The central banks’ “extraordinary” and “non-conventional” measures are now more than a decade old and they are still going strong.
If initially they were only supposed to last for a few years after the financial crisis of 2007-2009 until things “went back to normal”, this expectation was quietly dropped once it became clear that the extraordinary had become ordinary.
But as these measures continue, their toxic side effects are increasing. They may in fact be contributing to the sluggishness of the world economy and to the lack of productive investment, rather than counteracting them.
As populations around the globe — with very few exceptions — age, there is more and more need for income from savings. However, with interest rates at record lows and even negative on the safest investments, income is harder and harder to come by.
This leads to an increase in the amounts saved in order to ensure the income from savings is maintained even though the yield is lower. It also pushes usually cautious savers into riskier and riskier investments.
The paradox of lower rates in a world where the number of pensioners is increasing is not lost to central banks.
“We are aware that the negative interest rate is an unconventional instrument, and one that has side effects,” Thomas Jordan, the Chairman of the Governing Board of the Swiss National Bank said in a speech on October 31.
Jordan also noted that, for pensions, “the share of the ‘third contributor’ — the capital market — has diminished considerably. This makes it more difficult for the pension funds to meet their existing benefit commitments.”
But, perhaps appropriately scary for Halloween day, he continued: “The negative interest rate, and our willingness to intervene on the foreign exchange market as necessary, are still essential in order to ease pressure on the franc, thereby stabilising price developments and supporting economic activity.”
His are only the latest in a litany of comments in favour of negative interest rates, reinforcing the idea that they are here to stay, despite the fact that one third of total debt, or around $17 trillion, already has negative yields.
Two of the most pernicious consequences of negative interest rates are becoming more and more visible.
The first is on the health of companies. Not only are businesses taking on more debt but, because of the economic slowdown and challenges to profitability, even so-called “dividend aristocrats” have trouble keeping up their blue-blooded tradition of increasing dividends.
On this year’s list of 57 “dividend aristocrats” — S&P 500 index constituents that have increased their dividend payouts for 25 or more years in a row – almost half have payout ratios above 50%, meaning they distribute more than half their earnings to shareholders in the form of dividends.
Of these, four companies have payout ratios of more than 100% — they are paying out more money than they earn.
Source of chart data: IEX
While this is possible now because of the low interest rates – companies can just take on cheap debt and increase the dividend, keeping shareholders happy – it cannot last forever, and it is a dangerous road to travel.
The second harmful consequence of negative interest rates is not that obvious yet, but it will soon be. Pension benefits are being eroded in reaction to the fact that income is harder and harder to come by. Annuities that pay a pittance are only the first of a series of damaging effects of negative rates.
In his speech, Jordan warned about this, saying that Switzerland will perhaps have to follow the example of other countries, which have already worsened conditions for pensioners.
“In other countries, too, the population enjoys rising life expectancy while savers bemoan the low interest rates,” he said.
“Denmark and Sweden, for example, which are now ranked several places ahead of our country, have implemented far-reaching and thus painful measures to stabilise and modernise their pension systems.”
Sweden reformed its pension system as long ago as 1999 so that the level of pension payments rises when economic conditions are good and drops when they are bad, whereas Denmark indexed the retirement age to life expectancy back in 2006.
Such measures work well when the economy is in good or reasonable shape, but during a recession or years of economic weakness they are likely to make vulnerable pensioners suffer.
As central bankers like to stress, they are not politicians and therefore only look at meeting their monetary policy objectives as listed in their mandates. But as the malignant consequences of negative interest rates become more obvious, perhaps it’s time for these mandates to be rewritten.