May 6, 2014 7:10 pm

Wipe out rentiers with cheap money

Cautious savers no longer serve a useful economic purpose

High-income economies have had ultra-cheap money for more than five years. Japan has lived with it for almost 20. This has been policy makers’ principal response to the crises they have confronted. Inevitably, a policy of cheap money is controversial. Nonetheless, as Japan’s experience shows, the predicament may last a long time.

The highest interest rate charged by any of the four most important central banks in the high-income economies is 0.5 per cent at the Bank of England. Never before this period had the rate been below 2 per cent. In the US, the eurozone and the UK, the central bank’s balance sheet is now close to a quarter of gross domestic product. In Japan, it is already close to half, and rising. True, the Federal Reserve is tapering its programme of asset purchases, and there is talk that the BoE will soon tighten policy. Yet in the eurozone and Japan the question is whether further easing might be needed.

These unprecedented policies are needed because of the chronic deficiency of global aggregate demand. Before the wave of post-2007 crises hit the world economy, this deficiency was met by unsustainable credit booms in a number of economies. After the crises, it led to large fiscal deficits and a desperate attempt by central banks to stabilise private balance sheets, mend broken credit markets, raise asset prices and ultimately reignite credit growth.

These policies have succeeded in lowering the cost of borrowing. This has made it easier to bear both the huge quantities of private debt inherited from before the crisis, and the public debt that has been accumulated in its aftermath. A report from the International Monetary Fund published in October 2013 concluded that the bond purchase programmes from November 2008 lowered US 10-year bond yields by between 90 and 200 basis points. In the UK, bond-buying that began in 2008 lowered them by between 45 and 160 basis points. In Japan, similar interventions from October 2010 lowered rates by about 30 basis points, although Japanese yields started from a lower level. 

Lower interest rates have also had a significant effect on the distribution of income. A study by McKinsey Global Institute published at the end of last year shows large shifts in income from net creditors to net debtors. In general, governments and non-financial corporations have gained. Insurance companies, pensions providers and households have been among the losers.

Banks are in an intermediate position. US banks have gained because their interest margins have risen. Eurozone banks have lost because their interest margins have been squeezed. UK banks have also suffered small losses. (See charts.)

Some of the details are significant. Governments are winners not only because the interest rates they pay are lower than before the crisis, but because quantitative easing has monetised a substantial portion of government long-term debt. Thus, in the case of the US, the Federal Reserve transferred $145bn in gains from quantitative easing to the government between 2007 and 2012. This is in addition to the $900bn the government saved over the same period through lower interest payments. In the UK, quantitative easing produced gains of $50bn for the exchequer in addition to $120bn in interest savings.

Again, in the case of the US, sharply lower interest rates accounted for 20 per cent of the growth of profits of non-financial corporations between 2007 and 2012. But there have been adverse effects on pension funds that must honour the promises they have made to members in defined-benefit schemes, and on insurance companies – particularly those that offered guaranteed nominal returns.

In the case of pension funds, reduced long-term yields are particularly unwelcome because they both lower returns and raise the present value of future liabilities. Many life insurers might be forced out of business if these rates persist. This is a crisis on a long fuse.

For households, the distributional consequences of ultra-low interest rates are more important than their aggregate effects. In the US, households with heads aged 35 to 44 are gainers from lower interest rates, while older households are losers. On average, the younger group gained $1,700 in annual net interest, while those over 75 lost $2,700. Above all, the richest 10 per cent of Americans own about 90 per cent of all financial assets. Thus the main losers are relatively prosperous people who depend on interest income. At the same time, such people have also gained from huge rises in bond prices and strong equity markets, although McKinsey argues that low interest rates are not the most important factor behind equity gains.

This policy, however unpopular with some, is better than the available alternatives. Keynes even had a phrase for it – the “euthanasia of the rentier”. In a world of abundant savings, the available returns ought to be low; this is a consequence of market forces to which central banks are responding.

At present the world’s high propensity to save is not matched by a desire to invest. This is why fiscal deficits remain large and interest rates ultra-low. At the margin, additional savings are now useless. Returns are being pushed even lower by the fact that central banks are seeking to prevent the bloated balance sheets created before the crisis from collapsing in an episode of mass insolvency.

