Ultra-low interest rates: Is money worth anything anymore?

On 1 October 2019, the Reserve Bank of Australia (RBA) reduced the official cash rate to 0.75%, with RBA Governor Philip Lowe saying that it was prepared to further ease monetary policy in favour of achieving substantial economic growth. This now means we are in reach of something that was once inconceivable – a cash rate of 0% or below.

Minutes from an RBA board meeting earlier this year showed that the board had also explored the use of unconventional monetary policies – such as negative interest rates, or buying government bonds and other fixed interest securities to lower long-term interest rates.

Zero or negative cash rates are hardly unprecedented elsewhere in the world. Japan’s equivalent to our cash rate is −0.1%, while the European Central Bank’s is −0.5%. The US Federal Reserve Board also cut its short-term rate to zero in the aftermath of the US Financial Crisis (2007–2008).

Figure 1 (Global Interest Rates)
Globally, there are now approximately $US15 trillion ($A22 trillion) worth of government bonds (debt) with negative interest rates or yields. In August this year, that figure reached the highest peak ever recorded of $US17 trillion ($A32 trillion).

Germany is viewed as Europe’s economic powerhouse, but the government there issued 30-year bonds with an interest rate of −0.11% earlier this year. This means that creditors who have lent money to the German government have effectively signed up to lose money every year for 30 years, if they hold on to the bonds until maturity.

It is even becoming more common for companies in Europe to issue bonds with negative yields to their investors. On top of this, mortgage loans in Denmark are offered with negative cash rates. In layman’s terms, this means that European banks are now paying home buyers 0.5% to borrow their money.

So what happens to the Australian economy if the cash rates hit zero or below? It is a problem that economists and analysts will start to ask, if the sputtering Australian economy continues to struggle in 2020. Negative cash rates in Europe and Japan, as well as historically low rates in the US, have now forced global interest rates to come down, creating a unique global interest-rate setting.

Why do central banks around the globe cut short-term rates below zero? Why would a bank pay its mortgage buyers to borrow from it? Why would somebody buy a bond that guarantees they will lose money if they keep it to maturity? We need to go back ten years to the dark days of the global financial crisis (GFC) to address these questions.

Australian economists and policymakers are currently looking at what the United States did in November 2008. The Americans said it was “quantitative easing” (QE). We understood this as “printing money.”

QE was designed to force investors out of stagnant investments that contributed little towards economic growth, and into the kind of investments that could grow business and economic activity.  The United States Federal Reserve began buying government-issued bonds, a secure asset favoured by anxious investors who lost money in the GFC. The government bought its debt to drive up the prices of those assets.

Will Australia go down that path? Absolutely. While the jury is out on the success of QE’s role in Europe, most economists agree that it has performed well in the United States.

If you’re still reading this article, you’re likely to wonder what’s going to happen to all the debt that the government piles on itself. Before the GFC, the US government held around $US800 billion on its balance sheet in “safe” assets and investments. It had loaded on over $US2 trillion by mid-2010.

Doesn’t this debt bankrupt a country? No – that’s the beauty of reserve banks and central banks around the globe. They get to create money, as well as being able to magically erase any debt that’s holding its fixed-term investments until they mature.

Practising QE has its risks. The most significant repercussion is rampant inflation. The other major risk is the vulnerability of investors being addicted to QE. The mere thought that the US government would stop buying bonds for several years sent shivers down investors’ spines.

However, it is safe to say that RBA Governor Philip Lowe is in a better position in 2019 than US Federal Reserve Chairman Ben Bernanke was in 2008 when he kicked off the massive QE experiment by raising $US600 billion in debt!

If you have any queries in relation to this article, please don’t hesitate to contact the author:

Timothy Wedarachchi
Research Analyst
t.wedarachchi@banksgroup.com.au


This article is intended for general discussion and is not intended to represent specific advice. Banks Group shall not be responsible for any entity that acts on any of the comments in this article without first obtaining specific advice from Banks Group.

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