By Jason Simpkins
Six of the world’s central banks (Europe, Denmark, Sweden, Switzerland, Japan, and Hungary) representing 29 countries have taken interest rates negative. They range from -0.05% in Hungary to -1.25% basis points in Sweden.
As a result, other countries, plagued by the same low commodities prices and a soft global economy, are now under growing pressure to take the same action.
Defend your currency and suffer the consequences, or devalue it and play catch up. In many cases the decision is difficult, but seemingly inevitable.
This is what you call a race to the bottom — various countries all jockeying to devalue their currencies to maintain growth.
In some cases it makes sense.
Europe has been battling slow growth and deflation. GDP growth languished at 0.6% in the first quarter, and consumer prices are down 0.2% this month. The continent is also coping with the threat of a “Brexit,” as Britain ponders leaving the European Union.
And so, the ECB last month slashed its interest rates to record lows. It also ramped up its quantitative easing program to 80 billion euros ($91 billion) per month from 20 billion euros, and announced that it would also start purchasing corporate bonds.
However, this is far from an isolated case. Other central banks around the world are pursuing the same strategy — and some with far less justification.
Sweden’s economy grew 4.1% last year. The country has a healthy annual credit growth rate of 8.8%, and an account surplus equal to 6% of GDP. Housing prices climbed a staggering 14.2% in 2015, compared to 3.8% in the EU, 6.5% in Denmark, 5.4% in Norway, and 0.7% in Finland.
Sweden’s annual inflation rate was 0.8% in March, up from 0.4% in February.
Indeed, by pretty much any measure Sweden’s economy is doing okay.
Yet, despite all of the reassuring economic signals, the country’s central bank in February pushed Swedish interest rates even further into negative territory. The Riksbank cut the rate to -0.5% from -0.35%. Furthermore, it said rates, which have been negative for 14 months now, could go even lower if needed.
“On every metric, other than headline inflation, that’s a really strong economy. Yet [Sweden’s central bank has] said if their currency appreciates too quickly, they will intervene and [blame] headline inflation,” Adrian Owens, currency fund manager at Swiss investment house GAM told The FT. “But on every other metric what they are doing is completely inappropriate. That is as close to a currency war as you can get.”
Last week, the Riksbank raised its bond-buying target to 245 billion Swedish kronor ($30.35 billion). The new plan will see the government buy an additional 45 billion kronor in government bonds in the second half of this year, on top of the 200 billion kronor it is in the process of buying by the end of June.
Again, this is in a country where inflation just doubled on a monthly basis, and the housing market has all the appearances of being in a bubble.
Neighboring Denmark was the first country to go negative back in 2012. Its benchmark rate stands at -0.65%.
There, banks are paying homeowners interest on their mortgages. Realkredit Danmark, one of the nation’s largest mortgage lenders, told the Wall Street Journal it provided 758 borrowers with negative interest rates last year.
The Swiss aren’t so lucky, as banks there are passing negative rates on to their customers by charging them money to maintain their savings.
Now, not every bank has gone negative. There are notable holdouts, including the U.S.
The question is, though, how long can they continue to buck the trend?
Ironically, China, which kept its currency artificially low for many years, is battling to prop up the yuan.
As China’s economy has weakened, the PBOC has spent billions of dollars defending the yuan, drawing the country’s currency reserves down to $3.2 trillion from its peak of $4 trillion in 2014.
Many analysts, including Yu Hongding, a director of the Chinese Academy of Social Sciences, say China should give up the fight.
Professor Yu, who is a former rate-setter for the PBOC and currently a member of the national planning committee, says China is caught in two concurrent “deflationary spirals” (producer prices and debt deflation) that are feeding on one another. He suggests devaluing the yuan by 15% sooner rather than later.
“Reserves will continue to fall until we devalue,” Yu told the Daily Telegraph. “Once we get towards $2 trillion the markets will start to panic. They won’t believe that the government can control it any longer.”
China showed signs of caving at the end of March, when the PBOC weakened the yuan significantly against the dollar. It had almost no choice, as South Korea and Japan, its chief export competitors, have allowed their currencies to freefall.
Australia, another major exporter, is feeling the pressure, too.
The country’s GDP growth is at 3% and capital inflows are strong. But the Australian dollar is up 12% since mid-January, and is now at its highest level in 10 months.
That’s got the central bank glaring at its benchmark rate, which has held steadfast at a record low of 2% for the past 11 months.
“The Australian dollar has appreciated somewhat recently,” Reserve Bank governor Glenn Stevens noted in an April 5 statement. “ In part, this reflects some increase in commodity prices, but monetary developments elsewhere in the world have also played a role. Under present circumstances, an appreciating exchange rate could complicate the adjustment under way in the economy.”
It’s buried in the innuendo typical of central bank statements, but the message is clear: If you guys keep this up, we’re going to have to lower our rate, too.
The United States finds itself in a similar quandary.
The Fed is in the process of raising rates, even if it is at a snail’s pace. But it’s getting increasingly difficult to swim against the tide.
Even the Federal Reserve is backing off rate hikes — not necessarily because the U.S. economy can’t handle it, but because the rest of the world is headed in the opposite direction.
It’s becoming increasingly clear that gold has been oversold, based on the erroneous notion that the Fed would methodically jack rates higher.
But in fact, the opposite has proven true. The wheel is getting tighter with each turn, and central banks around the world are pulling in the opposite direction. As a result, a scenario where the Fed is forced to backtrack is increasingly likely.
Such a policy reversal would cause a sharp regression in the dollar and send gold soaring. Especially since demand for gold has already picked up in parts of the world where wealth preservation is no longer a duty entrusted to banks.
In Japan, for example, gold bar sales climbed by 35% in the three months ended March 31, as negative interest rates forced savers to find a new store of wealth. Demand is rising in Europe, as well.
After a prolonged surge, the dollar has already slumped to an 11-month low on speculation that the Fed won’t be able to raise rates any further. Gold has climbed 16% in that time.