Negative interest rate is toxic

March 10, 2016 13:49
Bank of Japan adopted the negative interest rate to achieve the target of 2 percent growth in the consumer price index. Photo: Bloomberg

In late January, Japan joined the European Central Bank in the “negative interest rate club”.

The market responded hesitantly: the yen depreciated only for one day and then climbed by about 6 percent in two weeks’ time.

Bloomberg reported on Tuesday that some of the country's money market funds will soon terminate their operations due to the impact of the negative interest rate and a yield curve approaching zero.

It is said that Mitsubishi UFJ will close the fund in May while Nomura and Daiwa are planning to terminate theirs in October.

It’s no big deal if money market funds stop operation, but, as more and more countries adopt negative interest rates, you should know the reason why they are doing so even after years of maintaining a loose monetary environment.

Bank of Japan governor Haruhiko Kuroda explained that the policy is meant to achieve the target of 2 percent growth in the consumer price index. It is reasonable, mathematically.

The European Central Bank considers it as an economic stimulus to force the banks to pour capital into the real economy.

In reality, however, banks use the money to buy government bonds due to the low risk. Neither do the bank depositors want to take risks; they just keep the money in cash.

The central banks’ negative interest rate policy is unfair as it trims depositors’ returns to subsidize the enterprises’ risky investments.

To fight the negative interest rate, is it feasible to withdraw all the deposits and hold cash?

The Federal Reserve pointed out in a study in 2010 that holding cash also has its cost, about 0.36 percent a year.

If the interest rate remains in a range of 0 to negative 0.35 percent, depositors are unlikely to take any action.

In northern Europe as well as the eurozone, the interest rate level is between negative 0.3 percent to negative 0.75 percent, but so far no bank is passing the cost of negative interest rate to the depositors.

Conservative investors prefer holding cash. Negative interest rates drain liquidity from the market, instead of creating an easing environment.

If the trend continues, capital from the negative interest rate region will flow into markets which offer positive returns.

The Aussie, New Zealand dollar, US dollar and gold will take advantage of the current situation. On the other hand, the euro and the yen may depreciate further.

Is it true that negative interest rates can reduce real debt? There are two prerequisites. First, the policy must be adopted for at least 10 years. Second, the debt level must remain the same, if not reduced, during the period.

Do you believe the current combined debt of Europe and Japan is as much as it was seven years ago?

This article appeared in the Hong Kong Economic Journal on March 10.

Translation by Myssie You

[Chinese version 中文版]

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head of private banking and trust services at Hang Seng Bank