The Great Interest Rate Divide

It doesn’t matter where you live, or where you go; in 2016, the world feels eerily familiar. While cultural differences do exist — be they rooted in societal mores, religious affiliations, or otherwise — we’re seeing an alarming lack of diversity in equally important areas of life.

Yet while every generation mistakenly believes it is unique in the existential problems facing it, this one might, for once, actually have a case to make.

You’ll have come to the realisation by now that we’re living in a peculiar time. A period of history in which the ‘international community’ steadfastly persists with a single — and helplessly broken — economic doctrine. A policy that delineates between the haves and have-nots. One that promotes economic theory which regularly misaligns with the interests of nation states.

Yet, like men, not all nations are created equal. But it is not through natural process that this is so; rather, it’s by design.

To illustrate the effects of this, you need only look at interest rate disparities around the world.

What reason, if any, is there to explain the vast difference between European and Russian interest rates for example? The Central Bank of Russia (CBR) sets the cash rate at 10.5% — a stark difference to the European Central Bank’s (ECB) 0%.

Is the CBR stingier, or perhaps more prudent, than the reckless ECB? Does the ECB have more reason to keep rates at rock bottom?

We can’t answer these questions definitively. But we can make some assumptions about them. We know, for instance, that central banks don’t act independently of each other. They work in concert. And we know this because of the existence of the Bank for International Settlements.

In its own words, the BIS is an ‘institution owned by central banks which fosters international monetary and financial cooperation and serves as a bank for central banks.

Yet, why does this institution exist in the first place? More to the point, do central banks need a supervisory body? Is there any reason for them to ever engage in dialogue with one another?

There is no good reason, of course. Not if the purpose of central banks is to direct monetary policy of independent states, as we’re led to believe.

But we’re going to present an argument that this isn’t the case. To better understand what’s being proposed, it is better to think of central banks as branches of a much larger business. A business that is not only global in the truest sense of the word, but one whose policymaking is above government decree, and that often works to undermine national interests.

The great rate divide

To begin, I urge you to have a look at this set of statistics, courtesy of Trading Economics. It’s a comprehensive list of interest rates across the world. We’ll only concern ourselves with major economies here.

Two things stand out when looking at this data.

As you’ll see, half of the 16 major economies have interest rates set at 0.50% or below. That includes the US, the UK, Canada, the Euro Area, Germany, France, Italy, Spain and Japan. In other words, a who’s who of the richest, most industrialised nations on the planet. On top of this, a further two (Australia and South Korea) have rates at below 2%.

Now look at the remaining six major economies with rates above 4%. Mexico (4.25%), China (4.35%), Indonesia (6.5%), India (6.5%), Russia (10.5%), and Brazil (14.25%). Four of these economies are part of the BRICS nations that make up the bulk of the emerging world.

As you can see, there is a clear divide in the way that central banks in the West, and those in emerging markets, use monetary policy in their respective nations. The ‘why’ of it isn’t quite as clear cut as you might suspect.

Take Russia as an example. Annual year-on-year (YOY) growth in Russia has been anaemic for years. Stretching back to 2013, there has only been one quarter in which YOY growth exceeded 2%. The rest were either below 1%, or just above it. What’s more, over the last five quarters, Russian GDP growth has declined heavily, falling in a range between -1.2% and -4.5%.

In addition, the Russian rouble has climbed by 50% since 2014. And yet Russian interest rates, which were at sub-6% in 2014, are now double that figure.

‘But didn’t the CBR raise interest rates to prop up the tanking rouble at the time?’

Maybe so. But a central bank working in the direct interests of Russia wouldn’t have tightened the peg at the exact moment the economy was starting to flat-line as a result of punitive international sanctions.

In any Western economy, like Australia, the central bank would’ve implemented a quick-fix rate cut (or cuts). But not in Russia. The CBR did the exact opposite. (Keep this in mind, as it’s an important point for later on.)

Let’s now look at what central banks in the West have been doing as a way of comparison.

These central banks, which preside over economies that regularly grow at 1–3% annually, have sent rates to record lows across the Western world.

Why is that, exactly? Especially when those in clear need of stimulus efforts, like Russia, continue to impose punishing lending rates? What downside would there be to the CBR pushing the cash rate back down to 6%? At best, it would stimulate the economy at a time when GDP growth is negative. At worst, it would merely mimic what everyone else is doing. And yet they don’t.

The argument you’ll hear in the mainstream is that Western economies need a kick up the backside, whereas emerging economies don’t. In some cases, this theory holds weight. China and India, for example, each record annual growth rates above 5%. Maybe central banks in the West are just desperate, foolish, and only able to think on the short term, after all.

