I’m a big fan of the original Winnie the Pooh stories. One of my favorites is when Pooh gets too much of a good thing, in his case honey, and gets stuck trying to exit Rabbit’s house. While most of us understand the idea of “too much of a good thing” when it comes to food, we don’t apply the same lessons when evaluating monetary policy. Yet there is solid evidence central banks aren’t delivering higher growth and may be undercutting their own mission by cutting rates too far.
Success (Or Lack Thereof)
Since the financial crisis of 2008, investors have welcomed rate cut after rate cut. The cuts were welcomed when the goal was to lower the cost of borrowing, when it was to decrease savings, and when it was to depreciate the currency.
But the results of all those rate cuts have been found wanting. The United States, Japan and Europe continue to struggle with low rates of growth. The U.S. hasn’t achieved 3% growth since 2004. The European Union seems stuck below 2%, and Japan is even lower. Emerging market economies aren’t picking up the slack, and the world still lacks sufficient growth.
Spurring growth seems beyond the capability of central bankers. The initial cuts were necessary – rates needed to go lower – but insufficient. At this point in the cycle, it is quite possible that the low rates are undermining growth in some ways and introducing economic risk. Undermining lending, reducing assets available for lending, and making inflation harder to manage are three negative consequences of very low rates.
Extremely low rates undermine savers and banks. When my son opened his first savings account a number of years ago, the banker stated that if he put $100 in the account and it earned 5%, he would have $105 a year later. I’m not sure the banker appreciated my pointing out the example had an interest rate around 40 times the actual rate, and it only got worse as time went on. Today, some countries charge people for their savings by paying negative rates.
Bill Gross, portfolio manager at Janus Capital Group, said in an April investment outlook that these cuts are seemingly logical, but are “not working very well because negative interest rates break down capitalistic business models related to banking, insurance, pension funds, and ultimately small savers. They can’t earn anything!” Extremely low rates remove the incentives banks have to pursue new business and the new loans central banks encourage.
Reducing Lendable Assets