The Japanese and European central banks have taken extraordinary measures to resuscitate their economies. Instead, they may be sending them further into a deflationary spiral. If you take a quick look at the major stock markets around the world, you will observe a clear pattern that is likely to surprise you. Zero/negative rates are highly correlated to poor stock market returns this year; while higher central bank rates correlate with high market returns. It is the economies that are in the worst shape that are having to test negative rates.
The perverse theory of negative rates
The point of negative rates is to penalize savers and force them to spend. However, you can’t force businesses to take loans and individuals to buy things like cars and real estate. That just isn’t how it works.
We think it is quite obvious why negative rates aren’t working. In the past, if you were a retiree with a million dollars and the bank paid 4% interest, you had a safe income stream of $40,000 per year to spend. That scenario put retirees in a good position to spend, without needing to take a lot of risk.
Today is a drastically different situation. If you are a retiree with a million dollars, the bank pays no interest so you will either have to reduce your spending or find a higher return somewhere else. The latter requires taking more risk, by the way. Let’s first consider finding a return in the financial markets. This is close to impossible in Europe and Japan. Bond yields have gone deeply into the red. This week, the yield on a 10-year German government bond went into negative territory. In Japan, yields are close to nothing for 30-year bonds. With no safe place to earn a return, you now have to pay for the privilege of owning a long-term government bond! Looking to riskier assets (stocks,) they aren’t helping either. As you can see from the table above, global stock markets are getting crushed. So your options are: earn zero interest on savings; earn negative interest on bonds or lose money in the stock market. These are bad choices. Therefore, retirees are forced to reduce spending and/or shift assets to “safe havens” like the US. Reduced spending creates more deflation and is doing the exact opposite of what the central bankers intended. It is clear to us that negative rates are creating a deflationary environment that is spiraling out of control.
