Industry view – 300 Club Stefan Dunatov is the chair of the 300 Club


BEING THANKFUL FOR ZERO POLICY RATES – HELPING THE NEXT GENERATION THROUGH PAINLESS DEVALUATION


Much has been written about the world of zero interest rates, both applauding or denigrating central banks for their role in it. This latest round of worry about central bank judgement is part of a persistent, misplaced view of how powerful the cen- tral banks of the Western World really are. What financial markets refer to as the ‘Powell put’ is really a misunderstanding of a broader macro-economic trend. To understand this, think of the financial markets as part of the broader economy. The economy has, despite financial mar- ket trials and tribulations, become more stable since the end of World War II. Re- cessions happen less frequently, they are less damaging to domestic demand, eco- nomic expansions last longer and although wage growth has not been equal- ly distributed, it has been positive. Changes to the underlying economy are responsible for these outcomes: we are a more service-oriented economy, with less exposure to volatile manufacturing cycles; we are also an economy that benefits from the disinflationary effect of technological


changes that continually substitute or dis- place parts of the global supply chain. At the same time, or perhaps because of it, government and central bank policy is being directed to one cause: sustaining domestic demand growth, which allows policy makers to target maximum levels of employment. It is because of this ongo- ing support to developed countries’ do- mestic demand that companies face strong growth outlooks and why equity markets have performed so well, especially since the early 1980s, when central banks began to become more in- dependent. There is no ‘Powell put’ – it’s a put on the whole economy, the value of which has grown exponentially as eco- nomic volatility has persistently fallen. There has, however, been one looming problem: the need to transfer real assets from older, wealthier generations to the younger generations in the face of high asset valuations. The most obvious exam- ple is property. One way would be for asset prices to eventually fall to a point that younger generations would be able to afford them. In the case of property, this would mean such a fall in house prices that price-to-income ratios became reasonable. However, such a fall would be crippling to the banking system (which lends against property) not to mention the financial implications for sellers. This is where zero, or negative, policy rates come in. Like a “painless” internal devaluation, zero interest rates are a long- term policy prescription to penalise wealth owners and subsidise the younger generation of buyers, to whom these assets must eventually be transferred. Policy rates aren’t being set at zero by


central banks with this in mind; they can only tactically respond to the broader fall in interest rates being dictated by the economy at large. Instead they, like the financial services sector that serves the real economy, are forced to reconcile how to accommodate a shift in asset owner- ship whilst keeping domestic demand growth stable. That requires zero or nega- tive interest rates – now and for many years to come.


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Journalist Catherine Lafferty c.lafferty@portfolio-institutional.co.uk


14 | portfolio institutional April 2020 | issue 92


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