Wednesday, July 18, 2012

Interest rates at minus as 'perfect storm' looms

When you borrow money you pay interest to the lender. The rate you pay is the cost of borrowing and lenders derive their profits from it. At least, that’s the way it is supposed to work.

Not any longer. On July 5, the European Central Bank cut its deposit rate to zero. That means it stopped paying interest on money deposited with it.

As a consequence, six countries with economies for the moment at the edge of the economic storm now offer negative returns for government bonds maturing in two years or less: Germany, Finland, Denmark, Switzerland, the Netherlands and Austria.

Investors in effect have to pay them to look after their money. It’s a kind of parking fee. Rather than receiving interest on the loan the investors are so desperate to find a home for their money as the crisis escalates, they are willing to pay for it to be stored. 

And as a further consequence, more than half of Europe’s money market funds investing in government bonds – so-called “securities” - have closed. Not only is there no money to be made, but, because the interest rates are negative, it means that the value of investments will fall.

Switzerland’s two-year bond yield is the lowest of the six, at minus 0.55%, while Austria’s comparable government bond yield edged down to a negative 0.01% on Tuesday.

This morning, Japan joined the stampede. The Bank of Japan scrapped the 0.1% lower limit on the rate it would pay for government bond purchases, opening its door to the possibility of buying debt with negative returns.

And in the US, policy makers “are looking for ways to address the weakness in the economy should more action be needed to promote a sustained recovery in the labour market,” said chairman of the Federal Reserve Ben Bernanke yesterday, using typically guarded language to disguise the seriousness of the situation.

Over the past 60 years the world’s economy was transformed. Production expanded, the population ballooned, the flow of commodities pouring out of factories turned into a flood.

Big and small companies operating from within national boundaries and subject to the home countries regulations expanded beyond their borders, becoming the transnational and global corporations so powerful that their requirements – for more growth from which more profits could be siphoned - determined national policies.

Regulation on the movement of capital was removed to allow the expansion of credit needed to fund continuously expanding investment. The ballooning of the credit (and debt) industry spawned a generation of brilliant, creative, inventive young people discovering ever new ways to make money out of money.

The amount of interest-bearing credit extant in the world soared, to become ten then, 20, 60 times larger than the real, substantial things of value in the world, like food, clothing, cars, roads, factories, computers,

And the velocity of its movement around the world accelerated as the power of those computers and the carrying capacity of the networks that linked them spread worldwide.
All that came to an end when the ability of people to repay their debts reached its limit, triggering the 2007/8 financial meltdown.

With the bursting of the bubble, global expansion has turned into its opposite - global contraction. In reality, interest rates have been effectively negative for years since central banks reduced their policy rates to below inflation in the wake of the crash to try and encourage more borrowing.  

The technical term for this is “financial repression” and millions of people around the world have felt its effects in unemployment, lost home, pensions, soaring food prices, and increasingly brutal austerity programmes.

Negative interest rates are a sign of increasing desperation in global economic and financial circles. Leading economist Nouriel Roubine is convinced that 2013 will produce a “perfect storm” as a number of factors come together to derail the global economy. You can’t say we haven’t been warned. 

Gerry Gold
Economics editor

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