Following the 2007-2009 financial crisis, there has been a tendency for interest rates to fall rapidly in the economies of the West. This process has spread to loans, bank deposits, debt securities and other financial instruments. Increasingly, interest rates are near zero and are even becoming negative, and this is just the beginning. Over time, the entire financial system could go under, i.e. every financial instrument will generate a negative return.
It is interesting that the fall in interest rates in Western economies is taking place against the backdrop of extremely high interest rates being maintained in the economies of countries on the periphery of global capitalism. Currently, the base (key) rates of central banks in certain developed countries are as follows: US (Federal Reserve System) – 0.25-0.50; Australia – 1.75; UK – 0.50; Canada – 0.50; and Norway – 0.50. A number of central banks have negative interest rates: Japan – -0.10; Switzerland – -0.75; Denmark – -0.75; and Sweden – -0.50. The interest rate of the European Central Bank, which oversees monetary policy in the eurozone (19 countries), is set at zero.
In contrast, the interest rate picture for the central banks of countries on the periphery of global capitalism is as follows: Brazil – 14.25; Russia – 10.5; Turkey – 7.5; Colombia – 7.0; South Africa – 6.75; India – 6.0; and China – 4.35.
These trends are changing the behaviour of market participants and countries’ economic and financial policies, and are impacting on people’s lives. Let us try to map out the most significant consequences of lowering interest rates in Western economies. The following ten seem to be the most significant.
Consequence one. The flight of clients from banks. Already, commercial banks in a number of countries have started to introduce negative interest rates on deposit accounts. This is not just worrying individuals, but companies and banks as well. In particular, commercial banks could begin withdrawing their own funds from deposits with central banks.
Consequence two. The flight of individuals from banks will increase demand for physical money, which people will either keep under their mattresses or in safe deposit boxes. It is not altogether impossible that a parallel money system will emerge (cash and non-cash). The demand for cash could also increase dramatically on the part of companies. One of Germany’s leading credit organisations, Commerzbank, has stated that it has no intention of keeping its funds in a ‘negative’ deposit account at the Central Bank and is planning to transfer hundreds of millions of euros in cash and store it in its vaults.
Consequence three. An increase in demand for land, real estate and other material assets can be expected on the part of companies and individuals. Investment in these will be an alternative to or in addition to transactions to convert non-cash money into physical money.
Consequence four. There will be a sharp increase in demand for gold and other precious metals, causing the price of gold to rise. While the price of one troy ounce of gold was equal to US $1061.50 at the beginning of the year, it has now passed the US $1300 mark. This happened after the Federal Reserve decided not to revise its interest rate on 15 June, leaving it unchanged at 0.25-0.50 percent. Investors are starting to turn their back on the US dollar in favour of gold. Experts are predicting that the price of gold will hit US $1400 per troy ounce by the end of the year.
Consequence five. There will be a sharp increase in demand for loans on the part of both individuals and companies. With the help of cheap or even free loans, they will purchase, among other things, real estate, other material assets and precious metals. Moreover, there will be a massive demand for loans if the interest rates on them become negative. Banks in Denmark and Belgium are already offering negative interest rate loans to individuals.
Consequence six. Many institutional investors (especially pension funds and insurance companies) are now experiencing serious financial difficulties. The problem is that their assets are primarily composed of debt securities issued by governments (Treasuries), but these securities are starting to go under. At the beginning of June 2016, the total volume of such securities exceeded US $10 trillion. Deutsche Bank estimates that on 1 February 2016, the share of bonds with a negative yield was 25 percent of the global volume of government securities, compared with 6.8 percent the year before. And even if the securities still have a positive yield, it is not enough for pension funds and insurance companies to fulfil their obligations in full. There are a large number of publications today on the critical condition of US pension funds. The bulk of the securities in their assets is made up Treasury bonds with low interest rates, which are insufficient to meet current obligations to pensioners. Back in 2014, experts predicted that 85 percent of all US pension funds would go bankrupt in the next 20 years.
In Europe, where pensions funds are obliged to buy local bonds with negative interest rates, the pension system will collapse much earlier.
Consequence seven. Many major corporations are starting to scale up the issuance of their own bonds, which look much more attractive compared with government bonds since they have positive interest rates. However, some corporations with a good market reputation are already talking about plans to issue debt securities with a negative interest rate. Their interest rate policy is that the negative interest rate of corporate bonds will be more moderate compared with the negative interest rate of government securities.
Consequence eight. Since the international reserves of central banks are largely formed through the purchase of government debt securities and these securities are going under, the profitability of these reserves is moving from positive to negative.
Consequence nine. The government debts of developed countries are beginning to quietly melt away. IMF data on the relative level of certain countries’ government debt is as follows (% of GDP, 2015): Japan – 248; Greece – 178; Italy – 132; Portugal – 128; US – 106; Belgium – 106; France – 97; Canada – 91; UK – 89; and Germany – 71. For comparison, here are the figures for a few countries on the periphery of global capitalism (% of GDP, 2015): India – 67; China – 44; the Philippines – 37; Indonesia – 27; and Russia – 18. It should be noted that the government debt of countries on the periphery of global capitalism cannot melt away, since the credits and loans given to these countries have rather substantial positive interest rates.
Consequence ten. It can be expected that investors and financial speculators from developed countries will try to penetrate the financial markets of countries on the periphery of global capitalism. This kind of business is already flourishing and specialists call it ‘interest rate arbitrage’ (taking advantage of differences in interest rates). Sometimes, neither economic sanctions imposed by the West nor the foreign exchange restrictions on capital transactions by countries on the periphery of global capitalism are enough to discourage people from wanting to make big money through interest rate arbitrage. A large part of this interest rate arbitrage involves shady business practices.
If the consequences of the West’s financial system going under had to be described in brief, one could say that negative interest rates are pushing businesses to spend money they do not have and build up debt they will never pay back. This situation is more than a little strange.
The public finance and economic management system that currently exists in the majority of countries around the world was built on positive interest rates. If the monetary authorities of those countries where a strong transition to negative interest rates is already underway have time to rebuild the management system, then it is possible that the negative consequences listed above can be prevented. At present, however, there are either no attempts being made to reorganise the management system in developed countries or impulsive attempts are being made to return to the good old days when interest rates were positive. No-one will be able to do this, however. A good example is the US Federal Reserve System. Last year’s statements by US monetary authorities on successive interest rate increases (to 3-3.5 percent in two years) are coming up against insurmountable obstacles. Near-zero interest rates have been unable to restore the US economy, which needs more and more injections of free money. Those in favour of America joining the ‘negative interest rate club’, to which many European countries and Japan already belong, are becoming ever stronger.
The long-term consequences of diving into the swamp of negative interest rates and deflation are impossible to calculate.