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Savers threatened with creeping expropriation

How investors can protect themselves from losses due to negative interest rates and inflation in times of high debt

Michael Ferber

The coronavirus crisis is causing debt to explode. According to the Institute for International Finance (IIF), a global association of financial institutions, global debt had risen by USD 15,000 billion to a total of USD 272 trillion by the end of September last year. This reflects the rescue programs of governments as well as the high level of capital raised by companies during the crisis. Since 2016, an unprecedented pace of debt has been observed, according to the IIF economists. It is very uncertain how the global economy intends to reduce this debt without a significant negative impact on economic activity.

Little attention

Despite this worrying outlook, the topic of debt receives little attention from many politicians and economic players. “At the moment, everyone is flying by sight,” says Ivan Adamovich, head of the family office Private Client Bank and co-editor of the book “From Credit to Debt – When Debt Threatens Freedom”. Hardly anyone is currently interested in what will happen in the long term and who will ultimately have to pay for the high level of debt.

Olivier Kessler, Director of the Liberal Institute in Zurich, agrees. “The consequences of the increase in debt for the future are definitely being underestimated. There is no other explanation for the recklessness and short-sightedness in imposing extensive political measures,” he says. There is hardly any consideration. The more we go into debt today, the less room for maneuver we will have in the future to master future challenges.

Debts are less of a problem if there are assets on the other side of the balance sheet. In the case of a private household, this could be a house or a stock portfolio, for example. However, Adamovich believes that this is less transparent for the state. “Government debt is much more difficult to grasp,” he says. It is possible that the debt creation of the past decades is already having considerable consequences today, for example through lower economic growth. “Higher national debt means that we are spending even more money that we have not yet earned,” says Kessler. This will have consequences for future generations. He quotes the economist Roland Baader: “We will have to starve for what we have eaten in advance.”

Central bankers are also aware of the risks. The governor of the Banque de France, François Villeroy de Galhau, recently said in a speech, as quoted by the bank BNP Paribas in a study: “We don’t know if and when a tragedy – a major confidence shock, for example – could happen. What we do know for sure, however, is that the growing national debt represents an ever greater risk – for us, but even more so for our children and grandchildren.”

The system undermined

The government debt ratio has been rising in most industrialized countries for 40 years, according to the study. A high level of government debt weakens the resilience of economies to rising interest rates or weaker economic growth. In theory, investors then demand higher risk premiums or yields when buying corresponding government bonds, the study states. Central banks have undermined this mechanism with their ultra-expansive monetary policy, such as their bond purchases.

Adamovich assumes that interest rates will remain very low for the foreseeable future. In hindsight, the speech by the then President of the European Central Bank Mario Draghi in 2012, in which he said that the ECB would do whatever it takes to save the euro (“whatever it takes”), was a kind of turning point. Since then, investors have finally relied on the central banks to rescue them again and again if a crisis occurs on the financial markets. “As a result, there can only be more and more interventions,” says Adamovich. This increasingly undermines the capitalist system and the market economy. Even if inflation picks up, he does not expect the central banks to raise interest rates immediately.

Kessler also expects interest rates to remain very low. The political pressure on central banks to keep interest rates low is likely to remain high as the mountains of debt pile up even higher in order to relieve governments of the interest burden and thus the consequences of their actions.

No one can seriously predict how long this game will continue to work. However, one of the consequences of monetary policy could be a greater social divide, as the abundance of cheap money is driving up share prices and real estate prices. The wealthy are the main beneficiaries of this. The less wealthy, however, often have large amounts of their money “on deposit” and in low-interest investments.

There is also the risk of a crisis of confidence. “A monetary policy that keeps opening the floodgates and flooding the markets with money cannot continue forever,” says Kessler. During the first wave of coronavirus in March, there was already a moment when market observers feared the system would collapse. Large parts of the bond market became illiquid, and even trading in US government bonds, which are considered particularly liquid, was affected. However, this situation was quickly remedied by the rescue operations of governments and central banks, and the stock markets also recovered very quickly from their coronavirus crash. “Nevertheless, this development could have been a kind of foretaste of what could happen in the event of a crisis of confidence,” says Adamovich.

The temporary “cardiac arrest” on the financial markets during the coronavirus crisis in March also has lessons for investors.Adamovich recommends diversifying your investments well. The entire asset situation should be taken into account – i.e. financial investments, but also any real estate or retirement provisions in the pension fund or pillar 3a.

Debt has created major risks in the financial system. Savers and investors can quickly be caught on the wrong foot here, for example if interest rates rise. “Investors should be aware that their risks in bonds are even less well compensated than in other asset classes,” says Adamovich.

For him, one of the most important rules when investing money is to always remain capable of acting and therefore to be solidly financed. However, a zero-risk strategy is not the right solution either. After all, in the current environment, you automatically incur losses. There is a threat of a kind of “creeping expropriation” through negative interest rates and inflation. This development, also known as financial repression, has long since become a reality, as negative real interest rates show.

Taking risks – in Massen

Despite the high risks in the financial system, savers and investors should therefore at least take risks on a mass scale, says Adamovich. However, these must remain under control at all times. “For example, you shouldn’t adjust your standard of living to expected returns on the stock markets,” he says. Buying a property is a bulk risk for most private individuals. At the very least, they should not take on too much mortgage debt.

For Kessler, too, there is probably no way around increased private saving. “Inflation is already much higher than the inflation figures suggest,” he says. After all, the inflation figures only include consumer goods and not assets.

Translated in DeepL