Ballooning deficit

The origins of negative interest rate of central banks lie in the neutral rate identified by Knut Wicksell almost a century ago. Negative interest rates meant that the rate of interest required to bring an economy back to full employment with a stable inflation could be even negative. The real job creators in any free market economy are not only producers but also consumers. Hence, both producers and consumers have to prosper for a robust economic growth. 

On macroeconomic level, there is a huge income inequality in global economy because of the reluctance of the central banks to follow a monetary policy which would usher a true free market economy. The United States’ Federal Reserve has also printed several trillion dollars in its ambitious Quantitative Easing (QE) programme after the 2008 stock market crash. As a result, the economy stabilised in 2009 and began to grow in 2010.

However, real wages of Americans fell, while the corporate profits skyrocketed. How did that happen? Because, the entire increase in government spending from rising budget deficit went into the coffers of already wealthy producers. This is how Goldman Sachs alone could give bonuses of over $20 billion to its executives in 2009, while millions of ordinary Americans were still being laid off from their jobs. While the consumer debt actually fell, government spending and hence its debt actually rose so much that executives received hefty extra compensation.

Due to the absence of a free market economy where wages keep pace with productivity, the central banks have to print dollars just to sustain deficits in respective economies. The trade deficits of the US are a result of off-shoring of manufacturing Low Labor Cost (LLCs) to Asian countries to increase corporate profits of US based MNCs. With a lost domestic manufacturing in developed economies to countries in Asia, the citizens in developed countries are relegated to low paying service sector jobs. Hence, the real wages of majority of citizens in the US have actually decreased with rising trade deficits. These trade deficits however have benefited the external shareholders of corporations who have reaped huge profits from the rising share prices resulting from a practice of off-shoring.

The growing economic disparity has also reduced the ability of low-wage earning citizens to pay a fair share of their taxes. Additionally, the tax cuts that are offered to corporations have added further to national budget deficits. Now, the growing trade and budget deficits can be sustained only by means of printing more currency. With their monetary policies, the central banks like Federal Reserve (Fed) or European Central Bank (ECB) print more money to bring down the rate of interest, and lower interest rates induces people to increase their borrowing or it increases consumer debt. As the wages fall with rising productivity resulting from technological progress, the wage-productivity gap keeps rising so fast that even the government has to raise its own spending and debt constantly to sustain an economic demand from the growing gap between wages and productivity. In this way, even the national debt keeps rising because of increased government spending. 

Hence, central banks keep printing more and more money and all the printed money keeps entering into the pockets of already wealthy individuals and corporations but such policies do not help boost domestic consumer purchasing power in economy. Hence, the real economic demand keeps stagnating and even falling in some cases. Since, wages contribute to economic demand and productivity contributes to an economic supply, wage-productivity gap contributes to demand-supply gap. 

The Fed’s benchmark interest rates are already close to zero per cent and just to keep the value of the dollar high in order to be able to export more goods to the US, the ECB entered into negative interest territory in June 2014. This unprecedented step of imposing a negative interest rate on banks for their deposits is in effect charging lenders to park money with the banks. Additionally, the monetary policies of central banks let wages trail productivity resulting in a lack of economic demand. This causes all the money that is not put into the bank accounts to not get invested into the economy due to a poor economic demand. In fact, negative interest rates are causing money to get stashed underneath mattresses, thereby steadily shrinking of the consumer credit in the economy.

When Fed hiked its benchmark interest rate by only 0.25 percent in early 2016, there was a net inflow of funds from developing economies into the US. This move has strengthened USD as compared to its other trading partners. The Asian trading partners like Japan are also following an unconventional monetary policy and Japanese central bank is moving into a negative interest rate territory just to maintain a net trade surplus with the US.

Hence, any reluctance by the Fed to hike its benchmark interest rate is undone by a decision of US trading partners to enter into a negative interest rate territory. 

A rising value of US dollar from all these policies is not good for the US economy as US  is unable to export its goods to other countries due to high value of USD. Hence, US trade deficits are steadily rising and could rise further if the Fed hikes its interest rates further in 2016. Rising USD combined with falling US exports are crashing the profits of US MNCs. All of this causes an inability of the US to be able to balance its budget in order to retain its AAA rating. The corporate bonds can no longer retain an excellent credit rating when corporate profits keep crashing because of falling consumer demand in the economy. 

A net inflow of capital from developing economies into the US has also triggered a panic in the developing economies as they are dependent on the capital arriving from developed economies. The US-based MNCs have neglected consumer demand in US economy, in search of a better Return on Investment (RoI) from Asian economies and this is crashing multi-national corporations (MNCs) profits in both developing as well as developed economies. Everything depends on the ability of the US to service its sovereign debt which would no longer retain its AAA rating as corporate profits start crashing. The end result of all this would be exactly like what has happened with the housing market crash of 2008, but this time the crisis will be much more severe than the housing market meltdown. Once the US defaults on its debt, the global economy would collapse like a ‘Fire Cracker’ .
The writer is engineer, macroeconomist, author and blogger