Posted on 08/27/2019 7:00:12 AM PDT by SeekAndFind
Over $17 trillion dollars’ worth of global debt is now “earning” an interest rate below 0%. Negative interest rates are infecting developed countries such as Germany, Switzerland and Japan. I read an article recently that said there are negative interest rate mortgages available in Denmark. Just trying to think about negative interest rates makes one’s head explode.
From a practical perspective, the mechanics of negative interest rates are clear enough. The borrower guarantees to pay, say, $1000 in a year. The lender then agrees to give the borrower $1020 (for a negative 2% yield) for the guaranteed payment. Voila, negative interest! You might point out that the lender would be better off just holding onto the cash, but that’s another story. A negative interest rate mortgage is even more cool. Each payment the borrower makes on the mortgage reduces the principal balance by more than the amount of the mortgage payment. How cool is that?
What has happened to interest rates that they are so low for so long? What does it mean for the economy in the United States and elsewhere? I certainly do not know, nor does anyone else. Interest rates are a price signal in the economy; the price of postponing consumption to a later period. Persistently low interest rates are a puzzle to economists and policymakers. Standard economic theory would expect that interest rates should be high enough to convince consumers to save something and not spend it all today and low enough that businesses can borrow and invest and still make a profit. In any case, economic theory does not expect negative interest rates.
Who determines what the level of interest rates should be? In a reasonably free economy with properly functioning financial markets, we do. That is, the interest rate is determined by the interaction of borrowers and lenders trying to do business together. If there are more borrowers seeking funds than lenders (i.e., savers) willing to lend them funds, then interest rates will increase. Borrowers compete for the scarce funds by offering to pay higher interest on the loans. This attracts more lenders and discourages some potential borrowers until the interest rate finally “clears the market” (i.e., demand for funds from borrowers is equal to the supply of funds from lenders). The reverse situation occurs when there are more lenders than there are borrowers.
In that case, lenders compete to attract the scarce borrowers by lowering the rate they require to make the loan. Falling rates attract more borrowers and deter potential lenders, until the interest rate “clears the market” (demand equals supply). Simple, right?
Well, not so much. You see, since the end of the gold-is-money era in 1971, central banks have played an increasingly active role in the manipulation of money and interest rates. The central bank for the United States is the Federal Reserve Bank. There are similar central banks in other countries. Here is how it works in central-bank-controlled financial markets:
"If the Fed (i.e., the central bank) wants to increase economic activity, it injects money into the economy. (How the central bank injects money is not our focus today, but it does matter.) “Easy money” lowers interest rates and attracts more borrowers and demand for loans thereby creating more economic activity. If the central bank wants to dampen economic activity, it drains money out of the economy (again, “how” is not our focus today). “Tight money” raises interest rates and reduces demand for loans thereby reducing economic activity."
Since the era of central bank control over money began for earnest in 1971, the level of interest rates has become increasingly separated from the wisdom of economic markets and increasingly controlled by the wisdom of a handful of technicians, “experts” in the ways of central banking. Fortunately, these technicians are immune from political pressures so they are free to act according to their economic models, not according to political wishes. (In case you missed it, the last sentence is firmly tongue in cheek.)
At least in the short run, low interest rates are a boon to debt-burdened governments and other debtors in that low rates keep the cost of debt down. (That is one reason President Trump has made no secret of the fact that he is “a low interest rate guy”.) If interest rates ever return to a “normal” level, watch out! Government budgets will be whacked hard to pay for the higher cost of interest on the government debt.
The interventions of central banks (especially the Fed, The European Central Bank and the Bank of Japan) have become very active since the financial crash of 2008 and there is no end in sight. The Fed, under Chairman Powell, made a good faith effort over the last two years to get out of the business of suppressing interest rates. But the global efforts of the European Central Bank and the Bank of Japan were in the opposite direction, further suppressing interest rates, and putting the Fed in an untenable situation. Last month the Fed responded by cutting interest rates and signaling that more cuts might be coming. Despite eleven years of economic growth, we are back to a world of low interest rates in the United States and negative interest rates in much of the developed world.
Where do we go from here? No one really knows. The hyperactivity of central banks has had some long-term damaging influences. Government debt has ballooned out of control, without the discipline of realistic interest rates to temper political ambitions. Corporate debt has also climbed to new heights, as low interest rates encourage companies to borrow cheap funds and buyback their own stocks. The world has learned how to manipulate fiat money for short term advantages. With the “quantitative-easing cat” out of the bag, populist politicians like Bernie Sanders can credibly call for government to just print money to finance pie-in-the-sky Socialist dreams. If America chooses the Socialist path, despite a century of misery for people under socialism, central bank induced low interest rates will be partly to blame.
It will be a long and difficult road back to the inevitable reality that the world is not flat, and that true purchasing power represented by money is earned and not just printed or created out of thin air. In the meantime, it might not be a bad idea to buy a little gold.
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Dr. Gordon Boronow is a professor at Nyack College.
