UBS: Borrowed time
One of the many paradoxes thrown up by the world of ultra-low interest rates is the disinclination to borrow. Why would borrowers, corporate and household alike, not choose to avail themselves of what would seem to be cheap money? Maybe, the effect of low rates has actually proved to be counterintuitive and just maybe, the effect of an interest rate hike will prove just as unexpected.
17.05.2016 | 10:41 Uhr
The wonderful thing about debt is it allows you to take money from someone you know quite well but have never met: your future self. You get the money today, but it is your future self who pays it back. The hope is that this future self is richer than your current self, so won't mind lending you the money. And if interest rates are low, all the better - might as well borrow more from your future self. The temptation for a government is even greater: borrowing today means that a completely different future politician has to find a way to pay it back. And that politician may even be from a different party. Corporate CEOs are no different: leveraging up for share buybacks boosts my share options today, and it is someone else's problem to pay it back.
So you would think that ultra-low interest rates should have resulted in a huge boost to credit. Well, that's what the central banks hoped for. But it hasn't worked out that way. If you are close to retirement you know that your future self is not going to be richer than you. The role is reversed: you need to give money to your future self (by saving). So the role of interest rates is reversed as well: with low rates you need to save even more money to give your future self the same amount of cash. With ageing populations there are more and more people who need to think this way.
And what if you also realised that you got a bit carried away and borrowed too much from your future self? In a fit of irrational exuberance you borrowed too much money (to invest in housing in the mid-2000s perhaps) and then the financial crisis hit. Your debt is too high even after the interest rate dropped, so you need to get that debt down. Suddenly the price of debt (the interest rate) becomes less important than the quantity.
This economic cycle is unique in that it is the first modern expansion in which households have reduced, rather than increased, debt relative to disposable income (chart 1a). This has essentially been an unwind of the 2001 debt binge. Initially corporates reacted the same way (chart 1b), but that was short lived and they are back to their old, pre-financial crisis habits.
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