Zero interest rates discourage savings and help create asset price bubbles

THE UNITED States Federal Reserve made news last week by raising its benchmark interest rate. However, even if the Fed continues with modest hikes, globally, rates close to and even below zero are here to stay, especially in the eurozone. The consequences for investment allocation, savings and political reform will be negative. European economies may end up in permanent sclerosis, writes World Review expert Professor Dr Michael Wohlgemuth. In the wake of the ‘Great Recession’ central banks around the world brought their policy rates close to zero, where they have remained for nearly seven years now. Some – like the European Central Bank (ECB), as well as the Swiss and the Swedish national banks – have even instituted negative interest rates for commercial bank deposits. Additionally, about 2 trillion euros worth of short-term government bonds are now priced with negative interest rates. If you lend 100 euros to, say, German Finance Minister Wolfgang Schauble for two years, the German government will hand you back 99.40 euros when the loan period is up. The Fed’s quarter point increase on December 16, 2015 finally ended seven years of zero interest rates, but it will not reverse the worldwide trend of extremely low interest rates. What this very modest, long-awaited and economically justified decision may do is trigger a massive reallocation of capital from emerging markets back to the US. Countries with current account deficits used capital imports based on cheap dollar loans to fuel domestic booms – these could now easily turn into busts. As Prince Michael of Liechtenstein pointed out in a recent GIS Statement, ‘the ECB is trying to resolve a trilemma. It wants to spur economic growth through low to negative interest rates, hit its targeted inflation rate of 2 per cent by increasing money supply, and relieve the fiscal pressures on member states by a huge bond purchasing programme.’ So far it has failed on the first two goals. According to economics textbooks, investment responds to interest rates. Lower borrowing costs make it cheaper to finance by credit and thus improve the return on investment. But in today’s circumstances, confidence is more important. Entrepreneurs need more confidence that the market and political conditions will remain stable. Banks require more confidence in borrowers, the business climate and their own future. The value of achieving the second goal (hitting the 2 per cent inflation target) is debatable in its own right. Both the Fed and the ECB are very well aware that in both of their economies core inflation – which excludes volatile food prices and drastically sinking energy prices, especially crude oil – has held fairly stable at about 1 per cent. A deflationary cycle is simply not on the cards. Policy makers also know that cheap money can cause dramatic problems, as it did before 2007. Too much money chasing too few serious investment options can lead to asset price inflation, as well as boom and bust cycles that shrink the economy. Only on the third goal, relieving fiscal pressure on member states, can the ECB claim to have had some effect – at a huge cost. While the ECB did manage to buy time for struggling finance ministers to get their accounts in order, the politicians have mostly failed to take advantage of the opportunity. The Italian government, for example, sold more than 7 billion euros of two-year government bonds at negative interest rates this year. This comes at a time when Italy is lagging behind the rest of the EU in terms of economic growth, domestic investment is at record lows, and the government’s debt-to-GDP ratio is topped only by Greece’s. For a more in-depth look at this subject with scenarios looking to future outcomes, go to our sister site: Geopolitical Information Service. Sign in for 3 Free Reports or Subscribe.

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