Is it getting dark?
Photo: Jason Jenkins. Source: Flikr. CC-BY-SA 2.0
It’s been said that you only see the starlight when the sun goes down. And the sun has been going down on interest rates for a long, long time. Japan is perhaps the poster-child for low rates. Their economy went through a serious contraction in the late ‘90s, and interest rates there fell to almost zero in 2001. They went negative in 2015.
In Europe, some countries began to see negative interest rates in the early ‘teens, after the Greek debt and Euro crisis. Central bank President Mario Draghi vowed to do “whatever it takes” to maintain the legitimacy of the common currency, and that included setting negative interest rates for bank reserves held with the European Central Bank. Since then, policy rates have gone more deeply negative.
Now, the Yen, the Euro, the Swiss Franc, and the Swedish and Danish Krone all have negative short-term rates. Among the top 10 economies of the world, four of them have negative rates. The US has higher rates than any developed economy – closer to China than to Germany or Japan. No country is an island: in an era of global trade and capital flows, negative interest rates will pull other interest rates down with them.
This is part of the reason the stock market freaked out last year when the Fed tried to “normalize” rates, and why it did the same thing in early 2016 when the Fed tried to do the same thing. Low rates lead to a low cost of capital, which causes some companies to be highly profitable. Central banks may “want” to have normal policy. But just wanting something isn’t enough.
Negative interest rates have a pernicious effect across the global economy. They distort asset prices, weaken the banking system, contribute to income inequality, and create incentives to simply game the system. After all, if you can create real risk-free returns by shifting deposits and holding paper currency, why not?
There are good demographic and fundamental reasons why interest rates in the US are as high as they are. But those aren’t written in stone. If Europe and Japan continue to flail about, they just might pull our interest rates down with them.
Douglas R. Tengdin, CFA
Charter Trust Company
“The Best Trust Company in New England”