By Chan Kung and Wei Hongxu*
Prior to the Covid-19 outbreak, ANBOUND’s researchers has noted an expanding of the global monetary environment of zero and negative interest rates amid a global glut of liquidity. The spread of Covid-19 has further exacerbated the decline in global interest rates. The impact of the pandemic on the economy and the financial market prompted the Federal Reserve to adopt the ultra-loose policy of zero-interest rate. Central banks around the world have also lowered their benchmark interest rates one after another, while buying large amounts of government bonds and carrying out large-scale fiscal stimulus. A total of 146 countries and regions have cut interest rates in 2020. Super monetary easing has made ultra-low interest rates such as zero-interest rates and negative interest rates a universal phenomenon worldwide. As the Nikkei put it, the ultra-loose policies of the world’s central banks are leading to “the death of interest rates”.
The Nikkei study of 10-year Treasury yields in 62 major countries as of June 12, based on data from Refinitiv, a financial information company, found that the equivalent of 48% or 30 countries had 10-year Treasury yields below 1%. The yields were negative in 10 of these countries and slightly more than 0% in these 20 countries. Compared with the end of 2019, there are six more countries, including the United States and Canada were added to the list. The yield on the once high-interest Australian dollar fell as low as 0.6%. Thailand’s 10-year Treasury yield is about 1%, and the decline in interest rates in emerging market countries is also very prominent. Even in this case, inflation has not risen in the U.S., China, and the eurozone and Japan, which have already implemented negative interest rate policies. This means that in the future, when the economy continues to slow down, the policy rate of all countries will keep zero interest rate or negative interest rate for a long time, and even lose its due role in the future.
Of course, the ultra-loose monetary policy represented by the Fed has indeed played a role in alleviating the crisis caused by the pandemic in the short term. In fact, many proponents of ultra-loose policy believe that it is essentially a “time-for-space” policy to reverse the downward turn of the economic cycle with policy stimulus before inflation rises. However, judging from the implementation of negative interest rate policies in the eurozone and Japan, in fact, years of negative interest rate and quantitative easing (QE) did not promote the inflation level, but fell into the dilemma of low-interest rate and low growth, making it difficult to exit from the monetary easing. After the 2008 financial crisis, the United States briefly raised interest rates in an attempt to normalize monetary policy, but capital market volatility and panic, as well as pressures from President Trump, forced it to continue abandoning the effort. This means that financial markets increasingly influence central banks, making it difficult for them to escape the effects of excess capital.
As ANBOUND previously suggested, the ultra-loose policy of the Fed has shown negative effects, especially the weakened function of interest rate, which makes it difficult to reflect the real financial demand and supply, and also leads to price distortion in the financial market. In this sense, it is true that interest rates face a real “death” if global monetary easing continues. Toshihiko Fukui, former governor of the Bank of Japan, once said that “1% is the lowest level at which rates can function”. Interest rates boost the economy’s metabolism by phasing out businesses. They can also signal fiscal deterioration and warn against inflation. With interest rates below 1% in half the major countries, the trend towards “death of interest rates” is even more pronounced.
The side effects of “killing” interest rates are significant. It directly promotes the “debt monetization” of various countries, making national policies play an increasingly strong role in the market, and the market itself is gradually losing its function. Estimates from the Institute of International Finance show that the Fed’s Treasury holdings reached 22% of outstanding issuance at the end of June, up 8 percentage points from the end of 2019. Moreover, the European Central Bank and the Bank of England hold about 30% of their national and regional government bonds, while the Bank of Japan’s holdings has reached 50% of outstanding government bonds after a long period of QE. The Fed is also following in the footsteps of the Bank of Japan, buying corporate bonds and becoming the biggest player in financial markets. As this continues, market participants will become more and more prone to policy arbitrage and the role of financial markets will gradually diminish. At the same time, excess money has driven up the prices of risky assets and is at the root of the current stock market bubble. That means more volatility in the stock and risky bond markets. For emerging economies adopting the loose monetary policy, the risk of capital outflow is greater due to insufficient credit of the central banks, which is more prone to monetary crisis and financial market crisis.
Most worrying part of all is that the “death of interest rates” will lead to the persistence of low growth. Due to low-interest rate, zombie enterprises that survive in the state of low yield increase globally, resulting in a continuous decline in investment efficiency, thus dragging the real economy into the “Japanization” trend of low growth. In the aftermath of the pandemic, it is likely that the global economy will sink into a recession. The global monetary system will also accelerate the shift towards the geopolitical pattern as mentioned by ANBOUND.
Final analysis conclusion:
Driven by ultra-loose monetary policy, the ultra-low interest rate environment around the world is expanding rapidly, making interest rates less and less useful as a measure of currency and financial prices. It is safe to say that Covid-19 is bringing the “death of interest rates” with unpredictable long-term consequences for the global economy and financial markets.
Founder of Anbound Think Tank in 1993, Chan Kung is now ANBOUND Chief Researcher. Chan Kung is one of China’s renowned experts in information analysis. Most of Chan Kung‘s outstanding academic research activities are in economic information analysis, particularly in the area of public policy.
*Wei Hongxu, graduated from the School of Mathematics of Peking University with a Ph.D. in Economics from the University of Birmingham, UK in 2010 and is a researcher at Anbound Consulting, an independent think tank with headquarters in Beijing. Established in 1993, Anbound