It’s More Than the Trade War
Though the trade war isn’t the only cause of slowing growth in China, it is a major factor. Costly business regulations and social programs in places such as in Japan and the European Union are also a drag on economic activity and investment. What’s more, even though modern economies run on debt, too much debt in the system hinders growth and demand. But central banks are betting cheaper borrowing costs will stimulate investment in the economy.A Race to the Bottom
Of course, dramatically cutting interest rates also tend to devalue a currency. That’s a real temptation because it makes a country’s goods and services cheaper on the world market relative to other currencies. When one country does this, however, others often do as well to gain the same advantage. It becomes a race to see who can devalue their currency the fastest. At the same time, those nations with devalued currencies import fewer goods, since those goods have become relatively more expensive. A vicious circle of devaluation and economic contraction can occur.Through the Financial Looking Glass
If the use of negative interest rates sounds backward or upside down, that’s because it is. Negative rates turn all the conventional rules and assumptions of finance and economics on their head.For example, under normal economic conditions, a trade occurs in a relatively continuous and steady manner. The business cycle expands and contracts and interest rates react accordingly. But generally, as economies grow and mature, long term demand grows as well. Banks, companies and individuals invest in an expanding economy and borrow or lend money to do so.
In this typical scenario, all the classic economic rules and assumptions of the time value of money, return on investment and so forth, apply. Positive yields in the form of interest received on money come with lending, just as interest paid by the borrower to the lender comes with borrowing.
A Downward Spiral
The risk-averse dynamic that accompanies or cause negative interest rates is a downward spiral for the global economy. As demand continues to fall, a new set of assumptions take effect.But wait, it gets worse.
Negative interest rates aren’t just impacting deposit accounts and mortgages. They’re now a part of the government and corporate bond markets in several countries that are paying negative interest rates on long term bonds.
Negative Interest Rates for the US?
So far, negative interest rates are not on the horizon for the United States. Although interest rates in the United States are low, they’re not near zero. The federal funds rate is between 2-2.25 percent. Still, more interest rate cuts are already expected due to the trade war with China and President Trump’s demand for lower interest rates from the Federal Reserve. Mainstream economic circles have been calling for negative interest rates for the past decade and there is a fair chance we will see them this time around, depending on if a recession hits and how bad it may be.A Sobering Reality
We’ve entered into an era of systemic malfunction and high economic uncertainty. Whether negative rates come to the United States or not, the U.S. economy will still be affected. In fact, it already has been. Foreign capital exposed to negative interest rates will continue to chase positive returns on their savings in the foreign-driven inverted yield curve in the U.S. bond market.The expanding use of negative interest rate bonds and deposits in economies around the world pose a sobering reality. Distorted interest rates no longer provide the market the information it needs to function properly. Without this price mechanism for money functioning correctly, how will capital flows remain efficient?