Tuesday, November 26, 2013

Quantitative Easing Part 2 - The Winners

In Part 1 of this series on the impact of central bank actions on the economy, I looked at the total size of the interference in the free market by the world's four major central banks; the Federal Reserve, the ECB, the Bank of England and the Bank of Japan.  As a reminder, here is a graph that shows what happened to the balance sheets of these four banks as their desperation to keep the world's economy from crashing continues:

Now, in Parts 2 and 3 of this series, we will look at how this prolonged experiment with near-zero interest rates (ZIRP) has had on these sectors of the economy:

1.) Central governments
2.) Non-financial corporations
3.) Banks
4.) Insurance and pensions
5.) Households

Obviously, the impact of low interest rates has positively benefitted some sectors of the economy where debt levels are high and growing and has had a strong negative impact on some sectors of the economy that rely on higher interest rates for income.  Here's a quote from the McKinsey report:

"The ultra-low interest rate policies of major central banks have had distributional effects through the impact on interest income and expenses of different sectors of the economy. These distribution effects are most likely unintended consequences of central bank policies."  (my bold)

Here is a graphic that shows which sectors have been winners and which have been losers under the new central bank reality:

Let's look at the three sectors that have been unintentional winners of the QE experiment.

1.) Governments

Obviously, today's highly indebted governments have been big winners as interest rates have dropped.  While the implosion of the world's economy resulted in massive government intervention in the form of stimulus which pushed up debt and deficit levels and an accompanying drop in tax revenue, overall, governments have benefitted positively on a net basis because they have been able to finance their massive debts and deficits at far lower interest rates than would normally have been the case as shown on this chart:

Note that the interest saved is on the amount of debt in 2007.  In the case of the United States alone, the amount of debt has risen from $8.68 trillion on January 1, 2007 to $17.2 trillion today, an increase of $8.52 trillion.  On that extra $8.52 trillion in debt, the interest savings alone is $204.5 billion annually using the drop in interest rates noted in the chart above.

On top of the interest savings, governments have also benefitted from the bloated balance sheets of their central banks.  As I noted in Part 1, the four key central banks have seen their balance sheets expand by $4.7 trillion since 2007.  Any profit generated by these additional assets is remitted to their respective federal governments.  For the Federal Reserve alone, the authors estimate that around $145 billion of the $291 billion remitted to the U.S. Treasury between 2009 and 2012 came from the expansion of the Fed's balance sheets related to QE.

Taking lower debt service payments and increased interest earned on the bloated central bank balance sheets, the benefits to central governments since 2007 can be summarized as follows:

United States - $1.045 trillion or 7.8 percent of government debt
United Kingdom - $170 billion or 7.3 percent of government debt
Eurozone - $365 billion or 4.1 percent of government debt

This works out to 3.8 percent of GDP for the Eurozone, 6.7 percent of GDP for the United States and 7.0 percent of GDP for the United Kingdom.

2.) Non-financial corporations

Corporations have balance sheets that are heavily weighted toward debt rather than interest-earning assets.  For example, in the United States, non-financial corporations have $15 trillion in debt liabilities compared to only $6 trillion in assets that could earn interest.  This means that non-financial corporations experience a net positive benefit from ultra-low interest rates.  It is important to note, however, that all corporations have not benefitted from lower interest rates; since larger corporations tend to issue more debt in the world's capital markets and since they have greater access to commercial bank loans, they tend to benefit more from QE than smaller companies.

Here are the net positive interest benefits in 2012, for the years between 2007 and 2012 and how much the interest savings have added to net income for 2012 for the United States, the United Kingdom and the Eurozone:

It is quite interesting to see that the non-financial corporations have seen quite a substantial benefit from lower interest rates and that these savings have added between 3 and 5 percent to the bottom line in 2012 alone.

3.) Banks

The current environment of low interest rates has impacted the effective net interest margins (the difference between interest paid on deposits and debt and the interest received on loans and other assets) for banks, particularly in the United States.

United States banks have seen their effective net interest margin increase by 63 basis points between 2007 and 2012, from 2.5 percent to 3.13 percent (after peaking at nearly 3.5 percent in late 2009).  This reflects a very steep drop in the interest rates paid to savers as shown here:

The current rate on a one-month Certificate of Deposit is 0.16 percent; this is down from a high of 5.5 percent in August 2007.  In fact, despite the fact that depositors were getting nothing in return for their bank savings, the fear rippling through the economy between 2007 and the present caused bank deposits to do this:

That's deposit growth of 57 percent or $3.5 trillion as nervous Americans sought the appearance of "safety" for their meagre savings.

By way of comparison to the very steep drop of around 5 percentage points paid on deposits, the drop in the effective interest rate received on loans was only 1.8 percent.  These two factors in combination are what has improved the effective net interest margin for U.S. banks.

Here is a chart showing the overall impact of the current near-zero interest rate policy on the banking sectors in the United States, the United Kingdom and the Eurozone:

Obviously, the banks in the Eurozone and the United Kingdom saw much less benefit to the current low interest rate environment compared to those in the United States.  In the case of the Eurozone, the interest rate paid on deposits only dropped from 2.9 percent in 2007 to 2.0 percent in 2012.  On top of that, large European corporate borrowers put pressure on the banks to pass along the decline in interest rates.

Let's summarize.  Three key sectors of the economy have benefitted handsomely from lower interest rates, none more so than our overly indebted federal governments that go on accumulating debt like there will never be a day of reckoning.  What I find most concerning about this research by McKinsey is the fact that two key sectors of the economy, the government and business, have relied on the current historically unprecedented period of near-zero interest rates to keep debt growth in check.  Thanks to the world's major central banks, the economy is being painted into a corner from which there is no escape.  It makes one shudder to think of what will happen to the economy when interest rates return to normal levels as they surely will.


  1. you did very good work as always bravo....

  2. Excuse me I somewhat get the picture, great work, but if the economy does recover and interest rates go to 7.5%, who makes the huge money on the cheap stimulus cash that has been thrown out there. Makes me wonder if the recession is a bit of a fabrication for the ultra wealthy to get more of a leg up. I live in Canada and there was never any sign of a recession here. You guys need those jobs in china back and regulation back in wall street. Just the way I see it after various forms of research. Pass the J.