Investment Outlook 2016 – Trend 5, Published Sep 26, 2016
This blog is part of Sanctum Wealth Management’s Mid-year Investment Outlook 2016. The Outlook gives us an opportunity to step back and look at the big picture to identify trends that have the potential to affect investment portfolios, both domestically and globally. We’re focused on six key trends and this week’s blog calls attention to the role of governments and private enterprises to make new money productive and how offering debt relief would be imperative to give the world a fresh start.
Cutting interest rates to historically low levels has failed to revive growth. Quantitative easing bought bankers a couple of years but mostly the banks sat on the cash instead of loaning it.
Negative interest rate policy
The central banks of Denmark, Sweden, Switzerland, Japan, and the Eurozone have moved forward on it. The U.S. Federal Reserve and the Bank of England have considered it. Negative interest rates are simply the case where a central bank taxes deposits instead of paying interest on commercial banks’ excess reserves. The idea is to compel banks to reduce their unspent balances and increase their lending or investments. That’s a dangerous incentivisation structure.
Negative interest rates are the latest attempt to overcome the mismatch of incentives for lenders and borrowers. Making it costly for commercial banks to park their money with the central bank should lower the cost of commercial loans. The hope is to incent commercial banks to put money into circulation, via loans or buying government securities, than to pay the central bank for holding that money.
But, as the World Bank points out, negative rates can have undesirable effects. They can erode bank profitability by narrowing interest-rate margins besides forcing banks to take excessive risks, leading to asset bubbles. Lower interest rates on deposits are a death knell to retirees.
Apart from these complications, the real case against negative interest rates is the folly of relying on monetary policy alone to rescue economies from depressed conditions. Keynes put it in a nutshell: “If we are tempted to assert that money is the drink which stimulates the system into activity, we must remind ourselves that there may be several slips between the cup and the drink.”
“For whilst an increase in the quantity of money may be expected…to reduce the rate of interest, this will not happen if the liquidity preferences of the public are increasing more than the quantity of money; and whilst a decline in the rate of interest may be expected…to increase the volume of investment, this will not happen if profit expectations are falling faster than the rate of interest; and whilst an increase in the volume of investment may be expected…to increase employment, this may not happen if the propensity to consume is falling off.”
Well said. Whether it’s taxing cash holdings, going cashless or showering the population with “helicopter drops” of freshly printed money, the only way to ensure the “new money” flowing into circulation is productive is to have governments or private enterprises invest it to build houses, renew transport systems, invest in energy-saving technologies, and so forth. Incidentally, this is precisely what the Government of India is doing.
“The only way to ensure the “new money” flowing into circulation is productive is to have governments or private enterprises invest.”
So where exactly does this lead to? Bill Gross recently made headlines by explaining that Japan was bankrupt and its central bank would have to acquire the nation’s debt and then `forego repayment.’ What billionaire Gross is talking about here is a debt jubilee. William White of Bank for International Settlements also said that the world debt was impossible to pay down and a debt jubilee would be necessary to give the world a fresh start.
This trend is the elephant in the room; the daily risk that investors and investment managers must live with. For now, central banks have managed to avoid a disaster. However, a recognition is now building that the central banks may not have a clear go forward strategy. The attendant loss of moral authority has been notable.
There was a time – a scant 15 years ago – when the U.S. reigned supreme as a superpower. The new century has seen the emergence of China, the re-emergence of Russia along with the emergence of Germany and India as powers that need to be counted. The world has largely caught up with the U.S.
Mid-Year Investment Outlook 2016