Why central bankers may be hurting rather than helping lenders

Cutting rates below zero distorts the market for banks and for investors

Huw van Steenis


The European Central Bank in Frankfurt © EPA-EFE


As central bankers weigh up cutting interest rates deeper into negative territory, investors should consider when the risks of this trend will begin to outweigh its benefits.

With almost $17tn of negative-yielding debt already out there, I fear we have already hit the reversal rate — the point at which accommodative monetary policy “reverses” its intended effect and becomes contractionary for the economy.

Conventional macroeconomic models typically take banks and other intermediaries for granted. As a result, the overall benefits of cutting rates below zero may have been exaggerated.

Like steroids, unconventional policy can be highly effective in short dosages, but just as long-term usage of steroids weakens bones, so below-zero rates can weaken the financial system.

Negative rates erode banks’ margins and distort their incentives. They encourage lenders to seek out opportunities overseas rather than in their home markets. They also risk disrupting bank funding.

All these effects run counter to the central banks’ desire to ease credit conditions and support financial stability. How policymakers assess where and when the reversal rate kicks in will be pivotal to how investors should weigh up different policy packages from the European Central Bank and others.

Japanese banks, and more recently their European counterparts, have illustrated some of the problems caused by cutting rates. Japan’s regional banks have among the lowest returns on assets of any around the world.

Larger banks have fared somewhat better, in part by lending more overseas. Japanese banks bought about a third of the higher-rated tranches of US collateralised loan obligations — investment vehicles that buy leveraged loans — in the past few years.

Quantitative easing programmes have helped the global economy and enabled banks to repair their balance sheets. Low rates have improved the affordability of their loans, reduced bad debts and lifted the value of assets.

Japanese banks have relied upon capital gains from owning government bonds to offset pressures on profitability. But increased ownership of bonds can become a dangerous dynamic, a phenomenon known as a “doom loop”, magnifying the effects of swings in prices.

Lower profitability also reduces the ability of banks to upgrade their technology and enhance cyber defences, storing up future risks to financial stability.

Suppressing bad debts in the eurozone via QE has been useful for the banks, but this has largely come from indirect benefits, such as by reducing the difference in yield between German and, for example, Italian bonds. If central bankers really want to help increase the flow of credit, then buying the banks’ own debt as part of QE, which is still a taboo for the ECB, may be a better option than cutting rates further.

One counterargument is that the impact of negative rates appears to have been fairly benign in Sweden, Denmark and Switzerland, through the tiering of rates, where only part of banks’ reserves at the central bank are penalised. While these measures help, they are no panacea.

Banks have sought to offset negative rates by charging higher fees, repricing mortgage spreads and, in some cases, lending more aggressively. The longer the experiment lasts, the more Danish and Swiss banks are having to pass on negative rates to clients.

These tiering schemes were explicitly designed as foreign exchange policies, to deter inflows and protect banks. The spillover effects via the currency need to be weighed carefully. Should the ECB follow the Danish model, it may inadvertently exacerbate investors’ trade war concerns.

Pension funds’ asset allocations are increasingly being distorted by negative rates, too. One of the most striking consequences has been to encourage investors out of Japanese and more recently European markets and into US credit and equities instead. The thirst for yield has led to a self-reinforcing bid for longer-dated bonds.

As most savers target a particular level of retirement income, the lower rates go the more they will need to save to hit their targets, reducing their ability to spend today.

Investors are no longer sure how low rates might go in a range of countries. As long as this uncertainty remains, it is hard for banks to know whether the loans they are making are economically sensible or for investors to price the securities of financial institutions with confidence.

The assumption of a world without financial friction has been a fundamental weakness in much macroeconomic analysis. Where the reversal rate may be, and how long companies can endure these conditions, should be central to the policy debate. Otherwise, central bankers could end up doing more harm than good.


Huw van Steenis is senior adviser to the chief executive of UBS.

Professor Charles Goodhart of the London School of Economics also contributed to this article.

The Saudi oil crisis, volatile leaders and the risk of escalation

All sides have an interest in compromise — but that does not mean it will happen

Gideon Rachman


© FT montage/Getty


For decades, any list of global geopolitical risks will have had “attack on Saudi oil facilities” near the top. Now it has happened.

The good news is that the world is less vulnerable to an oil price shock than it was in the 1970s, when the Opec oil embargo created turmoil in the global economy. It is also true that all of the major powers involved — Saudi Arabia, Iran and the US — have strong incentives to avoid an all-out conflict.

