Why are global interest rates falling?

Over 2019, interest rates for a variety of fixed terms have been declining – a topic that is likely to be front and centre at Jackson Hole over the coming days.  The weird behaviour of interest rates is something that is causing some big name economists to rethink monetary policy – such as Larry Summers thread here:

Coming into Jackson Hole, economists are grappling with a major issue: Can central banking as we know it be the primary tool of macroeconomic stabilization in the industrial world over the next decade? In my forthcoming paper w/ @annastansbury, we argue that this is in doubt. 1/

— Lawrence H. Summers (@LHSummers) August 22, 2019

However, all I’d like to do here is talk about one of the reasons why interest rates have taken another down step in the past month or so that sounds like it has gone under the radar – poor coordination between the US Treasury and US Fed regarding cash reserves.

We’ve heard the big reasons why interest rates are falling: uncertainty due to increasing numbers of mentally unstable politicians, technological change, population aging, and a general feeling it has been too long between recessions.

However, over at Zero Hedge I spotted an interesting post by a US investment banker warning about the liquidity issues stemming from the actions of the US Treasury in the last few months. Apparently The US Treasury decided to rebuild their cash reserves from 130$million to $350 million according to the estimates.  They do this by issuing illiquid assets (such as bonds) in order to raise the cash.

Now, if the US Treasury is selling bonds to get in cash reserves, they are reducing the number of US dollars floating around. If the central bank doesn’t provide the dollars to counter-match that, it tightens monetary policy.  The Fed could have attempted to sterlize these purchases by using open market operations (or a form of QE) – or in the extreme the US Fed could simply buy the bonds off the government directly if they were certain that these reserves didn’t correspond to additional spending. 

Why the FED hasn’t done it yet? 

Any type of purchase from the Fed that involves either money financing debt, or a more nuanced form of increasing the money supply, would be seen as unnecessary and dangerous in “normal” times – as that would lead to inflation . But when interest rates are persistently close to zero, inflation (and the price level) constantly under target, and bond yields are as low as they are these are not normal times.  Arguably at the zero lower bound we can go as far as saying that actions that are inflationary are the “good thing”. 

How the US Treasury reserve build-up affects the rest of the world?

US Treasury demand for cash is really an increase in the demand for the primary liquid and safe asset – US dollars, the global reserve currency.  This in turn creates liquidity issues in the US and the overseas. Furthermore, this creates a scarcity of US dollars which drives an appreciation in the US dollar.

If the US was just a small open economy, then the higher dollar would affect its own exporters only. But the US currency is the reserve currency for most of the world and now we have got a situation where there is an increased demand for safe asset, which creates shortage of safe asset around the rest of the world. This leads for funding for banks being perceived risky. That in turn, puts upward pressure on banks margins.  If this is the case, then the larger than expected cut in the OCR by the RBNZ may partly be due to netting outing the increasing margins – rather than being monetary policy easing.

New Zealand, being a small open economy, has to respond to what is happening overseas.  If pressures from poor fiscal-monetary coordination in the US change financing costs for NZ banks, and see a number of our trading partners cut their interest rates, we have to follow. 

P.S. One of the other main reasons why interest rates are falling is the trade war. Here is an interesting point made on the co-movement of business cycles internationally due to shocks such as a trade war between US and China. https://voxeu.org/article/international-business-cycle-co-movement-global-production-network