Deltec Flash Note From ZIRP to NIRO | Page 3

We are not the only ones who can see economic activity slowing around the world. Even the IMF, famous for not predicting any of the economic crises of the last 30 years, has noticed Emerging Market malaise metastasizing into the Developed Markets; they have cut their growth forecasts for 2020 to 3.0% as a result. The danger of a bleed from the producer economies into the service and consumption based economies of the Developed Markets has Central Banks falling over one another to add stimulus, even as economic data in the US is fading rather than collapsing. But where do policy makers go from here? They are already at or close to the zero bound. What happens to consumption and investment if/when ZIRP becomes NIRP? (Zero Interest Rate Policy, Negative Interest Rate Policy.)

We ask this question even though the Federal Reserve telegraphed a pause in cutting interest rates last week. We ask because we don’t think their equivocation will last long into 2020. Although we understand US consumers are still benefiting from stable employment, that US housing has been insulated by falling mortgage rates, and that recent global monetary stimulus has been generous enough to lift asset prices and confidence, we do not think underlying economic activity will rebound materially.

We think this because the restructuring away from debt fueled growth in China is ongoing; and because stretched corporate balance sheets globally means the efficacy of Central Bank’s primary tool, changing the cost of debt by moving interest rates, is limited. We think the credit channel is stuffed, and that the transmission mechanism is loose or broken. So far their efforts have only altered the slope of the decline, preventing an unpleasant acceleration down, rather than changing the direction of travel. If growth continues to fade as we expect next year, more rate cuts will likely be forthcoming.

When rates are already so low, it is worth asking, ‘What happens next?’ Logic and a basic analysis of supply and demand suggest if ‘cost’ falls ‘demand’ should rise; if interest rates are cut credit should expand. But economics remains a social science rather than a study of physical law. The medium is the agglomeration of human decisions, a tangle of human behaviors and emotions, so we need to examine exactly how elastic the demand for credit really is.

Looking at the ‘buyers’ of credit (i.e. borrowers) each has a different demand elasticity. Households, corporations and governments have different attitudes to the falling cost of debt depending on other externalities including: the condition of their balance sheets, their ability to increase revenue to repay debt (e.g. real wage increases, sales growth or tax increases) and their memories of recent shocks (e.g. the Great Financial Crisis).

Luckily we now have plenty of examples of negative rates including Japan, Sweden, Switzerland, Denmark and the Euro-zone. And in many of these cases the counterintuitive prevails: falling interest rates have actually led to an increase in savings, a decline in outstanding debt and outright deleveraging.

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