The bad news, however, is that the key decision makers in this particular drama — Donald Trump, the US president, Mohammed bin Salman, the crown prince of Saudi Arabia, and the leadership of Iran — are all headstrong and prone to taking risks.

It is likely that, if the US sticks to its claim that Iran was behind the attack, it will stage a military response. If and when that happens, there are no guarantees that the conflict will not escalate further. Given that the weekend attacks have already caused a 20 per cent spike in the price of oil, the potential for further mayhem on the markets is clear.

The importance of Gulf oil to the wider world has been imprinted on the collective memory of the west ever since Opec imposed an embargo in 1973. It caused oil prices to quadruple, doing serious damage to markets and the world economy. The lesson learnt — that stability of Gulf oil supplies is crucial to the world economy — helped drive the west’s ferocious response to Iraq’s invasion of Kuwait in 1990.

Almost 30 years after the first Gulf war, western economies are considerably less vulnerable than they were to disruption of oil supplies from the region. The rise of shale-oil production in the US means that American oil imports from Saudi Arabia are now just one-third of the level they were in 2003.

But less vulnerable does not mean invulnerable. There is still a global price for oil; and Saudi Arabia remains the world’s leading oil exporter. So if Saudi supply is disrupted, consumers and industries across the world will quickly feel the impact.

The vulnerability of Saudi oil facilities to attack has also just been demonstrated. If the attack was carried out by drones, as first reported, it is a shocking insight into how open advanced industrial facilities are to assault by cheap and widely available new technologies. The Saudis also have cause to worry about the safety of their water supplies. The kingdom gets around half of its drinking water from desalination facilities, one of which was targeted in a rocket attack last June.

Awareness of their vulnerability to further attack should make the Saudis wary of escalating the conflict. The kingdom’s social and political stability is also a factor; the ruling family has long fretted about the threat of internal unrest from their large Shia minority.

Despite massive military spending, Saudi Arabia has also been unable to prevail in a brutal war in Yemen — which is a much less intimidating proposition than Iran. So while the Saudis have been ardent supporters of the Trump administration’s policy of “maximum pressure” on Iran, they have minimal interest in an actual war.

Iran also has a strong interest in avoiding an all-out conflict, which would expose the country to the firepower of their well-armed Gulf neighbours and, above all, to attack from the US. In recent months, the Iranians have staged an array of provocations including seizing western oil tankers in the Gulf and (probably) encouraging its Houthi allies in Yemen to hit soft targets in Saudi Arabia.

But this kind of Iranian brinkmanship has been interpreted by most western Iran-watchers as an effort to demonstrate that Tehran is not powerless in the face of sanctions. The Iranians were also seen as attempting to gain leverage ahead of a possible resumption of talks with the US.

As for Mr Trump, despite his bellicose rhetoric, the US president’s most recent actions have shown that he is keen to make a diplomatic breakthrough with Iran. One important reason that Mr Trump fired John Bolton last week is that his former national security adviser was too hawkish and opposed suggestions that American sanctions on Iran should be eased in the interests of getting talks started.

So all sides have economic and strategic interests to step back from the brink. Unfortunately, all sides have also shown themselves to be erratic, emotional and prone to miscalculation.

Saudi Arabia’s Prince Mohammed has demonstrated his own propensity for violent miscalculation through his conduct of the Yemen war and by apparently authorising the gruesome murder of the journalist, Jamal Khashoggi. As for the Iranians, if they did indeed authorise an attack on Saudi oil facilities they have taken an enormous risk, with consequences they cannot control.

Mr Trump’s volatility has been amply demonstrated. The US president’s willingness to rip up the Iran nuclear deal — but then sack his most hawkish adviser on Iran — also does not inspire confidence that he knows what he is doing. It also means that the White House is entering what could be the biggest security crisis of the Trump years, with no national security adviser in place.

Ever since Mr Trump’s election in 2016, nervous observers have wondered how the president would behave in a real foreign policy crisis. We are about to find out.

A Dollar for Argentina

Argentines prefer to hold greenbacks. Why not bury the peso?

By The Editorial Board




Argentina is back in the soup, as it so often is. The prospect that Peronists might retake power has Argentines fleeing the peso for dollars, and on Monday the center-right government of PresidentMauricio Macriimposed capital controls. Here’s a better idea: Replace the peso with the U.S. dollar as Argentina’s legal tender.

