Bankrate.ca

 

Title: Can interest rates go below zero?

Sub-title: In real terms they already have

 

Canada’s economic picture has been looking sluggish at best lately. The country shed 22,000 jobs in January, after five strong months of gains. Worse, economic growth in the US, our largest trading partner, was actually negative during the fourth quarter of 2012. As if that were not enough, an International Monetary Fund report released this week said that Canadian economic risks remain weighed to the downside.

 

This continuing sluggishness on both sides of the border, five years after the US financial sector collapse and ensuing downturn, is something of a mystery. A recovery from a recession of that scale would typically be far stronger, particularly in light on the massive fiscal and economic stimulus that governments have pumped into the economy.

 

Part of the challenge, is that much of the economic growth that occurred in the Western world during the two decades prior to the economic troubles, has been fueled by central bank money printing. The Bank of Canada’s policy of cutting interest rates at almost every sign of sluggishness has been a perfect example.

 

To be fair, other central banks, including the US Federal Reserve, the European Central Bank and the Bank of England have all been doing the same thing. However with policy interest rates now near zero (0.75 percent in Canada) pretty much everywhere, politicians and economists are running out of room to do much more. After all, you can’t cut interest rates below zero can you? Well, actually you can. In fact Canada’s central bank is doing this right now, by playing with real interest rates (interest rates less inflation). Using “sleight of hand” they make it look like you are earning money on your savings, when you are actually losing.

 

Here is how it works. Let’s say you buy a 90-day Treasury Bill that pays you an annual rate of 1 percent. But inflation comes in at 0.8 percent as it did in December. That means your interest gains are almost totally wiped out (1 percent less 0.8 percent, leaves you with 0.2 percent in interest, near zero). Now let’s say core inflation hits the Bank of Canada’s the 2.0 percent mid-point target. If that happens, those who buy bonds will actually lose money (1 percent of interest, less 2.0 percent inflation). It gets worse, because our example does not include the taxes that many Canadians pay on their interest income.

 

Economists call the negative interest rate policies that governments are running “financial repression,” because they penalize savers who manage their money well and they bail out borrowers and spenders.

 

That said, there are signs that financial repression is going to become increasingly widespread in the coming years. That’s because money printing and low interest rates are like a “sugar high” that athletes take. They boost temporary performance, but they don’t build the muscle and skills that are needed to compete over the long-term.  Worse, not only are sugar highs hard to stop, it takes more and more sugar to keep getting the same high.

 

The good news is that Canadians are luckier than most. The country has vast natural resources, such as the Alberta tar sands, gold mines throughout Quebec and Ontario and potash in Saskatchewan, which are wanted the world over. These will go along way towards alleviating the pain that many other countries are going to feel, as the effect of all the sugar they have been taking starts to wear off.

 

peter@peterdiekmeyer.com

 

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