The Real Interest-Rate Risk

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Since 2007, the financial crisis has pushed the world intoan era of low, if not near-zero, interest rates and quantitative easing, asmost developed countries seek to reduce debt pressure and perpetuate fragilepayment cycles. But, despite talk of easy money as the “new normal,” there is astrong risk that real (inflation-adjusted) interest rates will rise in the nextdecade.
Total capital assets of central banks worldwide amount to$18 trillion, or 19% of global GDP – twice the level of ten years ago. Thisgives them plenty of ammunition to guide market interest rates lower as theycombat the weakest recovery since the Great Depression. In the United States,the Federal Reserve has lowered its benchmarkinterest rate ten times since August 2007, from 5.25% to a zone betweenzero and 0.25%, and has reduced the discount rate 12 times (by a total of 550basis points since June 2006), to 0.75%. The European Central Bank has loweredits main refinancing rate eight times, by a total of 325 basis points, to0.75%. The Bank of Japan has twice lowered its interest rate, which now standsat 0.1%. And the Bank of England has cut its benchmark rate nine times, by 525points, to an all-time low of 0.5%.
But this vigorous attempt to reduce interest rates isdistorting capital allocation. The US, with the world’s largest deficits anddebt, is the biggest beneficiary of cheap financing. With the persistence ofEurope’s sovereign-debt crisis, safe-haven effectshave driven the yield of ten-year US Treasury bonds to their lowest level in 60years, while the ten-year swap spread – the gapbetween a fixed-rate and a floating-rate payment stream – is negative, implyinga real loss for investors.
The US government is now trying to repay old debt by borrowingmore; in 2010, average annual debt creation (including debt refinance) movedabove $4 trillion, or almost one-quarter of GDP, compared to the pre-crisisaverage of 8.7% of GDP. As this figure continues to rise, investors will demanda higher risk premium, causing debt-service costs to rise. And, once the USeconomy shows signs of recovery and the Fed’s targets of 6.5% unemployment and2.5% annual inflation are reached, the authorities will abandon quantitativeeasing and force real interest rates higher.
Japan, too, is now facing emerging interest-rate risks, asthe proportion of public debt held by foreigners reaches a new high. While theyield on Japan’s ten-year bond has dropped to an all-timelow in the last nine years, the biggest risk, as in the US, is a large increasein borrowing costs as investors demand higher risk premia.
Once Japan’s sovereign-debt market becomes unstable,refinancing difficulties will hit domestic financial institutions, which hold amassive volume of public debt on their balance sheets. The result will be chainreactions similar to those seen in Europe’s sovereign-debt crisis, with avicious circle of sovereign and bank debt leading to credit-rating downgradesand a sharp increase in bond yields. Japan’s own debt crisis will then eruptwith full force.
Viewed from creditors’ perspective, the age of cheapfinance for the indebted countries is over. To some extent, theover-accumulation of US debt reflects the global perception of zero risk. As aresult, the external-surplus countries (including China) essentially contributeto the suppression of long-term US interest rates, with the average US Treasurybond yield dropping 40% between 2000 and 2008. Thus, the more US debt thatthese countries buy, the more money they lose.
That is especially true of China, the world’ssecond-largest creditor country (and America’s largest creditor). But thisarrangement is quickly becoming unsustainable. China’s far-reaching shift to anew growth model implies major structural and macroeconomic changes in themedium and long term. The renminbi’s unilateral revaluation will end,accompanied by the gradual easing of external liquidity pressure. With riskassets’ long-term valuation falling and pressure to prickprice bubbles rising, China’s capital reserves will be insufficient torefinance the developed countries’ debts cheaply.
China is not alone. As a recent report by the international consultancy McKinsey& Company argues, the next decade will witness rising interest ratesworldwide amid global economic rebalancing. For the time being, the developedeconomies remain weak, with central banks attempting to stimulate anemicdemand. But the tendency in recent decades – and especially since 2007 – tosuppress interest rates will be reversed within the next few years, owingmainly to rising investment from the developing countries.
Moreover, China’s aging population, and its strategy ofboosting domestic consumption, will negatively affect global savings. The worldmay enter a new era in which investment demand exceeds desired savings – whichmeans that real interest rates must rise.

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关键词：interest inter Rate Rest Inte twice era countries developed interest

Since 2007, the financial crisis has pushed the worldinto an era of low, if not near-zero, interest rates and quantitative easing,as most developed countries seek to reduce debt pressure and perpetuate fragilepayment cycles. But, despite talk of easy money as the “new normal,” there is astrong risk that real (inflation-adjusted) interest rates will rise in the nextdecade.this vigorous attempt to reduce interest rates isdistorting capital allocation.
Viewed from debtors’ perspective,The US, with the world’s largest deficits and debt, isthe biggest beneficiary of cheap financing. With the persistence of Europe’ssovereign-debt crisis, safe-haven effects havedriven the yield of ten-year US Treasury bonds to their lowest level in 60years, while the ten-year swap spread – the gapbetween a fixed-rate and a floating-rate payment stream – is negative, implyinga real loss for investors.

Viewed from creditors’ perspective, the age of cheapfinance for the indebted countries is over. To some extent, theover-accumulation of US debt reflects the global perception of zero risk. As aresult, the external-surplus countries (including China) essentially contributeto the suppression of long-term US interest rates, with the average US Treasurybond yield dropping 40% between 2000 and 2008. Thus, the more US debt thatthese countries buy, the more money they lose.

here is the original source, I guess:

http://www.project-syndicate.org ... -age-by-zhang-monan