Saving ammo for battle ahead
Interest rates are currently in the negative zone in many parts of Europe and Japan. About a quarter of the global economy is in the sub-zero rate zone. In theory, a negative interest environment is where a depositor is charged for placing money in a bank account instead of getting a positive yield. Currently, an average consumer remains unaffected as it only applies when a commercial bank parks money in the central bank.
But it nevertheless has a toll on borrowing rates. In Japan, placing 100 million won ($81,037) in a bank would only get 2,000 won return a year later as the interest rate per annum amounts to just 0.02 percent. People no longer can expect to live off interest income. So where should people without steady income like retired citizens take their savings? Life for seniors becomes more and more unstable because of the insecurity in long-term asset management in annuity funds like pension and insurance policies.
Negative rates would have been unimaginable a few years ago. It is an extreme monetary action. Why do central banks need to resort to such a drastic measure? The Bank of Japan, which took the stunning action on Jan. 29 after keeping interest rates at near zero percent for years and conducting massive quantitative easing (QE) program, explained that negative interest was an action to further stimulate consumer spending and corporate investment to kick the economy out of a deflationary cycle. The unorthodox choice is aimed at making financial institutions invest their money in stocks or real estate - instead of piling them up at the central bank - as well as persuading individuals and companies to spend rather than save.
But the problem is that consumers and companies did not act as hoped. Personal safes sold like hot cakes in Japan and Europe. People are opting to stash their money at home. Mario Draghi, president of the European Central Bank - first to venture below the zero interest zone last year - said the bank was contemplating doing away with the 500 euro bills. He said the move is aimed at preventing money laundering and abuse of notes, but is actually more targeted at making it difficult for people to pile up money at home.
Negative interest is the last resort in monetary tools. How it can actually stimulate consumer and corporate spending remains questionable. The action only played as a damper to confidence because it suggests authorities have run out of options to save the economy. The theoretical goal of negative interest rate is to stave off deflation and boost inflationary expectations. But people and companies are moving in the opposite direction; deflationary symptoms have deepened, further depressing consumption and investment. The setbacks are harsher for financial institutions. Shares of European and Japanese banks have plunged by more than 20 percent amid concerns for their profitability from poor deposit margins.
Despite the apparent risks, the central banks went ahead with the action in order to scare off foreign capital and devalue their currencies. Denmark and Switzerland have adopted negative interest to slow down and reverse appreciation of their respective currencies. Japan’s move has the same motive. As the Chinese economy stumbled and oil prices nose-dived, they turned to negative interest. The yen strengthened sharply because Japanese companies and investors sold off their overseas assets and brought them back home. The capital run towards safer assets also sent the yen sharply higher. From the end of last year, the Japanese economy began to contract and exports in January plunged by a whopping 12.9 percent. Abenomics that succeeded by reviving sentiment was in jeopardy.
Negative interest rates in Japan and Europe have triggered a currency war. The action will stall appreciation in currencies to some extent, but as international investor Jim Rogers repeatedly warned, the devaluation race could amount to a financial Armageddon. Negative interest rates will only create more bubbles in stocks and real estate to build up to a cataclysm.
The U.S. Federal Reserve has stalled its tightening campaign and instead may opt to lower the base rate back to near zero. The Bank of Korea is also pressured for similar action. The local bank should put off any rate action as long as possible. The won should be left up to the market. Once in a liquidity trap, even extreme measures like QE or negative interest can help little. Korea could be swept up in the currency war. We better save ammunition for the real battle.
JoongAng Ilbo, Feb. 22, Page 30
*The author is an editorial writer of the JoongAng Ilbo.