Stephen Jarislowsky is chairman and former president of Jarislowsky Fraser Ltd., and co-founder and director of the Canadian Coalition for Good Governance.
We are living in a period of unprecedented low interest rates. There are even countries where you pay interest on your own bank balances, such as Japan and some countries in the euro zone. Compare this with 18-per-cent interest rates in 1981, when inflation was rampant after tighter production targets by the Organization of Petroleum Exporting Countries caused crude oil prices to soar. At that time, wage inflation in North America competed with the rise in interest rates, as neither central banks nor politicians could or wanted to arrest the catastrophic loss in the real value of the North American currencies.
Today, we have almost no wage inflation in North America. Rather, real wages are on a down curve, due to globalization and low foreign wages – which will eventually lead to all labour costs becoming one commodity. As such, our high real wages will, over time, increasingly diminish in real value, while those in Asia and elsewhere, where they are now low, should begin to slowly rise. Lower labour compensation in North America means lower purchasing power and, until balanced with those in Asia, will result in a reduction in the standard of living.
Politicians do not win elections preaching belt-tightening. And central banks, while officially independent of government or political influence, are expected to maintain approximately 2-per-cent inflation, maintain employment and so on through what is called "monetary policy."
Well, with world trade comes world competition, and so in order to remain competitive, one has to keep costs as low as possible. Interest is a cost for manufacturers and other employers, and reducing interest rates is a reduction of cost. So interest rates were slashed. Moreover, in times of recession, government deficits increase, leading to new bond sales. The lower the interest, the lower the cost for government. At 1.3 per cent interest and 1.5 per cent inflation, the Canadian government pays no interest in real terms – it actually earns 0.2 per cent. If you want to maintain consumption, a low interest rate means low borrowing costs, lessening the burden for consumers with stagnant real income. Also, low interest rates inevitably allow them to carry more debt.
As this manipulation lowers rates, it benefits borrowers. On the flip side, it unfairly punishes the savers, acting like a tax on their money. The result is ever-increasing debt levels, which will ensure that the next recession is deeper and the subsequent recovery less robust. As our population ages and our life expectancy increases, the ratio of old people to productive people also increases. This will result in a material long-term income deficiency, thus reducing the standard of living for those who are retired – as well as for the working population, which must now shoulder the costs for retirees. Low interest rates also lead to rising prices for housing and other large consumer purchases.
On the same side of the ledger, low interest rates make dividends more valuable, as the spread between the stock yield and interest rate has widened. This leads to higher share prices. Also, companies that borrow money to operate have lower interest costs, accelerating possible profits.
The low interest rates we're seeing are unprecedented – they have fallen year after year since 2008.
Aside from these fabricated rates, central banks also printed money and used it to buy bonds and mortgages. This massive buying demolished normal supply and demand and fuelled a worldwide race for the bottom to maintain consumer spending while lowering domestic costs to compete with exports.
Here is why I believe the central banks have been mistaken in all this:
- Low rates distort rational markets. In a free country, investors are entitled to free markets, not “rigged” ones. Risk should be fairly rewarded.
- Low rates represent a destruction of wealth creation if more than strictly temporary – especially for older people, who need to cut spending or buy higher-yielding assets that come with risks they should not have to take.
- Low rates only postpone the eventual adjustment. In the meantime, the consumer becomes even more indebted. Once interest rates rise to normal levels, there are serious bankruptcy threats and, for many, reductions to an already low standard of living, especially for older people. They also lead to excessive government debt and eventual reduced social spending.
- Low rates postpone a return to growth and prosperity by delaying balance-sheet repairs that would lead to new productive investment and a wider economic upswing. Overindebted consumers make such a renewal near impossible.
- Low rates do little to stimulate trade, as most countries around the world follow suit with rate cuts of their own. What does result is long-term damage to all economies, without any accrued advantage.
The U.S. Federal Reserve's month-after-month hesitation to correct these injustices, even in a minor way, illustrates the road to negative consequences. The medicine has not cured the patient, even though ever more was prescribed – it is doomed to failure.
If they are truly independent of politics, I suggest that our central bank chiefs agree to gradually raise rates, in tandem, so as to not allow any country to "beggar thy neighbour." In so doing, we would avoid any sudden shocks to the world economy and mitigate the inevitable bankruptcies and suffering.