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.
What do you think welfare is?
I’ll go with not too well.
Another question. Is gold truly fungible? My understanding is that most gold ownership is evidenced by paper certificate and not the physical possession of the commodity.
“There is no safe harbor in the coming storm............”
You can always short the market. Buy lots of long term puts.
A fair point. I was once told that if you don’t physically possess the gold you buy, then you don’t really own it. Seemed to make sense. In an incident, who’s to say your paper would be honored?
You claim to ax a 'serious question', and then you ax a joke question.
Did you not know that gold has been an accepted currency for over six thousand years.
While salt and sea shells were currencies for a few years, since the discovery of gold, man, almost universally, has accepted it as a device for trade.
Any currency is just a substitute for barter, a pig for cow, a sheep for a goat, a horse for a woman, you can figure it out...you ax serious questions.
I don’t see why negative interest rates would cause a depression. Negative inflation (deflation) is known to cause depressions but not negative interest rates.
Negative interest rates simply means that you’re willing to pay a government to hold their debt rather than hold currency. Maybe there are storage/security costs associated with the currency, or risks inherent with individual banks that don’t exist or are less with government debt instruments.
It may make a statement about investment opportunities. For example, say the media is talking up a recession and you don’t want to invest in case they are successful.
That is a choice of the owner. Lazy people "buy gold" and get a piece of paper that says, "You own Gold" others get real gold and then have to decide how they will protect their "hard assets".
If you invest in gold, like any investment, you have financial choices to make that have real effect on your wealth.
It just seems to me that if a bank is promising to give you less money than you gave them it is because they are well aware of a high probability the money they have now will be worth substantially less in the future. Which, as you say, is deflation. But if a bank isn’t even willing to risk it’s own capital it probably does say a lot about what the economy is predicted to be which would likely be depression.
If you “own gold” it sort of goes without saying you also are pretty well invested in steel, copper, brass, and lead.
“Neither the article nor the posts so far don’t say why you shouldn’t just hold the money. Is it because if you hold it yourself it might be stolen? Then why not put it into your safe deposit box?”
If you have a billion dollar you don’t keep it in cash under a mattress or in a safety deposit box.
A lot of the big money that are buying these negative interest rate bonds are doing it because they think the interest rates will drop even lower, thus making them money.
I’ve struggled to understand this.
Aren’t the PTB simply admitting that the dollar (or whatever currency) is declining in value while inflation is increasing exponentially as happened in Germany pre-WWII?
Such weird schemes to trick people into spending more money they dont have to buy more stuff they probably dont need, in order to keep other people employed...IOW simply to get ANY money circulating in the economy...scary.
“A lot of the big money that are buying these negative interest rate bonds are doing it because they think the interest rates will drop even lower, thus making them money.”
Maybe I get it now. The money is used to buy bonds, not just put into a money market account. Thus, if interest rates drop the value of the bond goes up to more than offset the negative interest rate.
How does that sound?
“Maybe I get it now. The money is used to buy bonds, not just put into a money market account. Thus, if interest rates drop the value of the bond goes up to more than offset the negative interest rate.
How does that sound?”
Couldn’t have said it better myself! :)
One more thing. These bonds are sold at auctions, therefore it is the buyers themselves that set the interest rates, it isn’t dictated by a bank.
So it goes something like this. A government agency holds an auction for 30 year bonds. It says I guarantee 30 years from now I will pay you back $1000 for this denominated $1000 bond, how much are you willing to give me now? Well apparently there are a lot of people and entities voluntarely willing to pony up more than $1000 now in exchange for $1000 30 years from now.
And these people are not dummies. Do they know something we don’t?
“And these people are not dummies. Do they know something we don’t?”
I can be comforted to know that my money market account won’t take money away from me! It’s buying power might go down but ... who knows?
Negative interest rates? “We’ll pay you to use our money”?
Curious - how much does your money market pay?
I’m not going to be able to make an argument that makes sense, standing as we do in the US and conditioned to believe that any loan should pay interest and any investment made intelligently is supposed to have a positive ROI. I say again, “conditioned”. Because the entire concept of negative rates makes no sense. As Mr. Greenspan said, though, the entire notion of positive or negative rates is “only a number”.
BTW, you should think of a bond purchase as a LOAN. Not an INVESTMENT. True; it makes equally no sense that you would make a loan with sure knowledge that your payoff will be less than the amount you lent as you would make an investment with the sure knowledge that your ROI would be negative. I am just making the linguistic distinction, moot as it may be.
On the other hand, the US at our 1.47 - 1.50 ten year rate is miles higher than ALL German bonds. Did you know that the Danish gov’t is now buying US Tsys as part of their program to offer zero-rate mortgages? If you are a Euro, then buying US Tsys makes astounding sense. And I for one believe that this is going to continue because this is not a ship that is turned around quickly. Go look at a chart of TLT, the 20-year Lehman (not Lehman Bros) bond fund, or, of TNX, the 10-year yield. Rocketship/collapse.
Here we have utilities, in the form of XLU, being bought with both hands. XLU utilities have a traditional beta of let’s say .35. Why are they up 20% YTD like a blazing tech stock? Because people are frantically chasing yield. All over the world. If German bonds are yielding neg rates then even a .75% rate is attractive. Let there be no doubt, should this reverse, the financial system could theoretically implode.
A lot of this is probably defensive as well. Someone paying 1/2% to stash reserves anticipates that most other asset classes are going to do a lot worse.
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