Waiting for the scales to tip towards risk

Banks around the world are preferring to hold money for almost no return and businesses and customers are still spooked. But there are some signs furious rate cutting is starting to work.

You be the judge of the strength of the global economy and the inflation risks that are confronting policy makers. Or should that be deflation risks? Consider the following.

Many countries with scope to do so are furiously and often unexpectedly cutting interest rates.

Those countries with interest rates at or near zero with no scope to cut rates are printing money through quantitative easing or considering the notion of having negative interest rates.

There is no doubt that global monetary policy, if there was such a simple measure, is the easiest it has been in economic history. Every country in the G7 has interest rates at 1 per cent or less, by way of simple illustration of that point.

In the last month or so, there have been interest rate cuts in the eurozone, India, Australia, South Korea, Kenya, Poland, Botswana, Mongolia, Belarus, Moldova, Austria, Belgium, Hungary, and Turkey, to name a few. 

Over recent times, some of the biggest economies in the world have either extended quantitative easing or canvassed the idea of buying bonds – the US, Japan, the UK and the eurozone (again) are standouts. The European Central Bank President, Mario Draghi has even flagged the possibility of setting negative interest rates in an effort to get banks lending to households and business and thereby supporting investment, economic growth and jobs.

While I have not had the opportunity to examine the background to the easier monetary in all of the examples listed, the end point, no doubt, is that sub-trend economic growth, high unemployment, persistently low inflation and heightened risks to the economy are the main reasons behind the moves.

Supporting the stance of extremely easy global monetary policy has been fiscal consolidation, that is smaller budget deficits or moves to surpluses; or in more extreme examples, fiscal austerity which entails extreme spending cuts as governments strive to have a smaller budget deficit at all costs. 

The budget measures in most of the countries cutting interest rates or embarking on QE are pulling money and therefore economic growth out of a country. The national accounting identity of Gross Domestic Product equaling Consumption Investment Government Exports – Imports (C I G X-M) has a big negative for ‘G’ throughout the world. No wonder GDP growth is weak or falling.

Easy monetary policy is endeavouring, in this instance, is making money so cheap that eventually spending, borrowing, investment and then job creation must pick up.

For reasons to do with capital preservation and the elimination of risk, banks are willing to accept a near zero return or rate of interest for holding their cash in short term government bonds or in deposits with their central bank.

The alternative, after all, is a higher return by lending it to another bank, a business or an individual but with the risk that the counterparty who borrowed the money will not pay it back.

This, of course, assumes the potential borrowers want to approach the banks for cash to use for investment or spending. When economic times are tough, profits are weak and employment fragile, demand for credit will be weak.

And this is roughly where we are in the global economy. Banks don’t want to lend, potential borrowers don’t want to borrow – even with interest rates skirting zero. 

Banks are preferring to hold money in bonds or deposits and get next to zero return, while business and consumers are shy of debt given their experience in the global financial crisis, and in weak economic conditions, a viable investment destination.

The end game is a lack of confidence from both potential lenders and potential borrowers.

It is to be hoped that monetary policy will eventually work and this risk aversion changes. There are signs of monetary policy starting to work with the surge in stock prices over the past year or so.

Flushed with cash, investors are buying stocks, which is pushing share prices to record highs. The bulk of this is probably speculative rather than fundamentally driven, but the day is hopefully getting nearer when all this liquidity and record low interest rates does spill over to the real economy. When it does, investment and spending will rise which will generate job opportunities and with it an economic recovery.

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