There is, however, a puzzle. Why is private investment not stronger, given that the non-financial corporate sector is apparently so profitable?

Perverse managerial incentives are one explanation. The weakness of the financial sector is another. Then there is the vicious circle from weak demand, to sluggish investment, and back to weak demand. And to many, it seems sensible to postpone investment until the world is more predictable.

Low interest rates are certainly unpopular, particularly with cautious rentiers. But cautious rentiers no longer serve a useful economic purpose. What is needed instead are genuinely risk-taking investors. In their absence, governments need to use their balance sheets to build productive assets. There is little sign that they will. If so, central banks will be driven towards cheap money. Get used to it: this will endure.

The Techno-Political Transformation

Klaus Schwab

MAY 5, 2014

GENEVA – It would be an understatement to say that our world is undergoing rapid and far-reaching change. The global economy, the geopolitical landscape, the environment, and technology are subject to constantly shifting conditions that reinforce and transform one another in a web of complex interactions. In such an unpredictable and interconnected setting, effective leadership must be based on a radical outlook, a multifaceted skillset, and an understanding of technology and talent.

The trends that are shaping the twenty-first-century world embody both promise and peril. Globalization, for example, has lifted hundreds of millions of people out of poverty, while contributing to social fragmentation and a massive increase in inequality, not to mention serious environmental damage. Likewise, big data offers untold benefits to companies and consumers, but poses a real threat to privacy and personal freedom.

A similar dichotomy applies to many other critical issues, including adaptation to climate change, efforts to improve resource management, urbanization and the rise of megacities, increased labor mobility, and human-capital expansion.

The scale and complexity of the challenges that lie ahead are undoubtedly daunting. But rapid, far-reaching change can also present great opportunities. To make the most of them, the world needs technologically literate leaders – call them “techno-politicians” – who have an intuitive understanding of how to shape progress in this new, unpredictable environment.

Within the framework of techno-politics, economic growth and technological innovation are the two most important factors shaping the global landscape. How we adapt to and guide their trajectories will determine our collective future.

In economic terms, the world is entering an era of diminished expectations. If, as predicted, average annual GDP growth amounts to 3% in the foreseeable future, it will take 25 years for the world economy to double in size – ten years longer than it took before the global economic crisis, when average GDP growth stood at 5%. Learning to live with slower growth will not be easy.

Given that debt-fueled consumption has run its course, productivity gains will become an increasingly critical driver of economic growth. But, at a time when rising inequality is undermining social cohesion, it is far from certain that the conditions required to support such gains – that is, improved education and stronger incentives to innovate – can be met.

Perhaps most important, even as economic growth slows, technological change continues at a breakneck pace, raising seemingly unanswerable questions about its potential impact on the global economy. While some warn that technological progress will leave many unemployed, others remain convinced that displaced workers will find new jobs that do not yet exist, as has occurred in the past. All that is certain is that technology and innovation are disrupting virtually every aspect of life.

How can we adapt to such a world? What underpins success in this new and challenging environment?

In a techno-polity, two inextricably linked factors are crucial: talent and innovation. Talent is now the key factor driving competitiveness (or the lack thereof) for companies and countries alike. Indeed, “talentism” will be the prevailing economic credo, with human or intellectual capital becoming the most critical asset – and the one most difficult to acquire and retain.

Innovation, spurred by talent, will determine success. In the future, the distinction between high- and low-income countries, or between emerging and mature markets, will no longer matter. The question will be whether or not an economy can innovate.

A techno-polity also recognizes the critical role of cooperation, strategic thinking, and adaptation. The biggest challenges nowadays are global in nature, and thus can be addressed only by engaging decision-makers and interest groups from various spheres. New partnerships must be forged, even among actors with seemingly disparate interests. Those who struggle to cope with change must be supported, not scorned.

But effective techno-politicians must go beyond firefighting to think about the long term. They must be able to respond to new and impending developments without delay, constantly experimenting with new ideas and processes. Moreover, they must to be able to understand and react simultaneously to multiple competing realities.

The role of the techno-polity is to steer the world toward positive outcomes. It will demand that decision-makers use their heads and hearts – and it will also test their nerves.

Klaus Schwab is Founder and Executive Chairman of the World Economic Forum.