The actual election is in October but the August primary victory of left-wing populists—presidential candidateAlberto Fernándezand his running mate, former presidentCristina Kirchner —has triggered a monetary panic. The demand for dollars has soared, the peso has fallen some 20% against the dollar, and central bank reserves are declining.  



President Macri has done nothing to shore up confidence. After the primary vote foreshadowed a likely defeat in his bid for a second term, he announced a gasoline price freeze, a minimum-wage hike and new subsidies for special interests. This Peronism-lite did nothing to restore government credibility.

Last week Argentina failed to roll over its maturing dollar-denominated debt, and candidate Fernández, who is promoting the impression of chaos, said the country is in “virtual default.” The capital controls will limit access to dollars for businesses and individuals. Exporters will be required to bring their hard-currency earnings back to Argentina.

Argentina needs access to capital markets but its history of stiffing creditors makes it high risk. EconomistSteve Hankerecently wrote in Forbes that Argentina had “major peso collapses” in 1876, 1890, 1914, 1930, 1952, 1958, 1967, 1975, 1985, 1989, 2001 and 2018. Each time Argentines have had their savings, earnings and purchasing power diminished.

Now the government is telling investors that if they put their money in Argentina, they can’t be certain they can take it out. This is sure to be a drag on growth. The economy is expected to contract this year and next.

Dollarizers face resistance from the Peronist party, which relies on the inflation tax to fund its populism when revenues run low. Yet demand for dollars suggests that Mr. Macri would have popular backing for adopting the greenback as the national currency. Lawyers in Argentina differ about the legality of dollarization under the Argentine constitution, but our sources believe Mr. Macri could dollarize with the backing of a majority in Congress.

Panama has used the dollar as legal tender since 1904, and El Salvador and Ecuador dollarized in 2000. Ecuador did it to resolve a banking crisis and El Salvador did it to bring down interest rates. El Salvador and Panama now have the lowest domestic borrowing rates in Latin America and the longest maturities. Ecuador has price stability not seen in at least a half century.

One objection to dollarization is that Argentina would lose the profits a central bank earns by printing its own currency, known as seigniorage. But this is a political excuse disguised as economics. What is lost in seigniorage will be more than offset by ending peso crises.

Setting the right exchange rate also matters. Several Argentine economists propose converting short-term government paper to longer-term bonds to reduce the number of pesos that need to be exchanged for dollars in the short run. But the best rate is probably the black-market rate where the peso now trades.

Dollarization eliminates the moral hazard that central-bank rescues encourage in the banking system; international capital markets become the lender of last resort. Another benefit is that it would be nearly impossible to reverse, unlike Argentina’s one-to-one convertibility law with the dollar of the 1990s, which politicians violated when they were back in hock in the early 2000s. Argentines also ought to have the right to keep their dollars abroad if they choose. This would alleviate the worry that the government might “corral” bank accounts as it did in 2001.

A Macri decision to dollarize would break this ugly cycle by giving Argentines a store of value and a medium of exchange they can rely on. It might not save his Presidency, but it would ensure a legacy for Mr. Macri as the leader who dared to defend Argentine savings from a marauding future government.

Dousing the Sovereignty Wildfire

In time, the current spat between French President Emmanuel Macron and his Brazilian counterpart Jair Bolsonaro regarding the Amazon rainforest may become a mere footnote. But other rows between collective and national interests are sure to erupt, and the world needs to find a way to manage them.

Jean Pisani-Ferry

pisaniferry101_Brent StirtonGetty Images_fire


PARIS – On the eve of the recent G7 summit in Biarritz, French President Emmanuel Macron described the Amazon rainforest as “the lungs of our planet.” And because the rainforest’s preservation matters for the whole world, Macron added, Brazilian President Jair Bolsonaro cannot be allowed “to destroy everything.” In reply, Bolsonaro accused Macron of instrumentalizing an “internal” Brazilian issue, and said that for the G7 to discuss the matter without the countries of the Amazon region present was evidence of a “misplaced colonialist mindset.”

The dispute has since escalated further, with Macron now threatening to block the recently concluded trade deal between the European Union and Mercosur, unless Brazil – the largest member of the Latin American trade bloc – does more to protect the forest.

The Macron-Bolsonaro dispute highlights the tension between two big recent trends: the increasing need for global collective action and the growing demand for national sovereignty. Further clashes between these two forces are inevitable, and whether or not they can be reconciled will determine the fate of our world.