Or maybe not, because, elsewhere, this theory falls flat. We’ve already mentioned Russia. But it’s the same story in Brazil, too, where, despite five quarters of negative growth, rates remain at a hefty 14.25%. Mexico is another example. Despite similar growth rates to the US (around 2%), rates are at a relatively high 4.25%.

Why have the central banks in these countries not taken cues from their brothers in the West? Especially when there is not only a clear motive for monetary easing (in the case of Russia or Brazil), but ample room in which to do it?

Why is access to credit less important in Russia than it is in the Euro area? And why do Russian businesses have to put up with demanding borrowing rates, while European businesses can borrow to their hearts’ content?

Again, the mainstream narrative would suggest that this is a sign of independence among central banks.

But dig below the surface, and a different picture emerges.

In truth, central banks do act in concert, probably more than any of us would like to admit.

There are the chosen ‘haves’, and the hapless ‘have-nots’. The haves are part of the ‘old world’ international financial system, whereas the have-nots are those that aspire to join (or rebel against) it.

You see, in any normal world in which credit has expanded as much as it has, rates don’t keep going down. They tend to go up, to suck up some of that excess credit floating in the system.

But this isn’t a normal world. And despite a decade of evidence showing that efforts to stimulate growth by aggressive rate cutting aren’t working, they’ve stuck to their guns.

Meanwhile, emerging nation central banks continue to saddle their economies with prohibitively onerous rates.

What we are positing here is that this policy is intentional. That central banks work in concert to designate which economies have access to cheap credit, and which don’t. It entitles select economies to endless borrowing, with little recourse — something we’ve seen reflected in rising asset prices, like property and stocks, across most of the developed world.

Those economies that aren’t part of this ‘establishment’ are cast aside, forced with little recourse to boost growth.

A world in which ‘developed’ and ‘emerging’ economies play by the same rules

Just imagine what would happen tomorrow if interest rates across the emerging world started falling. How would the exporting sectors across the developed world fare? And what do you think would happen to currencies like the US dollar, the euro, or the Aussie dollar?

In all likelihood, they’d experience upward pressure. Their currencies would start to appreciate.

The Reserve Bank of Australia, which meets tomorrow to decide on whether to lower rates again, wouldn’t be thrilled. Anything that puts upward pressure on the Aussie dollar would be bad for business, as a cheap dollar boosts exports and tourism.

But it won’t happen, because the central banking cabal works in favour of Western economies. The RBA can, and will, take Aussie rates to 0%, because they’re allowed to. The CBR won’t be allowed to. Russia has been cast aside as a pariah of the international political and financial system. Until that changes, don’t expect to see Russian interest rates anywhere near 5%.

(Remember, central banks can enact monetary policy independent of governments. Hypothetically, if this theory that they do work in concert is true, it would be very easy to coordinate policy to serve the interests of the West.)

Ultimately, it’s hard to escape the feeling that this is a very carefully designed plan that central banks are implementing as a collective. It is certainly possible that they’ve decreed that Western economies should have rock bottom rates to boost growth (and asset prices), while simultaneously ensuring they stymie the growth of emerging economies, using their central banking outposts in these countries.

Conspiracy theory? Perhaps. But all you need to do is look at what is happening, rather than what is being said. Central bank policymaking is geared too far in favour of the West. Nations which are still growing continue to receive rate cuts. Those that aren’t, like Russia or Brazil, are bound by prohibitive lending rates.

Are these grounds for a global central banking conspiracy? You be the judge.

Mat Spasic,

Contributor, Markets and Money

PS: The RBA convenes tomorrow to decide whether to lower interest rates to a record low 1.5%.

As Markets and Money’s Phil Anderson says, interest rates are likely to remain low for a long time to come.

In his latest report, ‘Why Interest Rates Could Stay Low for the 21st Century’, he warns that you won’t be able to rely on your savings to fund your retirement. As Phil says, inflation — from low rates — is eating into your savings. You can’t rely on savings accounts or term deposits for your retirement. The regular return on a term deposit has halved in the last four years alone!

That’s why Phil wants to show you the best way to invest in this low interest rate environment. He’s prepared a four pronged strategy that’ll boost your wealth. You’ll learn where to park your cash over the coming decades to potentially profit in the coming low interest rate environment. To download the report, click here.

Markets and Money offers an independent and critical perspective on the Australian and global investment markets. Slightly offbeat and far from institutional, Markets and Money delivers you straight-forward, humorous, and useful investment insights from a world wide network of analysts, contrarians, and successful investors.

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