The United States, Germany, and other economic powerhouses haven't learned the dire lessons of Japan's lost decades.
- By Gillian TettGillian Tett is U.S. managing editor of the Financial Times and author of The Silo Effect: The Peril of Expertise and the Promise of Breaking Down Barriers.
In 1998, when I was a reporter in Tokyo, an event happened that economists once thought impossible. Japan was at the height of its banking crisis, and as panic swelled, short-term market interest rates — what traders pay to borrow one another’s money overnight — dipped below zero for the first time ever.
It was such a shock that computers at local banks went haywire; programmers hadn’t prepared for negative interest rates. I told my colleagues that a world where people got paid for borrowing money, rather than paying for the privilege, was crazy. It would never last.
I was wrong.
This June, Fitch Ratings released a report calculating that there are $11.7 trillion worth of bonds carrying negative interest rates. That represents almost half of all sovereign bonds in developed countries. Consider 10-year bonds, which, as of press time, carried yields of minus 0.01 percent in Japan, negative 0.5 percent in Switzerland, and minus 0.06 percent in Germany. Meanwhile, rates were slightly positive in the United Kingdom but at record lows — and sinking. In July, the yield on U.S. 10-year bonds dropped below 1.4 percent, to the lowest point ever.
In truth, it seems unlikely that medium- to long-term rates will turn negative in America, because the national economy is growing. I would not dare to rule it out, however — not after what’s happened in the two decades since negative yields first appeared. The world has slipped into an economist’s version of Alice’s Adventures in Wonderland: a place where normal rules are turned upside down and nothing can be discounted.
There are at least three explanations for tumbling interest rates. One is the deliberate decision by central banks to push yields down. This trend started in the 1990s, when the Bank of Japan slashed official policy rates — what central banks charge private ones to borrow — to zero in a desperate and ultimately failed bid to boost growth. This January, Japan announced that when private-sector financial institutions left money on reserve overnight, a rate of negative 0.1 percent would be imposed. Similarly, the U.S. Federal Reserve and European Central Bank (ECB) cut policy rates to zero to offset economic stagnation after the financial crisis; this spring, the ECB levied a negative 0.4 percent yield on funds stored overnight.
A second explanation is that structural factors are prompting investors to gobble up an abnormally large quantity of bonds, lifting prices and depressing market rates. (Bond prices move in an inverse direction to yields.) Since 2008, a host of new regulations, including in the United States, have been introduced that encourage, if not force, big financial institutions to buy more bonds. Supposedly, this gives banks a spare cushion of “safe” assets to better withstand financial shock. Meanwhile, pension funds are stockpiling bonds in an effort to meet future payout obligations.
The third reason, and perhaps the most difficult to address, is pessimism about the global economic outlook. Investors are buying bonds because, perhaps, they cannot imagine anything else that would offer value in a low-growth world or because they think consumer prices will drop. This shift in viewpoint is hard to quantify. Recent surveys from the Federal Reserve of New York, however, have pointed to a small decline in consumers’ expectations of inflation and growth.
Some blend of all three factors bears responsibility for the fall down the rabbit hole. So pointing a finger at just one culprit — as some analysts have done in recent months, targeting especially central banks’ policies — isn’t terribly productive. Instead, attention should be focused on the dangerous, debilitating consequences of subzero interest rates.
After all, a world of negative yields is one in which savers are penalized for being thrifty; they lose money just by leaving funds in the bank. Moreover, entities that hold large quantities of bonds tend to find it very hard to make decent investment returns and meet their claims. Many pension funds, for example, have devised financial plans that assume they will earn around 8 percent annual returns on the bonds they’ve amassed, so yields oscillating around zero threaten to open a gaping economic hole in the coming decades.
In theory, these disadvantages could be offset by low rates prompting consumers to spend money on new goods or spurring companies and governments to borrow funds and invest in areas like infrastructure. In reality, though, there is precious little evidence this is playing out. People are so nervous about the future that companies are leaving money idle on their books: There are an estimated $1.7 trillion unused funds sitting on U.S. corporate balance sheets. The risk is that as asset prices rise — for, say, real estate — income inequality will increase, because it’s the rich who have entrée to assets in the first place.
Is there any solution, even a partial one, to interest rates bottoming out? Some governments, such as Canada’s, have embarked on fiscal spending programs. But these are exceptions. For America, Germany, and other major economic players, the idea of a stimulus remains too politically controversial to implement. Similarly, central banks’ governors, such as Janet Yellen and Mario Draghi, are so anxious about being blamed for starting a recession or for instigating market shock that they are proceeding “cautiously,” which means keeping interest rates low.
Yields, then, seem likely to stay at historic nadirs for much longer than anyone ever imagined. Never mind the sorry history of the place where negative yields were born. I’m referring, of course, to Japan’s “lost decades.” In Wonderland economics, it turns out, rules aren’t the only things that don’t matter. The lessons of experience don’t either. This bizarre landscape is no solution to modern financial woes, and the longer we remain in it, the harder it will be to muster the political courage and clarity of vision to leap out.
A version of this article originally appeared in the September/October 2016 issue of FP magazine under the title, “Through the Looking Glass.”
Illustration by Matthew Hollister