The Crisis Ended but Policy Remains in Crisis Mode

February 7 2018

Finally. After a few disappointing and downright poor years of economic growth, we concluded an economically excellent year a few days ago. And, as it appears now, we will inaugurate an equally strong year. A good moment to celebrate, right?

It was an epic performance: in 2017, the Dutch economy grew at an annual rate of over three percent. The last time the economy grew this fast, was when the Dutch national selection did participate in a World Cup and the Orange squad still consisted of players such as Giovanni van Bronckhorst, Ruud van Nistelrooy, Jan Vennegoor of Hesselink and Edwin van der Sar.

In contrast to earlier years, when a quick glance at the website of the national statistics bureau (Centraal Bureau voor de Statistiek or CBS) was often a rather depressing experience, a visit nowadays produces a big smile on a reader’s face. On the website of the bureau, a lot of positive news can be read: the public debt is declining; corporate profits are extraordinarily high; disposable income of Dutch households is on the rise at an increasingly faster rate which leads to higher consumer spending; housing is becoming more expensive, businesses invest more, the number of unemployed fell, yet again, below 400,000 and there are 8.7 million people with a paid job – more than ever before.

And this is not where the story ends. Elsewhere, we can read that pension funds are now in more steady waters. As a consequence, our pensioned fellow countrymen can now hope for a letter on their doormat in the course of 2018 that includes an announcement that his or her pension will be adjusted upwards.

The outlook for this year is without a doubt rosy. The CPB was in the autumn of 2017 excited about an expected economic growth of 2.5 percent this year. But recently the bureau’s statisticians in The Hague saw reason to pull out their economic calculators again: their screens indicated a solid three percent growth for 2018. Moreover, the Dutch central bank (DNB) sees our economy growing by more than three percent as well.

Given the performance in 2017 and the outlook for 2018, we can rightly conclude that our country is currently in a phase of expansion. The Netherlands is, of course, no exception: the entire Eurozone economy ended last year with a GDP of almost three percent higher than at the beginning. The Eurozone even outperformed the United States: in the US economic growth equaled approximately 2.5 percent. The International Monetary Fund (IMF) is forecasting a two percent growth (or even a little bit higher) for 2018 in both the Eurozone and the US. Consumer confidence on the other side of the Atlantic is at its highest level since 2000.

That is a welcome change after a rather disappointing decade. We have survived the worst crisis in almost a century. Hooray!


But still. I am not sure if the motive behind my skepticism is the fact that the crisis has taken so long. Or has my skepticism to do with the fact that I vividly recall the forecasts of our statisticians in The Hague from the recent past? They forecasted, for instance, 1 percent growth in 2012 and almost 1 percent in 2013, while the Dutch economy contracted almost 1.5 percent in both years. At any rate, I cannot reasonably say that it is justified to give the “all-clear” signal.

Not that I don’t want to. To the contrary, I would shout it from the rooftops if central banks, now everything from an economic perspective seems to have normalized, would also switch their monetary buttons back to normal mode. Or at least indicate when in 2018 they are planning to do so. But that seems to be unlikely.

In the Eurozone, the most important interest rate, the rate that the ECB sets, will remain at zero percent over the coming year. In comparison: the last time that all economic indicators were looking as rosy as they look now, the ECB rate stood at more than three percent. Moreover, we have to add the fact that the central bank will continue pushing down interest rates by purchasing billions of euro’s worth of bonds during a large part of the year.

While the US central bank, the Federal Reserve, perhaps embarked upon a trajectory of official rate hikes, it is still raising rates at a very slow pace given the evolution of the US economy. The official rate is currently at 1.5 percent; if the Fed does what it promised for 2018 and 2019, that is, raising interest rates another three times in both years, then the Fed rate will be at only three percent at the end of 2019. If we compare that to the rate of interest in 2007, the last normal economic year before the crisis, then the discrepancy becomes immediately clear: the Fed rate stood at more than 5 percent at the time.

A good rule of thumb for the preferred level of the official rate is that it is roughly the sum of economic growth and (expected) inflation. If we apply that rule to the Eurozone and the US, then we would arrive at an interest rate of approximately 4 to 4.5 percent. In reality, the current 2018 official rates are still far removed from those levels and it seems very likely that in the short run not much will change – especially in the Eurozone.

This raises a question: do our monetary knights see a danger heading our way that we, plain mortals, cannot see coming? Or do they assert that all the positive news and figures from CBS and Eurostat are merely because of zero percent interest rates?

