Less than zero

In emulating the measures taken by the Japanese in the 1990s, it looks likely that zero percent interest rates are coming – but can this prevent further recession?

Zero percent interest is coming – but can it stave off recession?

Not while frightened bankers refuse to lend.

Governments around the world have been looking for a stick to beat the banks into submission, and they may have found it. A two-part plan, modeled on the rescue package that helped solve Japan’s economic crash during the 1990s: low interest rates and increased liquidity.

The first is relatively easy. The Bank of England cut rates by 1 percent as expected on Thursday to a record low. The European Central Bank followed by reducing its key rate to 2.5 percent after a record three-quarter point reduction.

The scale of the Bank of England's cut, from 5 percent to 2 percent in two months, confirms what the Government, the City and world’s financial analysts have known all along. The UK is among the worst affected nations in this economic crisis.

Central banks in the Asia-Pacific region joined as part of the coordinated wave of interest rate cuts on Thursday.

Indonesia's central bank announced a cut of 25 basis points, to 9.25 percent. New Zealand followed with a record 1.5 percentage point reduction to 5 percent, while Sweden reduced its rates by almost half, another record cut of 1.75 points to 2 percent.

If there is hope, and we must believe there is, the world is in this together.

But while interest rate reductions have been welcomed, they are no panacea.

The bank of England’s cut pushed the pound to a record low against the Euro of 86.96 pence, and at one point it fell to $1.46 against the dollar.
Previous rate reductions in the US have also helped, but are no where near resolving the underlying problems in the economy.

American retailers reported worsening sales in November sales and car manufacturers put renewed pressure on Congress to release the $34 billion in loans they claim are necessary to survive. US factory orders in October fell by the most in 8 years, while 4.09 million Americans received government unemployment checks in the week ending November 22, the most since 1982.

The problem with interest cuts, as demonstrated in America, is there are limits to how far they can come down. You can’t go lower than zero.
Rumours abound that nations may already be thinking the unthinkable. Part two of the plan: print more money.

Known as ' quantitative easing', the Japanese government most famously used this as a tactic to solve the financial crisis in the early 1990s.

The Bank of Japan has maintained low interest rates ever since, currently at 0.3 percent. Much more importantly it has encouraged commercial banks to lend by injecting more liquidity into the financial system. This boost to banks’ reserves was achieved by buying government bonds at a rate many more times than was required to set the interest rate to zero.

Look out for British banks being forced to buy hundreds of billions of pounds in government bonds under proposed rules over the coming months.

The Financial Services Authority recommended on Thursday a proportion of banks’ assets should be in the form of ‘highly liquid’ government bonds.

These proposals will have far-reaching implications for the banks. Their efforts to generate riskier, but larger profits will be restricted by the enforced switching of more than £200 billion worth of assets into bonds, which produce lower yields than current fixed-income instruments.

It worked for Japan.

The question today is can liquidity and zero interest rates save economies that have been infected by a debt burden that is as yet unknown.

I’m an optimist. Maybe.