Negative Interest

This topic came up in the comments of another blog I follow and I didn’t know much about it. After a brief search (and to my surprise), I was able to find a useful article here (I guess Yahoo! isn’t always worthless). This article made clear that it is worthwhile to understand this topic because “[n]egative interest rates — where the lender gets paid back less than they’ve loaned — now add up to 30%, (and counting), of the global tradable bond universe, according to JPMorgan”. Continuing with a quote from another part of that article:

-How, when, and why did negative rates come about?


It appears that negative interest rates are a modern phenomenon that was first implemented to spur sluggish economies that couldn’t get traction coming out of the Great Recession. (Yes, brought to you by central bankers.) Denmark’s Nationalbank [...] in July 2012 was one of the first, followed by the European Central Bank in 2014, the Bank of Japan, and now much of the rest of Europe.

These negative rates were “paid” (or levied really) on banks’ deposits in central banks. The point was to penalize banks from keeping too much money in central banks and thereby encourage them to lend. Negative rates then spread to government bonds — especially in Europe — and to corporate bonds, as well. That’s because prices for these financial instruments (which move in the opposite direction of rates) went higher and higher as investors were willing to pay more and more for safe places to park their money. Rates turned negative on these bonds when investors were so anxious for safety they would even accept less than 100% of their investment back.

I had a problem with this article in that it starts well and then gets sloppy about identifying the bankers. Negative interest rates were invented by governments and then implemented by their own central banks. And imposed on commercial banks. I didn’t feel like blogging about this topic, until I read this blog post is (curiously, it also references the Yahoo! article). Being Canadian, the author is obliged to slam Trump a couple of times, but then he gets to the heart of the matter (my bold).

What matters to the general public is that central banks are doing this at the behest of governments that cannot afford their social programs, and negative interest rates provide a means to do so without raising taxes or pissing off consumers. Governments that issue negative interest rate debt don’t pay interest when they borrow, they receive it in this new wonderland – money for nothing.

As you can imagine, this practice is catching on rather rapidly. About two months ago there was $13 trillion of negative interest rate debt in the world; as of last week, there was $17 trillion. Governments are becoming addicted to the phenomenon, which they facilitate by creating more money and pumping it into the system.

And, well, so what?

Well, here’s the scary part. Since governments have found a way to pay for social programs with no downside (central bank economists assure them), think of the consequences. When word gets out that governments are unencumbered to spend by pesky things like raising taxes, there will be lines around the block of various demanders. Powerful unions will demand wage increases from the government and threaten to strike if not sated. New infrastructure projects will be demanded also. Seniors will riot for better pensions (and will have a valid case, because their hard-earned savings in a negative interest rate world won’t buy them a can of beans, literally). In days gone by, governments have always been kept in check by some sort of budgetary restraint, but no more. So here you go, raises all around.

There was a sentence of what happens if the US does not go join in on the fun (it hasn’t yet).

The US is resisting negative interest rates, but, as Trump knows, is getting pulled into the game; leaving interest rates in “normal” territory acts as a magnet for the currency, which helps all the negative rate countries be competitive with the US.

This I don’t understand. I wish it was better explained.

Regardless, the original article got into a bunch of different results that were interesting, acting against the free-money scenario.

Bank of America Merrill Lynch (BAC) postulates that, “…if banks ever start passing negative rates onto retail depositors, the effect would be similar to inflation — cash today would be worth more than cash tomorrow. Consumers might respond by consuming more and saving less, boosting GDP growth in the short run. But this “substitution effect” could be offset by what economists call a negative “income effect”: expected erosion of savings could actually make households more conservative, pulling back on consumption both today and in the future.”


How will this end? As you can tell, my take is, badly. But I’m not sure what form the ugliness will take or, more vexing, what we should do about it.

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