The International Monetary Fund is urging Central Banks to hold on to low-interest rates, as medium-term growth prospects have weakened. This includes the Fed, the Bank of England, the Bank of Japan, and the European Central Bank. On Sunday, Christine Lagarde raised the spectre of an emerging market spillover to mature economies and urged for further, albeit unorthodox, quantitative easing.
Her position reflects the status quo. Across developed economies, interest rates are close to zero. Sweden even went into negative interest rates territory. Meanwhile, the global economy has been infused with $7 trillion of extra liquidity since 2009. Still, the ECB is expected to announce a second wave of quantitative easing; the BoJ holds on to the most expansive monetary policy in Japan’s post-WWII history; and, on September 17th, the US Federal Reserve defied fiscal hawks and postponed a rise in interest rates. So, perhaps Lagarde is preaching to the converted.
The status quo does not remain uncontested. Lagarde is, in fact, trailing the primary policy consensus rather than forming it. But, there is a challenge to be reckoned with; the dream team of monetarism came together to sign a report against low-interest rates. It is approved by Jacob A. Frenkel, the most fierce of Yellen’s opponents and former Governor of the Bank of Israel, the ex-ECB President, Jean-Claude Trichet, as well as Axel Weber, previously president of the German Bundesbank and currently of the UBS. They are all calling for a rise.
Entitled “Fundamentals of central banking; the lessons of the crisis,” the report makes one factual and one ideological argument.
First, that cheap liquidity has allowed for corporate and sovereign debt to build up. Only on Monday, a $ 100 bn merger was announced between InBev and SABMiller. That will create a super consolidated monopoly, likely to bring lower employment and tax base erosion.
Secondly, cheap liquidity may allow the government to skip “structural reforms,” a frequently used byword for austerity policies. On Monday, the Spanish government defied Moscovici’s call for measures to hold the deficit within stated objectives, only to be accused of partisan politics.
Incidentally, they also have behind them a quite powerful sector that has quite a bit to lose from low corporate and sovereign bond yields. As yields on capital tumble, those dealing with cash lose out. Not only stock market bubbles are forming, but pension funds and insurers, who must maintain high liquidity and are required to be risk-averse, are losing out.
Dutch pension funds and German life insurers are in serious trouble. The Standard and Poor’s, the Bundesbank, and the Dutch Pension Federation are warning of difficulties ahead, for the long-term, defined returns investors. That may force such institutional insurers to seek higher-yield-for-higher-risk solutions, which will increase financial volatility. And if such institutional investors become insolvent or guarantee fewer returns, then individual contributors will be encouraged to save more, hurting demand further still.
Part of the problem is that cheap liquidity fuels capital markets but does little for the real economy, where investment — at least in Europe — is below 2007 levels. On the one hand, it is hard to attract institutional investors to higher risk but low-yielding bonds. For example, the European Commission’s plan to funnel €316 bn into the real economy through the EFSI may not be that attractive to investors as it is to policymakers.
Of course, there is another approach to making use of low(er) interest rates to boost demand, that is, the Chinese way. China is doing a lot of what the US and Europe have been doing. Since November 2014, interest rates have been reduced four times; over the summer, massive asset-buying programs were put in place to control the free fall of an overleveraged stock market. But, China also deploys a classic 1950s policy.
Seventy years ago, the United States invested 4% of its GDP, hoping that in rebuilding Europe demand for US products would also be boosted. Something of a similar scale and importance is happening today. China has created the Asian Infrastructure and Investment Bank, backed by $ 40 bn USD. And Beijing has earmarked $ 3oo bn in soft loans for investment in infrastructure. That is without leverage and private investors.
Where is the money to be invested? The vision is to create a new Silk Path, allowing China a pivot to Europe and entrench in the Pacific and Africa. China’s One Belt, One Road (OBOR) project has one continental dimension (belt) and one sea dimension (road). Infrastructural investment will be supporting industrial production, exports, income, market access, and demand directly, not through various “trickle-down” effects. Incidentally, it will also increase China’s geopolitical leverage.