Global commons are nothing new. International cooperation to fight contagious diseases and protect public health dates back to the early nineteenth century. But global collective action did not gain worldwide prominence until the turn of the millennium. The concept of “global public goods,” popularized by World Bank economists, was then applied to a broad range of issues, from climate preservation and biodiversity to financial stability and Internet security.

In the post-Cold War context, internationalists believed that global solutions could be agreed upon and implemented to tackle global challenges. Binding global agreements, or international law, would be implemented and enforced with the help of strong international institutions. The future, it seemed, belonged to global governance.

This proved to be an illusion. The institutional architecture of globalization failed to develop as advocates of global governance had hoped. Although the World Trade Organization was established in 1995, no other significant global body has seen the light since then (and the WTO itself does not have much power beyond arbitrating disputes). Plans for global institutions to oversee investment, competition, or the environment were shelved. And even before US President Donald Trump started questioning multilateralism, regional arrangements began restructuring international trade and global financial safety nets.

Instead of the advent of global governance, the world is witnessing the rise of economic nationalism. As Monica de Bolle and Jeromin Zettelmeyer of the Peterson Institute found in a systematic analysis of the platforms of 55 major political parties from G20 countries, emphasis on national sovereignty and rejection of multilateralism are widespread. When John Bolton, the current US national security adviser, wrote in 2000 that global governance was a threat to “Americanism,” many regarded the idea as a joke. Few are laughing now.

True, nationalism hasn’t won the war. Despite Brexit and the rise of far-right parties in Italy and other countries, the European Parliament election in May did not produce the feared populist landslide. Growing segments of public opinion simply want policymakers to address problems in the most effective way, including at European or global level if needed.

Nowadays, however, international collective action cannot be based on further universal treaty-based obligations. The question, then, is which alternative mechanisms can address global challenges effectively while minimizing encroachments on national sovereignty.

Some models are already at work internationally. On trade, for example, burgeoning “variable-geometry” groupings are tackling new issues related to “behind-the-border” regulations such as technical standards, and the blurring of the distinction between goods and services. Corporate giants’ global abuse of market power is being confronted by the extraterritorial rulings of national competition authorities.

Likewise, the effective strengthening of bank capital ratios resulted not from any international law, but from the voluntary adoption of common, non-binding standards. And although the world is lagging on climate-change mitigation, the 2015 Paris climate agreement has prompted several countries to act, including by mobilizing regional and city governments, and triggering private investment in clean technologies.

But because not all global problems are alike, such mechanisms will provide a suitable template for collective action only in certain cases. When the various players are willing to act, a modicum of transparency and trust-building is sufficient to ensure cooperation. In other cases, however, the temptation to free-ride or abstain can be countered only by powerful incentives or even sanctions.

That brings us back to the Amazon fires. The interests of Brazil and the international community are not aligned. For Brazil’s small farmers and big agri-food corporations, the economic value of the land matters considerably. But the rest of the world is mainly concerned with the rainforest’s ecological and biodiversity value.

Time horizons also differ: unsurprisingly, the wealthy in the Global North value the future more than the poor in the Global South do. Even if large segments of Brazilian society value the preservation of the rainforest, it is wishful thinking to believe that moral suasion and nudges alone will resolve differences between Brazil and its external partners.

In the case of the Amazon, the only hard instruments available are money and sanctions. Through the transfer of more than $1 billion to the Amazon Fund since 2008, Norway already subsidizes the preservation of the environmental service that the rainforest provides to the world (it interrupted transfers last month in protest against Bolsonaro’s policies). Macron’s alternative is to coerce Brazil into valuing the environment by making trade deals and other international agreements conditional upon the country managing its natural resources sustainably.

Both options are problematic. Payments open an enormous Pandora’s box, and reaching a significant scale requires an agreement on who will actually bear the burden: the annual social value of carbon capture by the Amazon rainforest is hundreds of times larger than the Norwegian transfers. Coercion is also tricky, because there is only an oblique logical relationship between deforestation and trade. But because there are no other options, solutions will probably have to involve some combination of the two.

In time, the Macron-Bolsonaro spat may become a mere footnote. But other disputes pitting global concerns against national sovereignty are sure to erupt, and the world needs to find a way to manage them.


Jean Pisani-Ferry, a professor at the Hertie School of Governance (Berlin) and Sciences Po (Paris), holds the Tommaso Padoa-Schioppa chair at the European University Institute and is a senior fellow at Bruegel, a Brussels-based think tank.