"Municipal bonds, Ted. I'm talking double-A rating. The best investment in America." - Robert Stack in "Airplane"
Regards,
SD boxes are in some ways quite problematical. First, they are *not* insured, either by way of some imagined “security” offered by a bank with thick walls and steel doors; and secondly, there are numerous situations whereby legal authorities or the government in one form or another can block your access to same OR seize the contents.
There is an argument for holding green cash, which is, in times of stress, you may be able to negotiate a “dime on the dollar” purchase of something that has great intrinsic value....like a cashflowing piece of real estate or a machine of some sort that can produce something or perform some task of real value.
Of course, if you are an insurance company or other fiduciary, you cannot legally do this, you HAVE to place trust funds in an interest bearing account. I do not know what the law states as to placing funds in a negative yield account. I can’t imagine that sort of action being within fiduciary guidelines.
Imagine what the hell you might do if you are trustee for a pension fund. One that has all its numbers based upon a project 7.5% annual return.
I agree completely.
I’m talking about making money from it right now and the foreseeable future, while taking the risk that a trade agreement will send it back down below 1500.
But a catastrophic economic meltdown you’re right. Things people actually want or need would be worth more.
Even in a regular meltdown gold will be good to have.
But you add catastrophic and that implies that everything has gone to hell and people can’t get the basics.
then gold is worth spit.
That’s always what I kinda assumed would happen, total catastrophic destruction. Like great depression+CWII. Our society today couldn’t handle a grapes of wrath type situation and would probably go completely ape $hit
On what planet?
Looking at the list of 100 new offer muni bonds on Fidelity the TOP expected yield is 2.5%.
Yeah some munis list a 5% interest rate, but the expected price is 135....
When you can “easily” (at low or no risk) get 5% return on your money, it’s because inflation is around 5%.
Today you can easily get about 1.9% on your money and inflation is around 1.6%.
That’s not bad. More return requires more risk, and it always has. The numbers have changed which throws people off, but the relationship between bank rates and the inflation rate stays about the same.
During the S+L crisis, I was getting 10% in money market funds. Inflation was around 10% but people thought they were really making out by just having money in the bank. We weren’t.
Ross Perot held hundreds of millions in tax free municipal bonds from Maine to Hawaii.
Regards,
If you expect the unit of money to be worth 5% more at maturity of the bond then a rate of -1% is a good deal. Or if you expect equities and other sorts of bonds to lose much more than that, same.
Yes he did. His marginal tax rate for his entire income was 8%. I used to keep up with him back then.
Please show us some quotes for 5% muni bond rates that aren’t rated junk.. I’ll buy big. I’m not seeing. them.
I like my credit union. No fees. Long ago I had my small account in a bank and was always worrying that my account would dribble away whether I withdrew anything or not or I would write a check on an account that had shrunk in the meantime so that I was 75 cents Insufficient Funds.
In a deflationary situation it could make sense as a way to induce people to borrow. In an inflationary situation it doesn't make sense for the lender, unless their goals are different than just earning money.
Heck, I might even take out a few trillion in cash to help stimulate the economy. Again at a negative interest rate, of course.
Nonsense.
Historically long term government bonds averaged 5-6% returns since 1926. Inflation did not average anywhere near 5% our the same period. Inflation averaged 3.15% from 1913. So a spread of 2-3 %.
If things were normal, if inflation were 2% ( a figure that I believe is artificially low because of the things NO LONGER considered), the rate on treasuries should be around 5%...,
The push by central banks for negative rates is driving the movement towards a “cashless” society. When every penny you have is digital, it will be simple to just “withdraw” that negative interest from you....
I’m pushing for negative tax rates.
What happens when those municipalities become insolvent?
Do you want to be holding bonds from the City of Chicago when they "defer" their next coupon payments?
“There is an argument for holding green cash, which is, in times of stress, you may be able to negotiate a “dime on the dollar” purchase of something that has great intrinsic value....like a cashflowing piece of real estate or a machine of some sort that can produce something or perform some task of real value.”
I see that but still don’t see why you would invest your money somewhere where you’re guaranteed to lose some of it.
Is it only because you’re less likely to get your money stolen if you put it into a negative-interest savings account, the negative-interest account being the only game in town?
“Negative interest rates? How does that work?”
it sorta “works” only as a foolish bet that rates will go even more negative and your bonds can then be sold for more than you paid for them ... when the bonds mature, however, whoever owns them gets paid back less than the face-value by the seller (hence the “negative interest rate”), so the new buyer better still be paying less than that ...
Actually, it was in Florida.
Much of the reason for low and now negative interest rates is that the immense wave of wealth creation in the Third World over the last twenty years has generated both an abundance of capital and a preference by much of it for the security of financial assets denominated in dollars, Euros, and other major developed nation currencies. Unfortunately, due to the relative lack of growth in the Eurozone, most such economies lack the capacity to absorb the incoming currency. Yet Mr. Chandra et al. in Mumbai and Mr. Chang and his associates in Shanghai are pleased to have much of their wealth in hard currency assets instead of being stranded in the miserable token money of of their native countries.
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