An International Conundrum of Low Interest Rates

A reader pointed out to me that he thought I was onto something when I am focusing my energies understanding what is going on in Asia, notably Japan and China. He also suggested that I look a little further at the complex of interest rates in thedeveloping countries, which exhibit NEGATIVE real interest rates. With that as a back-drop, he suggested hat money over there is strongly being encouraged to invest in anything real, and not financial. Here is a summary of interest rates and inflations rates for some selected countries:


Country    1 yr CPI    10 year govt bonds  Real rates

India        11.54                8.15       -3.39

Russia        7.00                5.31       -1.69

Brazil        4.70                3.75       -0.95

Japan         1.00                0.90       -0.10

Thailand      3.00                3.05        0.05

Mexico        3.70                3.82        0.12

Korea         3.61                4.14        0.53

China         3.00                3.70        0.70
Canada        1.70                2.71        1.01

Germany       1.30                2.43        1.13

USA           1.10                2.50        1.40

Norway        1.91                3.35        1.44


The top 3 countries, in terms of negative real interest rates are 3 of the 4 BRIC’s, with China in the middle of the pack. With suspicion about how real their reported CPI numbers are in China, I am not sure how real that data point is. In fact, because the government more or less controls the price of everything in China, it is hard to tell what a market driven inflation rate would be. It is known however, that real estate prices, which are not government controlled, are moving at double digit rates, and by this metric of inflation, real interest rates are quite negative in China as well.


The take-away from this is that the developing economies, which on average, run trade surpluses, and have seen their localmoney supply go up proportionate to their trade surpluses, and have created an environment for investors to invest in real property which will appreciate at least as fast as the inflation rate. Which, as the chart above illustrates, is far better than the return to be earned on government debt. Meanwhile, in the developed countries, such as the US, there is less incentive to invest in real assets, as the prospects for inflation are much lower, with real interest rates being positive, in contrast to the negative interest rates in the BRICs.


This complex of interest rates and inflation scenarios also explains why investors would want to own the currency of any of the BRICs. The only problem with all this is that there is so much more money of the developed countries, dollars and euros predominately, that it will create a major problem if a portion of these funds were redeemed for local BRIC currencies.


China is a unique situation unto itself. The Chinese government controls who can convert foreign currencies into the local currency, and for their part, the People’s Bank of China (PBC), China’s central bank, holds $2.6 trillion of foreign currency (mostly dollars), as backing for their $3.3 trillion balance sheet, denominated in yuan, and comprising currency in circulation, and credit/reserves in the domestic banking system. I am not sure how the other developing countries conduct their monetary affairs, or how they intermediate the flow of dollars and euros into their banking system. The Chinese government themselves have converted dollars and euros by just holding them on their own balance sheet. On some level, they own a lot of currency risk, to the extent that Fed policies cause the value of the dollar to depreciate.


Another point to emphasis is how the money is going to flow away from the US, since our inflation rates are low. At a time when the Fed is printing money, and trying to encourage inflation, it does not appear to me that the configuration of real interest rates around the globe is going to encourage real property investments in the US. In order for there to be a shift, the Fed would need to push US (10 year treasury) rates down to zero, in order to produce a real interest rate of -1%, on par with the BRICs. Is that remotely possible? I would say not! And until that happens, the supply of dollars held by our trading partners is going to stay over there, in such a way as to encourage local investments. This further re-inforces the difficulty the Fed will have engineering inflation in the US, but I am sure this will not prevent them from trying.