By Zarathustra, who is the founder of Hong Kong blog Also sprach Analyst. He was educated at the London School of Economics and the Chinese University of Hong Kong and was once a Hong Kong-based equity research analyst focusing on Hong Kong real estate (which he did not really like), with a secondary coverage on China real estate sector (which he actually hated). Cross posted from MacroBusiness
Zero interest rate policy and quantitative easing is not working to stimulate the real economy. No country has succeeded. The pioneer of quantitative easing, the Bank of Japan, failed (and Japanese yen is uber-strong). The Federal Reserve has failed, and the Bank of England has failed.
Before going to quantitative easing, let’s consider whether zero interest rate policy (ZIRP) works. Michael Pettis offered some interesting observations recently in his newsletter. He says that even though theory reckons that lowering interest rates should make people less likely to save, and to consume more, empirical data suggest the otherwise. In fact, people save more when rates are low, not less:
In China, for example, deposit rates are seriously negative and have been negative for many years, and yet the household savings rate is nonetheless very high. In fact it seems that, as a rule, countries with repressed interest rates have higher, not lower savings rates.
What’s more, I have seen US historical data that suggests that when interest-rate declines have coincided with falling, not rising, stock and real estate markets (as they have recently), the savings rate usually rises rather than declines. In other words households care mainly about their wealth, not about the reward for postponing consumption.
So in an environment where the asset side of household’s balance sheet is falling in value (as in recent years in the US), it makes sense for households to save more, regardless of the interest rates. That’s debt deleveraging or balance sheet recession as we know it.
Now let’s consider Japan. It underwent debt deleveraging or a balance sheet recession for two decades. As corporate balance sheets were underwater because the asset side was falling in value, corporates increased their saving level. Thus there plenty of demand for holding Japanese yen (and for that matter, Japanese Government bonds as a vehicles for savings). That’s why JGBs yields are so low, because the saving level in the corporate sector has increased.
Of course, when everyone is saving and not spending and borrowing, asset prices will be under even more pressure, and that encourages even more debt deleveraging as that pushes everyone’s balance sheet even deeper under water. So we have a vicious circle of falling asset prices, increasing saving level, and deflation.
If central banks can’t break this deflationary vicious circle even as they are getting bigger and bigger, Prof. Nick Rowe considers the following somewhat bizarre endgame in his terrific post:
What happens as we push this process to the limit, and keep on reducing the long run inflation rate, down to zero, and then into deflation? The central bank keeps on getting bigger and bigger, and owns a larger and larger share of the total assets in the economy. It buys all the short-term government bonds, then all the long-term government bonds, then all the commercial bonds, then all the shares, then all the land, then all the houses….Because as the rate of inflation falls, falls to zero, and keeps on falling into negative territory, people will want to hold more and more of their wealth in the form of central bank money. And unless the central bank satisfies that demand, by selling them money and buying their other assets, the result will be an excess demand for money and recession.
Where does it end? Do we ever hit some absolute liquidity trap where people want to hold money rather than any other asset? Well, not really. Because the central bank has to keep on buying assets that people do not want to hold because they want to hold money instead.
It doesn’t end in a liquidity trap. It ends when the central bank runs out of things to buy, because it already owns everything, right down to your house, furniture, and toothbrush, which it rents back to you. It ends in communism.
Karl Marx certainly did not say that quantitative easing can achieve his goal, although he did want to see the following according to the Communist Manifesto:
Centralisation of credit in the hands of the State, by means of a national bank with State capital and an exclusive monopoly.