Crisis Policies Are Maintained

The worst crisis since the Great Depression is over. The only awkward thing and a possible cause for concern is the fact that the central banks, such as the European Central Bank (ECB), cannot align their abnormal low interest rates with such positive economic times. While the economic landscape is flourishing, the ECB is keeping interest rates at crisis levels.

A possible explanation of the ECB’s policy choice is that the economic recovery perhaps appears strong, stable, structural and solid, but in fact is not. In other words: all signs are positive, but only because interest rates remain low. In that case, a rate hike would mean that the economic boom would come to a premature end. The fact that the ECB is keeping interest rates at zero percent, could, however, also have different motives.

A quest in the dark recesses of Eurostat, the European statistics bureau, leads us rather quickly to an overview of the public debt levels of all Euro countries at the end of 2007 (the last year before the crisis) and at the end of 2016 (the most recent figures). Some quick math shows us that the public debt in all Euro countries is currently higher than before the crisis.

Percentage-wise, Lithuania showed the strongest rise in public debt: from 1.8 to 10.1 billion euro – an increase of an astonishing 450 percent. The Lithuanian debt is still relatively small, and moreover: the country is a dwarf among Eurozone countries. What is especially important, is of course at what rate the public debts of the big four – Germany, France, Italy and Spain – have increased.

And there we observe something that surprises: the rise in the Italian public debt is “just” 38 percent. That is not much more than the increase in the German public debt; at the end of 2016, the German debt was about 34 percent higher than at the end of 2007. The best performing Eurozone country is, from this point of view, the country that nobody would bet his money on: Greece. The Greek public debt has risen by over 30 percent since 2007 (and that number from 2007 has been checked and double-checked, it is not a fabrication of the Greek statistical wizards).

Nevertheless, in the case of France and especially Spain there is nothing but bad news: the French public debt has risen by 72 percent while the Spanish public debt has increased by over 188 percent compared to the end of 2007. In the meanwhile, the Netherlands saw its public debt rise from 261.5 billion euro to 435 billion euro: an increase of 66 percent.

Since the beginning of the crisis the ECB lowered the official rate to zero percent. The central bank is also busy purchasing on a large scale government bonds to push down the yields on maturities between 1 and 30 years. One of the consequences of these purchases, is that Euro countries pay substantially less in interest over their debts.

The average interest rate that France, for instance, paid over its public debt is below 1 percent. Average rates in Italy and Spain are currently between 1.5 and 2 percent. In comparison: at the end of 2007, Paris had to deal with an average interest rate on French public debt of 4.15 percent. In Rome and Madrid, governments were faced with average rates of 4.4 and 4.18 percent.

Billion Dollar Bill

If we would apply the usual rate that these three Euro countries paid over their respective public debts on December 21, 2007 on the most recent government debt levels of these countries, then we see that France would pay 37 billion euro more in interest annually than it did at the end of 2007. For Italy, the increased interest expense would amount to 27 billion euro; for Spain, 37 billion euro.

If we would compare the interest that countries would pay at historical average interest rates to the interest paid in 2016, then the differences for France and Italy would be even larger: an additional 74 billion euro (France) and 63 billion euro (Italy). Each and every year. The reason for this is of course that their interest burden in 2016 was substantially lower despite much higher debts than in 2007 due to the spectacularly decline in interest rates. Even Germany, the according to many financially perfectly healthy country, would with a normalization of interest rates have to pay tens of billions of euros in additional payments of interest.

Add to that all those households and businesses that accumulated debt over the past few years to consume and invest. They often did so against a historically low, variable rate of interest. Increase interest rates, and many households and businesses would get into financial trouble. A rise in savings rates could neutralize such an effect, but experience teaches us that savings rates increase at a much slower pace than rates on loans. Moreover, it remains a big question mark whether commercial banks can raise savings rates as long as they can borrow unlimited amounts of money from the ECB. That measure remains in full force for the time being.

Speaking about savings: we should not forget all those households that have moved their savings over the past few years into stocks because savings would barely earn interest. Increase interest rates substantially and you risk a decline in stock prices, something which the beaming confidence of consumers and their spending – that is, growth – would affect.

Increase rates, and you risk all of this. Keep rates low, and the risk of an uncontrollable inflation increases over the longer run. Thus, the ECB finds itself in a devilish dilemma: both choices point one way or another to disaster. A crisis that would overshadow the last crisis becomes inevitable. At least, that would indeed be the conclusion of a pessimist for whom the glass is always half full. There is one important “if.” An “if” that could change the course of events the coming years with enormous, not to be underestimated consequences for precious metals prices. More on that later this week.


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