Cheap credit has created many problems around the world, OCBC

What is the impact of cheap credit on the global economy?  Will a prolonged low-interest rate environment raise risks? 

We may stave off this recession, but can we escape the next? Howie Lee, Economist at OCBC Bank, in sharing his views on how a prolonged low-interest rate, cheap credit, environment potentially raises medium-term risks explained what companies can do to create long term sustainable growth for themselves.

In speaking on how cheap credit has affected the global environment, Lee said:

“The prospects for global economic growth are mixed at best. There are increasing concerns that the world may be heading to a recession the next one-to-two years. Any capitalistic society (will face) booms and busts in their business cycle. But this current downturn is made worst because of the US-China trade war that has disrupted many trade flows as well as supply chains.

The global economy is in this state today because it has been far too reliant on cheap credit for too long. Since 2008, during the global financial crisis, major economies around the world have come together to put a series of cheap monetary policies across the globe. This cheap monetary policies were never fully withdrawn and it has created many problems.

Firstly it has created a huge increase in asset prices, that only the rich with assets to capital could take part in. Also at the same time we are seeing a hollowing out of the middle class. These two problems glued together has resulted in the rise of protectionist policies around the world.

We have already seen it happening. We have seen BREXIT happening in the UK, we have seen the rise of far-right groups in Europe; as well as the ongoing US-China trade war.

Central banks around the world now, find themselves in a tight spot because interest rates are low and they have little space to cut. In Europe and Japan for example, interest rates are already negative and there is so much more they can cut before interest rate loses their effectiveness all together.

In the US, the Federal Reserve stopped hiking rates at 2½%. Typically, they have to space out at least 5% to cut rates in the event of a severe downturn. This means that they are going into this downturn with potentially only half of their ammunition available and that is a worrying thought.

If monetary policies were to lose their effectiveness, than there will be an increasing attention on fiscal stimulus. However, there is only so much that monetary or fiscal stimulus can bring to the table. In the long run, any company should always invest in human capital, in innovation, as well as knowledge. Only the can it create long-term sustainable growth for itself.”

A recent Wall Street Journal article explains how Europe’s central banks have made cheap credit a permanent feature of the landscape.

“For five years, European nations have been trying to jump-start their ailing economies with what was supposed to be a radical, short-term remedy—negative interest rates. Instead, central banks haven’t been able to wean their economies off them. Increasingly, they appear to be a permanent feature of the landscape. No major bank that introduced negative rates during Europe’s debt crisis has turned main policy rates positive again.

The negative-rate policy shows how weak  and vulnerable Europe’s economic engines are, the article pointed out. it added that the cheap credit policy “threatens pensions, creates the risk of real-estate bubbles and doesn’t fully quell the specter of deflation.”

“European banks struggle with weak interest income and thin margins on loans, putting them behind American peers in profitability and making it harder for them to finance the economy.”

A low interest rate environment occurs when the risk-free rate of interest, typically set by a central bank, is lower than the historic average for a prolonged period of time. In the United States, the risk-free rate is generally defined by the interest rate on Treasury securities.

Much of the developed world has experienced a low interest rate environment since 2009 as monetary authorities from around the globe cut interest rates to effectively 0% in order to stimulate economic growth and prevent deflation. Low interest rate environments are meant to stimulate economic growth by making it cheaper to borrow money to finance investment in both physical and financial assets.

Paul Ho, chief mortgage officer at iCompareLoan said, “there are two sides to the climate of cheap credit and low interest rates. To to those that are affected, low interest rates can be both a boon and a bane.”

“In a country like Singapore where 90 per cent of the population are homeowners, a low interest rate environment will meant that they will be able reduce their monthly mortgage payments. The cheaper costs will only serve to entice prospective buyers into the real estate market,” Mr Ho added.

“Cheap credit and low interest rates may mean more spending money in consumers’ pockets, which will give them the confidence to borrow more; spurring demand for goods and services, This benefits the banks as well, as they will be able to give out more money.

Low interest rates are bad news for those that are trying to save money in the banks. Their savings will earn very little interest and they will not be able to grow their money. With inflation in the ranges of 1.5–2.5%, your money needs to grow at least by that rate so as not to depreciate in value.”