Low Interest Rates: Bad News for Your Wealth?

Surprise surprise…the Reserve Bank of New Zealand has opted to stick with its current historically low Official Cash Rate of 1.5%…with the not-so-subtle hint that a ‘a lower OCR may be needed over time’.

Our friends at the Reserve Bank of Australia made that call three weeks ago…taking the Australian rate to a decade-low 1%…with another 0.25% cut likely in the weeks ahead.

Across the Pacific, it’s looking like the Fed will follow suit. The Financial Times a.k.a. the pink paper reports:

Markets seem convinced that the US Federal Reserve is going to cut interest rates next month. The only questions investors are now debating is to what extent the central bank will trim rates in July — and how low it will ultimately go.

Japan joins the Swiss and Swedish by going negative…and promises to start buying up assets if that doesn’t work.

The European Central Bank sits at a flat 0% right now…and the Brits continue toying around under 1%.

As you’d expect, the only markets out there with interest rates over 2.5% are the emerging ones: Brazil at 6.5%, Russia at 7.5%, India at 5.75% and China at 4.35%.

Why does all this matter?

It’s all really odd.

Normally, you’d almost never see interest rates and central bank chatter popping up in newspaper headlines. They might bump rates a tiny bit or drop it a smidge…but keeping around a general level…historically over 5%.

These decisions should be based on small changes in unemployment and inflation rates.

But these days, the cart rides before the horse…with central bankers making key decisions based on changes that might happen…or even worse, that their overseas counterparts think might happen.

The RBNZ even said it plainly in the last statement, ‘The [Monetary Policy Committee] pointed out the fact a number of central banks around the world are easing their monetary policy settings to support demand.’

As such, they’ve taken their whole operation — called monetary policy — and completely transformed it.

Instead of being a reactionary background-level mechanism, central bank decisions have become the driving force of economies…with central bankers speaking with the vox dei…the voice of God.

With so little as a vague sentence in a report, a central bank governor can send investors fleeing from the stock market…savers emptying accounts…young people buying houses by the dozen.

It’s bizarre.

Monetary policy’s original purpose was to keep economies on track…heading towards the optimal balance of high employment and low employment.

That’s what economists call the ‘Goldilocks’ Economy’.

Not too hot. Not too cold. Just right.

But pay close attention…the RBNZ’s policy objectives only include employment and inflation.

Not growth.

The economy could be tanking, but as long as people are working and prices are fairly stable…the RBNZ’s job is done.

Theoretically.

These days, central banks’ territory has unofficially expanded into economic support…with the interest rate being used primarily to prop up growth.

And in New Zealand, that means propping up house prices.

You see, there’s a phenomenon in economics called the wealth effect. When people’s investments perform well, they get this idea that they’re wealthier…and then they are a little looser with their wallets.

Here, the cultural norm of property investment coupled with rapidly rising valuations has created an entire generation of Kiwis that think they’re rich because the local council says their hut is worth a few million.

It’s an illusion of wealth.

(Of course, those that manage to get lucky and liquidate at the top might get to enjoy a comfortable life when the economy hits rock bottom.)

When the RBNZ lowers rates today, it does so to encourage spending…to give the economy some extra artificial oomph.

Since Kiwis invest in houses, lots of that easy-money-funded-spending goes into houses…lifting prices further…and expanding the wealth effect.

So, in the end, the organisation designed to keep inflation in check ends up being the monster driving housing inflation to the brim.

As old Frierich Nietzsche once said:

Whoever fights monsters should see to it that in the process he does not become a monster. And if you gaze long enough into an abyss, the abyss will gaze back into you.

But before I go casting the RBNZ as the monster in this story, realise that governor Adrian Orr is simply following in the footsteps of his counterparts around the world.

There’s a whole host of ‘easy money’ monsters out there…making up one of the greatest illusions the world has ever seen.

A lower OCR now is most consistent with achieving our objectives and provides a more balanced outlook for interest rates.’

—Adrian Orr

In the absence of improvement, such that the sustained return of inflation to our aim is threatened, additional stimulus will be required.’

—Mario Draghi

If you see weakness, it’s better to come in earlier rather than later.’

—Jerome Powell

Conductors, magicians, the men behind the curtain…our central bankers have flooded us with credit and we’ve loved them for it. Made them heroes. Thanked them for having the ‘courage to act’ (coincidentally, the title of Ben Bernanke’s memoirs).

But it may not be long until reality hits and the curtain falls to reveal a fragile mess of a global economy without a leg to stand on.

Best,

Taylor Kee
Editor, Money Morning New Zealand


Taylor Kee is the lead Editor at Money Morning NZ. With a background in the financial publishing industry, Taylor knows how simple, yet difficult investing can be. He has worked with a range of assets classes, and with some of the world’s most thought-provoking financial writers, including Bill Bonner, Dan Denning, Doug Casey, and more. But he’s found his niche in macroeconomics and the excitement of technology investments. And Taylor is looking forward to the opportunity to share his thoughts on where New Zealand’s economy is going next and the opportunities it presents. Taylor shares these ideas with Money Morning NZ readers each day.


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