Draghi’s economics gets a D

The President of the European Central Bank attacked German politicians who accused him of fomenting extreme right-wing views and political parties with his negative interest rates. He said that the interest rates reflected a savings glut and weak demand for capital. He blamed Germans too for the savings glut. That is high school economics. It deserves a D or worse.

There are many alternate explanations which people like him and Bernanke have deliberately shut their eyes to.

Interest rates are low because low interest rates engender deflationary expectations and a vicious circle forms.

If demand for capital is low, it must be because returns to capital are low. That, in turn, flows from the above statement about deflationary mindset being created and entrenched by negative rates.

If returns to capital are low, then why are stock markets not reflecting that? So, are negative rates stoking demand for capital for real investment or are they stoking demand for capital for speculative investment?

May be, bond markets are pricing in the collapse of asset price bubbles created by loose money policies and a further worsening of real economies and hence bond yields are negative in many countries.

Check out this observation from a ‘Buttonwood’ blog post in March:

This relationship between the Fed’s actions and market returns dates back well before Ms Yellen’s tenure. GMO, a fund management company, recently published a paper looking at market movements on the day of Fed meetings. The Fed only meets eight times a year. But since 1984, the returns on the days of Fed meetings have provided a quarter of all returns. Take those returns away and US equities would look reasonably priced under Robert Shiller’s cyclically-adjusted price-earnings ratio methodology. Indeed, in the depths of the crisis, the market would probably have fallen back to a single-digit p/e. The Fed prevented the market from reverting to the mean. [Link]

Finally, even if we were to consider Draghi’s savings glut explanation for the sake of argument, precisely where is the savings glut coming from? Oil-rich economies are struggling. Pre-2008, they were the big contributors for the global pool of savings with their current surpluses.Now, they are running huge deficits. Japan’s household saving rates are negative now. They should be increasing their savings actually. China’s current account surpluses have come down. The savings pond has shrunk a lot. Hence, at the margin, interest rates should have gone up and not down.

Therefore, it is not savings glut that is contributing to low and negative rates. The reasons lie elsewhere. Search above.

If you want to read common sense stuff, check out the Buttonwood column on the ‘wrong kind of savings’:

it could be argued that rich countries with ageing populations should be running current-account surpluses and investing in faster-growing emerging markets. The euro area, in aggregate, does follow this approach (although Germany, its biggest economy, is often criticised for doing so), but Britain and America run persistent current-account deficits. [Link]




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