Negative on Japan’s Negative Interest Rates

Negative on Japan’s Negative Interest Rates

by Brad McMillan Commonwealth Financial Network

negative interest ratesOne of the most interesting (and surprising) pieces of news on the economics front has been the Bank of Japan’s decision to take rates to negative levels—in other words, to charge depositors to keep their money in the bank. This is not an unprecedented move, as negative rates have been in place for a while in some European countries, but it’s still somewhat unusual.

Negative rates: logical or nuts?

In some respects, negative rates are a logical extension of current low interest rate policies. The whole point of central bank bond-buying was to push down interest rates, making it easier and cheaper to borrow. If that’s not working, the argument goes, why not take rates negative? It would certainly encourage banks to lend, if only because any positive return is better than a negative one. And on the consumer front, it would actually make it profitable to borrow.

The logic is clear. It’s also, to use a technical economics term, nuts.

Imagine how negative rates might work in your own life. If you get a mortgage, for example, you could choose every month between perhaps having the bank send you a check or just having the principal reduced. Would you be more willing to borrow under those circumstances? I know I would. In 30 years, you would own your house, without making a payment.

Negative-rate mortgages are not on the table, even in Japan, but the thought experiment shows us something. Easy financing of assets, like we saw with homes in the mid-2000s, tends to lead to jumps in asset prices but doesn’t actually drive sustainable economic activity. Lower interest rates may accelerate economic activity, but they don’t create it. This has been the (reasonable) argument against quantitative easing. The argument for it is that, as a temporary measure, it can help jump-start the economic engine. Here in the U.S., that does indeed appear to have worked.

The key words here are “temporary measure.” If borrowers know that low rates will soon rise, they have an incentive to act. If not, there is no urgency, and activity stagnates. You'll never see a car dealer advertising “Low prices indefinitely! Come on down whenever you feel like it—no rush!” Again, the idea behind the Fed’s recent decision to raise rates (and to hang tough on the possibility of further increases) is to return to normalcy and make it clear that the time to act is now.

Self-destructive policy could add to Japan’s troubles

In Japan, it’s apparently too late for that. The Bank of Japan has been unable to create a sense of urgency and is now reduced to forcing banks to lend by charging them for keeping money idle. This is a policy that will destroy itself.

With negative rates, bond yields, especially of government bonds, will continue to decline, which means private buyers are even less likely to want them. That doesn’t matter now, as the central bank is buying those bonds as part of a quantitative easing program, but it means the central bank is now the only buyer—and that Japan is now reliant on monetizing its debt. Savers are getting decimated, and with an aging population, most people have been forced to be savers. Negative rates will only make matters worse.

This is, in many ways, a desperate move, and one that highlights the need for the U.S. and Europe to get rates back to normal levels as quickly as possible. Once a country is caught in the kind of deflationary trap that has ensnared Japan, getting the economy back up to speed is difficult—and, in this case, apparently impossible.

Japan’s economic woes are about to get much worse in the next couple of years.

 

Commonwealth Financial Network is the nation’s largest privately held independent broker/dealer-RIA. This post originally appeared on Commonwealth Independent Advisor, the firm’s corporate blog.

Copyright © Commonwealth Financial Network

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