Millennium Post

Western bankers have no solution

Central bankers in the developed world are entering into a surrealistic world. Ever since unconventional monetary policies were launched in the wake of the financial crisis of 2008, the central banks are wading into areas further and further from reality. They had introduced low-interest rate regimes to encourage economic activity. When that did not work, they started quantitative easing or simply pushing more and more money into financial systems.

When it seemed that the economies were talking of returning back to normal policy frames, threats of renewed recession put a brake in the process. Then came ultra-low inflation and QEs were followed up by the EU and Japan. When even that did not work, the central banks decided to get into negative interest rate regime.

Consider what a wonderful world it would be if you are able to walk into a restaurant, eat to your content, and then before you come out you are paid some money – maybe, a part of the listed price of the food—for the pleasure of having eaten the fare provided by the restaurant.

If you don’t believe it is possible, something similar is happening. Not in India, but in Japan. Not in eating joints but in the financial transactions between the Japanese central bank and its banks, between investors in Japan and the Japanese government.

A couple of weeks back the Japanese central bank had earlier introduced what has come to be a “negative interest rate regime”. It had stipulated that the banks will get the negative interest rate on their deposits with the central bank. It will, in effect, mean that a bank depositing, say, Rs100 with the central bank will get a small amount (say, ten paise deducted from its deposit amount. It is like when you lend your money, you just as well pay a little fee for accepting the loan.

When the transactions happen in huge volume, the small deduction amounts to considerable loss and act as a disincentive. Why did the central bank do it? 

The central bank was trying to give a push to economic activity. A negative interest rate was thought to be enough to drive the banks lower their lending rates and offer more bank credit. This should also help to lift inflation in the economy as Japan has been seeing falling prices again. Known as “deflation”, fighting falling prices is much more difficult than fighting rising prices.

Is negative rate working? Looks like it is not. As the banks are facing a loss of profit and earnings on their deposits with Japanese central bank, banks could either cut their deposit rates. This will depress consumer spending and further push prices down. Alternatively, banks are seeking to raise their lending rates and this could bring down credit and discourage economic activity.

A culmination of these policies happened this week in the Japanese Treasury bond market. For the first time in history, any government bond is having a “negative yield”. That is, investors are buying Japanese government bonds – known popularly as 10-year JGB—at prices which offer them a negative return. The yield on JGB stood at minus 0.03 percent in the Japanese financial markets on February 10.

This could happen because as equity markets globally were sinking, investors had all flocked into Japanese government bonds for security and the bond prices rose to such an extent that the interest rate on it gave a negative yield. This was the result of what is known as “risk aversion” on the part of investors.

This movement of funds into Japan has also pushed up Japanese currency’s exchange rate to an all-time high of 114 yen to a dollar. Japanese central bank has been trying to bring down the exchange rate to around 120 yen to a dollar.

The central banks in the developed countries have been experimenting with monetary policy as never before. Now the results of those policies are coming home to roost.

In a way, central banks extraordinary monetary policies are creating fresh distortions in the global economy and now starting to crimp economic activity. Since the introduction of quantitative easing (QE) and a low-interest regime, debt volumes have risen to unprecedented heights and this is over-hanging on the global financial system. Instead of that loan overhang encouraging activity, now it is bearing down on economies. Overall debt has risen from $40 trillion to over $225trillion today, according to figures.

Experts are pointing out that the central bankers have followed policies which started influencing financial assets pricing and hence, this is weighing on the financial markets. The results are sprouting in surprising zones. This sudden flight into Japanese government bonds happened on the back of an all-round slide in global stock markets.

European stocks fell sharply in trading on Tuesday, (February 9) on fears of a recession. To add to the woes, negative reports came flooding which left some of the key sectors struggling. A report that Germany’s biggest lender, Deutsche Bank, did not have enough funds to meets in payments obligations on some loans by 2017, led to a collapse of the share price.

In the course of a day, Deutsche Bank market valuation was lost to the tune of 2 billion Euros. That affected the banking stocks in general and the sentiments in the stocks markets. On February 10, all Asian markets tumbled.

Two questions are coming up fast: first, will the financial markets turmoil affect the real economy and bring about a collapse and recession? Secondly, how to get out of the extraordinary monetary policy phase and get into a normal world. There are no answers as yet.

(The views expressed are strictly personal)
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