But it’s not just the United States and Japan. Name a country with three elements—a stable political system, a credible central bank to call its own, and a free flow of capital across its borders—and it has, right now, extraordinarily low interest rates. That’s true for Canada and Australia (10 year yields of 1.85 percent and 3.36 percent), of Switzerland and Sweden (0.55 percent and 1.6 percent). Britain, certainly (1.94 percent), but even some countries that don’t technically fit our classification because they lack their own central bank (Germany at 1.42 percent and France at 1.99 percent. That would be the same France that The Economist, in a cover story last month, called “the ticking time bomb at the heart of Europe.”).
So what is going on? Interest rates are, essentially, the relative price of money today versus its value in the future. And investors are saying that they don’t need very much compensation to delay their spending for the future, as long as they can feel secure that they will get their money back and that the money they get back will be worth roughly what they put in.
To put it a different way, around the world there are all sorts of savers—pension funds, wealthy individuals in emerging nations, governments that want to ensure they have reserves put aside in case there were to be a run on their currency—for whom the goal is not so much to get a big yield on their savings, but rather to ensure that they will get their money back when they need it.I may have more to say about this over the coming weeks as I'm writing a book chapter related to the topic, but for now let me just mention that this isn't only about the domestic factors that Irwin describes. It is also related to broader developments in the global economy in recent decades. The only development model which has sustained success is export biased: emerging economies export resources and consumer goods to developed countries. Second, the opening up of global trade has increased reliance on comparative advantage, thus benefiting the owners of the abundant factor of production. Third, the decline in capital controls have allowed financial flows to increase markedly. These three factors have led to a world where trade flows constitute 60% of global GDP, international financial balance sheets are 150% of global GDP ($100 trillion), and income inequality has increased markedly.
But it also means that the global economy is fundamentally imbalanced: developing countries must run persistent current account surpluses, while developed countries must run persistent current account deficits. These must be offset by financial transactions: developed countries essentially hand over IOUs to developing countries. And this process must be indefinite; or, rather, they must continue until the whole world has reached roughly equivalent levels of development, until a new political system makes the export-biased development model impossible (restrictions on trade and/or capital movement), or until the imbalances reach a tipping point and a crisis ensues.
The question is what deficit governments should do in this environment. Irwin suggests that they should take advantage of cheap finance to make domestic investments in infrastructure and education. Another option is to try to reduce the probability of a future (domestic) crisis by balancing the books. In the 1990s they largely chose the latter, which ended up leading to crises in the developing world as imbalances unwound. In the 2000s they chose the latter, which ended up leading to crises in the developed world as imbalances fueled asset price bubbles in real estate and sovereign debt.
The story of the 2010s will be how these imbalances are managed.