The record low in major currency interest rates and bond yields is “extraordinary”, says Harvard economist Kenneth Rogoff.
Writing for Project Syndicate, he notes that: “ten-year interest rates in the United States, the United Kingdom, and Germany have all been hovering around the once unthinkable 1.5% mark. In Japan, the ten-year rate has drifted to below 0.8%.
For now, the situation seems stable. “Global investors are apparently willing to accept these extraordinarily low rates, even though they do not appear to compensate for expected inflation.”
But, “over the longer term, however, this situation is definitely not stable”.
Rogoff, who shot to prominence following a stint as chief economist at the International Monetary Fund (IMF), believes the current situation is down to a “perfect storm” of factors.
One is a global savings glut. Ageing populations in the West are saving for retirement, while governments in the Middle East are keen to save surpluses from the boom years. Meanwhile, in China, the government buys US Treasuries to keep the renminbi down.
Another factor is central banks’ credibility. Despite monetary stimulus and record low interest rates in many countries, central banks have somehow managed to make investors believe “their mantra of low long-term inflation”.
The final element of the storm is the fear of financial disaster: “Meltdown fears, even if remote, directly raise the premium that savers are willing to pay for bonds that they perceive as the most reliable”.
Of course, none of these conditions are permanent, says Rogoff.
In Japan and Germany, an increasingly elderly population is already starting to draw on its savings. “Meanwhile, new energy-extraction technologies, combined with a softer trajectory for global growth, are having a marked impact on commodity prices, cutting deeply into the surpluses of commodity exporters from Argentina to Saudi Arabia.”
As for the central banks, they will soon start to “generate higher inflation expectations”. They’ll have to, if they want to force “investors into real assets, to accelerate deleveraging, and as a mechanism for facilitating downward adjustment in real wages and home prices”.
The final factor – fear – may seem the most stubborn. But “eventually the clouds over Europe will be resolved”.
The example of Japan shows that interest rates can remain low for an extraordinarily long time, says Rogoff. “But today’s low interest-rate dynamic is not an entirely stable one. It could unwind remarkably quickly.”