of the economies it hasn’t really worked. You are still seeing situations where there is low growth,” Wallace says.
Negative interest rates are thus one more tool to try and stimulate growth.
Another reason is for potential currency depreciation, which makes an economy more competitive, he says.
The fear of deflation
The big driving force behind these policies is the fear of deflation. In a deflationary environment there is an expectation that prices will fall. As a result, consumers delay their spending and economic growth suffers.
Governments (typically the biggest debtor in an economy) keep borrowing money, but as deflation increases, the real burden of their debt also grows. This is a situation governments would rather avoid, he says.
Another concern is wages. In an inflationary environment wages increase in line with the price levels of goods and services, but while prices would drop in a deflationary environment it is very difficult to adjust wages lower. People will either have to be retrenched or other aggressive ways of cutting wages will have to be found – a move that will likely result in social unrest.
To avoid this, and to get inflation back into the system, Central Banks cut lending rates, encouraging banks to lend to consumers and corporates who use it for capital development and in that way stimulate the economy, Wallace explains.
Do negative interest rates actually work?
Wallace says a lot of the evidence suggests that negative interest rates may not be as effective as policymakers have anticipated.
Despite negative interest rates in Denmark, the country’s deflationary cycle continues. Although negative interest rates should result in lower mortgage rates for banking clients, the opposite has happened in Switzerland, presumably because banks don’t want to pass on negative rates to depositors. Instead, they absorb the cost and set it off by increasing the rates on mortgage loans or longer-term loans, he says.
Notwithstanding efforts to devalue its currency, negative interest rates in Japan have had the opposite effect.
While it may still be too early to really gauge the success of the negative interest rate experiment, “helicopter money”, a term coined by American economist Milton Friedman in the 1960s, may arguably be the next step.
In very basic terms, helicopter money refers to cutting out the sophisticated investor middleman, and giving money directly to consumers. This money can then be spent directly in the economy to stimulate demand.
One example of this was a recent Swiss proposal to introduce a monthly income of 2 500 Swiss francs (roughly R38 300) for all adult citizens. It was voted down by “a wide margin” earlier in June, Reuters reported previously.
Similar proposals have also been raised in Finland, Canada and the Netherlands.
Unlike other expansionary policies, which tend to transfer money into the hands of sophisticated investors who invest it in other financial assets that often fail to stimulate economic growth, helicopter money arguably puts money into the hands of consumers who buy goods and services that can stimulate the economy, Wallace says.
The implications for SA
With inflation still outside the Sarb’s target band of 3% to 6% and interest rates on the rise, deflation is not something keeping local policymakers up at night.
But as global growth remains subdued, South Africa will also struggle to kick the economy into gear, Wallace says.
“Theoretically the government should be able to go out to the international financial world and be able to borrow money more cheaply, but in reality we know that this low global growth has meant low demand and low commodity prices and so emerging markets are suffering from it.”
In theory, the high interest rate differential between South Africa and countries with negative interest rates should encourage money into local bonds and equities and into the local economy. It should also be positive for the currency.
Until South Africa addresses ineffective policies and sorts out its political issues, it is unlikely to get any of the benefits of low interest rates internationally, he says.