Negative interest rates: Great for gold but are they any good for the economy?
London (Aug 16) Central Banks have been viewing ultra-low, or in many cases directly, or effectively, negative, interest rates as being the panacea for all economic ills. Deprive savers of interest, so the theory goes, and they will opt to spend their savings instead, thereby generating a boost for the economy. Low interest rates also make borrowing costs lower for industry and, with supposedly additional availability of capital through quantitative easing programmes should thereby boost investment in necessary services, plant and equipment.
It is becoming more and more apparent that neither of these strategies are working, or at least not to the extent anticipated by the economists promoting this policy which is, unfortunately, being followed by many of the world’s major central banks.
From the savings angle, what the policy is really doing is driving savers away from traditional income generating securities and into assets like gold which may pay no interest – but no interest is better than negative interest – but offers the possibility of capital accumulation. Those in countries like the UK, where the currency first weakened against the US dollar post the Brexit vote, and then again when the Bank of England cut the base rate and re-introduced monetary stimulus, will have seen some substantial gains through moving into gold. We advised, ahead of the Brexit vote, for UK investors to at least put some of their investments into gold for example as insurance against a ‘Leave the EU’ decision, and those who did benefited very nicely indeed, thank you, at least in terms of the pound sterling. The combination of the rising gold price in US dollars and the fall in sterling against the dollar has had a multiplying impact on an investment in gold or in silver - and even more so in gold or silver mining stocks.
On the business front there’s little evidence that the huge move towards zero, or negative, interest rates has done much to stimulate activity. Businesses are seen as reluctant to borrow, even when the cost of borrowing is so low, to put money into new plant and equipment, or services, when demand for their products is not seen as being positive in any case. For many the imposition of such low interest rates is seen as yet another indication of a sick economy and an ultra low-growth environment.
Among the nations which have moved to the imposition of negative interest rates are, most significantly, the European Central Bank (ECB) and the Japanese Central Bank (BoJ), while Denmark, Sweden and Switzerland have also followed suit. The Bank of England (BoE) is almost there too and with the prospect of another rate cut should the post-Brexit economy not pick up, could be in zero, or negative, territory by the year end. And with inflation probably running higher than most governments will admit, all these, and more including the USA, are effectively in a below zero environment as far as bond investment returns copared with a rising CPI are concerned. All this is positive for gold, but of increasing worry for the Central Banking system which seems to have little more ammunition left with which to try and stimulate flagging global economies.
Just to emphasise the problem a recent survey, published in the UK’s highly respected Financial Times newspaper suggested that the universe of sub-zero-yielding debt - primarily government bonds in Europe and Japan but also a mounting number of highly-rated corporate bonds - has reached the enormous total of $13.4 TRILLION.
Another factor which is indeed worrying for businesses and which could see them look to deposit any spare cash in alternative investments is the looming possibility of bank bail-ins, whereby large holders of money in the banking system see some of their hard-earned cash effectively confiscated to help rescue an ailing bank. This was brought to the fore a couple of years ago in Cyprus when a bail-in was imposed for major clients of the Bank of Cyprus which was close to failure because of its large holdings of Greek debt. As the UK’s Daily Telegraph reported at the time. the imposed bail-in forced big savers to foot the bill for the recapitalisation of the nation’s biggest bank. The bank said at the time that it converted 37.5% of deposits exceeding €100,000 into "class A" shares, with an additional 22.5% held as a buffer for possible conversion in the future. Another 30pc was temporarily frozen and held as deposits.
Legislation was subsequently changed to permit bail-ins of this nature across the EU and now the spectre of something similar occurring in Ireland has been reported with one of the country’s biggest insurers said to have been moving its cash holdings out of the banking system into government bonds for fear of another property price crash putting the Irish banking system in peril.
There is thus something of a confluence in factors which would seem to be gold supportive in the medium term, while the increase in geopolitical tensions between the Ukraine and Russia, and China’s belligerent rhetoric over its de facto annexation of large sections of the South China Sea, and the uncertainties engendered by perhaps the most politically divisive US presidential election ever, is further adding to the positive environment for the gold price. Whether the markets will recognise this after the Labor Day holiday, when the US traders, bankers, fund managers et al are back from their holidays, which has seen something of a volatile marketplace for precious metals over the past month, remains to be seen as there are a lot of big vested interests at play here, but we do see the overall pricing environment as distinctly positive.