A remarkable if obscure event last week
highlighted the potentially colossal impact on the global economy of
the collision of two forces: the pension needs of aging populations
throughout the developed world and the collapse of long-term
interest rates. Pensions do not feature in the long list of subjects
to be discussed at the World Economic Forum in Davos this week, but
they ought to.
The event last week was
the fall in the rate of return of 50-year inflation-indexed British
government bonds to under 0.4 percent. That is far worse than
anything even Japanese savers have experienced - the inflation
adjusted on yen bonds was never below 1 percent.
The British bond bubble
is exceptional and caused in part by regulations that force pension
fund trustees to seek safety more than yield. But it is also part of
a global phenomenon. For example, yields on 20-year U.S. Treasury
inflation-protected bonds are 1.9 percent and those on French,
Canadian and other equivalents are lower. Conventional bond yields
are close to record lows almost everywhere, including emerging and
higher risk markets such as Russia and Argentina.
So why should this be a
problem? Are not low interest rates good for economies, stimulating
consumption and encouraging investment? Unfortunately, not always -
particularly when pension schemes in many companies and countries
are already inadequate to meet future obligations.
In the case of Britain,
the fall in long-term rates over the past year has added $30 billion
to the existing pension fund deficits. In the United States, many
funds already had overly optimistic of rates of return on funds. For
the time being, a pick-up in some equity markets may be delaying a
day of reckoning. But funds assuming an annual return of 8 percent
to 9 percent, when 10-year treasuries yield half that and corporate
dividend yields are under 2 percent, will face a crisis if yields do
Low long-term interest
rates are having or will have very serious negative consequences
that outweigh temporary apparent benefits:
The more aware
corporations become of the further growth in their unfunded pension
liabilities, the less willing will they be to invest surplus cash in
new ventures. It will go to shore up the funds. In the United
States, the weak corporate investment response to very healthy
profits suggests this is happening already.
As in Japan, low
interest rates have minimal impact on willingness to consume.
Instead they make it seemingly painless for the government to borrow
heavily for investment in schemes and bridges to nowhere.
Low long-term interest
rates encourage asset bubbles of all sorts. The world may not be in
an equity bubble but many parts of it have been enjoying property
bubbles - and now the bond bubble. That gives central banks, fearful
of bubbles bursting, reason to delay return to more normal rates.
Low rates of return from
bond and equity markets encourage a shift into nonconventional
assets such as hedge funds and private equity. These promise higher
returns but their lack of transparency and high leverage promise
more train wrecks ahead.
Annuity yields are so
low that pensioners will be forced to rely on the state for welfare.
It has become
fashionable in the West to see "excess Asian savings" as the main
cause of low bond yields. Yes, there is scope for China, South
Korea, Japan and parts of Southeast Asia to spend more and save
less. There is a trend in that direction already - and, in time, oil
exporters now accumulating vast surpluses will also spend more of
their new wealth.
None of this can
adequately explain, however, why real interest rates in the United
States can be at record lows while household saving is nonexistent
and the government deficit enormous. Or why British rates are so low
despite record levels of household debt and a rising government
A more plausible
explanation is the extraordinarily rapid pace of money supply growth
almost everywhere - in Europe, Australia and even Japan as well as
in the lead money printer, the United States. Rapid expansion of
reserve currencies has quickly been followed by monetary surges in
Asia and Latin America.
Of course there are
other influences. In the information technology era, growth may be
less capital-intensive than during the era of steel. And global
demographic change is adding to savings and reducing growth in
demand for new houses and factories.
But the major central
bankers and finance ministers should stop either blaming the Asians
or just musing over the causes of low rates. Individually and
severally, they are supposed to be in control of money creation,
credit growth and the supply of long-term public debt.
The problems of aging
and pensions were already challenging enough. Current attempts to
buy short-term expansion with artificially low interest rates can
only make the long-term problems greater than ever.
Davos: please discuss.