Are negative nominal interest rates sustainable
The great silence
The role of interest in the economy
As prices, interest has a central economic function in all markets. Interest is the compensation of the obligee for his temporary waiver of consumption or the price that the debtor pays for the early right of disposal over goods or the use of capital. The interest includes a surcharge for the risk that the debtor will not repay the loan in the future, and in this way creates the economic link between the present and the future. So low interest rates generally indicate a low demand for investments or an oversupply of money. Inflation plays an important role here; the real interest rate is ultimately calculated from the difference between the nominal interest rate and the inflation rate. Negative real interest rates have not been uncommon in Switzerland since the Second World War, but negative nominal interest rates as part of monetary policy are actually new - their necessity is justified by persistently weak growth and subdued inflation expectations.
So the approach of the National Bank makes sense at first glance, but the previous, extreme monetary expansion since the financial crisis of 2008 could not sustainably boost growth, and today at the latest we have to say the other way around: The central banks are with their then triggered (and since then unrestrained ) Money tsunami are responsible for the persistently negative interest rate development, because the more money they produce, the less it costs. At the end of 2016, bonds with a value of over CHF 10 trillion were showing negative returns worldwide, including around 30 percent of all government bonds. Even for bonds from the de facto bankrupt EU country Italy, investors had to accept negative returns in 2016. As a result of this perverse economic and political environment, the Swiss National Bank is also severely restricted in its activities, although it is politically independent. What should - and what can - do they now?
The Swiss National Bank and the general interests of the country
According to the Federal Constitution and the National Bank Act, the SNB conducts “a monetary policy that serves the general interests of the country”. The National Bank Act even specifies the mandate: The SNB has to guarantee price stability and take account of economic developments. In mid-December 2016, SNB President Thomas Jordan explained the SNB's expansionary monetary policy. The aim, according to Jordan, is to stabilize the price trend and to support economic activity. The negative interest rate and interventions in the foreign exchange market served to make investments in Swiss francs less attractive. Then came the mantra of “the franc, which is still clearly overvalued”. With the help of the negative interest rate, the SNB intends to artificially restore the previous interest rate differential with other countries. However, the SNB Governing Board did not address the side effects of the negative interest rate at the media talk. In mid-December 2016, the Federal Council also commented on the low interest rate environment and the strength of the Swiss franc. Same game here: nothing has been said about the side effects of the negative interest rate policy. The SNB and the Federal Council seem to be equating the “overall interests of the country” with the interests of the export industry. In concrete terms, this means: the exchange rate of the franc against the problem currency, the euro, takes precedence over all other aspects.
Of course, the Swiss franc is “overvalued” in terms of purchasing power compared to the European Union (EU). A Big Mac costs around 50 percent more in Zurich than the EU average. But income is also correspondingly higher in Switzerland. Switzerland is an efficient country with a healthy economy and healthy public finances. Our economy generates sustained high export surpluses in the movement of goods and services. This shows that the Swiss franc is definitely competitive - so valued high does not necessarily mean overvalued. A look at the past makes this clear: Over the past 40 years, the real value of the franc, weighted for exports, has increased by an average of 0.6 percent per year. The export companies in Switzerland can obviously live with that. It is not imperative that the SNB and the government pay exclusive attention to them. Overall, the hard currency has more advantages than disadvantages for Switzerland. From an economic point of view, short-term, violent exchange rate fluctuations are more dangerous than a highly valued currency. Why? They are poison for companies because they can no longer plan sensibly in such an environment.
The consequences of low and negative interest rates
So if the SNB and the Federal Council are silent, it should be remembered at this point what consequences low and negative interest rates have for the "overall interests of the country": In the short term, they favor debtors who can get into debt too cheaply and too heavily. But when interest rates normalize one day, the debtor's interest burden will very quickly become very high - and then drive many into bankruptcy. This not only applies to companies, but also to private individuals and, above all, to states. The low and negative interest rates reward the latter for irresponsible debt-making and at the same time release politicians from the unpleasant duty of restructuring national budgets and liberalizing the economy. In this regard, Switzerland has so far been a lonely exception in Europe.
However, low and negative interest rates also put creditors at a disadvantage. These are now mainly private individuals, insurance companies and pension funds. In Switzerland, the pension funds are particularly affected: Although falling interest rates increase the market values of fixed-income investments for a short time, the current income for financing pensions decreases. The pension obligations also increase as a result of discounting at falling interest rates and lead to pension deficits. With the future turnaround in interest rates, the fixed-income investments will weaken the substance of the pension funds through book losses. Due to low and negative interest rates, banks are sometimes losing the ability to generate regular income with traditional interest rate arbitrage. In addition, banks expose themselves to maturity transformation risks through the very short-term refinancing of long-term mortgages, which in the event of a turnaround in interest rates will have an impact in the form of sharp drops in cash flow. In general, interest rates that are too low lead to price bubbles in the financial markets, especially for bonds and the real estate market.
We have a communication problem
The longer negative interest rates apply, the worse the damage will be - economists are largely in agreement on this. So it would be best to have them lifted immediately. The SNB could do that, but it will refrain from doing so out of consideration for the franc exchange rate and to prevent its balance sheet from inflating further. A gradual increase in the Swiss franc rate would be feasible, but the SNB would have to clearly announce and justify this in the interests of all parties involved. She didn't do that. And here we are at the heart of the matter: On the occasion of the announcement of negative interest rates on December 18, 2014, the SNB said that they would apply “until further notice”. This succinct hint, however, is not enough if one wants to draw attention to a future mandatory change in policy and to prepare the markets. It neither explains the long-term policy of the SNB, nor does it create explanatory incentives for creditors and debtors. What should the SNB communicate instead? My suggestion in terms of your mandate is:
“We prevent short-term, strong fluctuations in the Swiss franc rate. Our exchange rate policy is designed for the long term. This gives the economy a solid basis for planning. We are in favor of a strong Swiss franc and are orienting ourselves towards strong currencies, currently the US dollar. In addition to clear political communication, buying and selling of foreign currencies is the main instrument of intervention. The negative interest rates will be lifted as soon as possible. The franc will continue to stand out from other currencies in the future thanks to low nominal and real interest rates. "
That would at least give an indication of where the journey should go - and with it, debtors and creditors would have time to prepare for the future and let the market mechanisms take effect. Because not only the SNB but also the other players have to act: companies and private individuals should avoid long-term fixed-income investments. Investing in real assets is preferable, preferably in stocks of high-dividend companies with robust balance sheets. If the financial situation permits, long-term debt should be entered into and short-term refinancing should be longer. Long-term mortgages, Swiss banknotes and precious metals as nest egg are suitable for private individuals. Pension institutions would have to exhaust the legal limits for their investments and minimize the proportion of long-term fixed-interest investments. Long-term mortgage investments, however, are permitted. Residential properties in good locations also generate a reliable cash flow, but lead to tight returns on new investments. Not only because of the low interest rates, but also for demographic reasons, the occupational pension scheme in Switzerland today is on uncertain feet. This requires political reform decisions. And the pension funds would have to rethink their pension plans and investment strategies.
"Who invented it?"
Nominal negative interest
In mid-1972, Switzerland introduced a negative interest rate on the inflow of foreign customer balances of 2 percent per quarter. It was later increased to 10 percent. The measure was intended to prevent the speculative inflow of foreign client funds and the associated appreciation of the Swiss franc. In 1979 the negative interest rate was abolished again. The measure was a failure - it was too easy to circumvent it. This is one of the main differences compared to negative interest rates since 2015.
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