Tag Archives: Negative Interest Rates

The Truth About Negative Interest Rates is Ugly

Dan McCrum’s Insight column in today’s US print edition of the Financial Times is fascinating. You’ll find it on the back page of the Companies and Markets section. It is titled, “Negative rates reverse assumptions about financial decisions“.

Mr. McCrum explains away a basic financial truth about the time value of money. He explains that a given financial truth, the time value of money, results in the idea that money is more valuable today then tomorrow. It seems that we would spend our money tonight on a beer our favorite burger rather than hold on to that money for the same purchase in the future. The reason for this change in value over time is that many things may change between now and that future, such that shorter term gratification takes priority over long term riskier rewards.

To explain how we cope with that difference, we offer interest rates to those that loan money. The change in interest rate explains and accounts for an increase, or decrease, in the reward for carrying that risk over the duration of the loan. This is all basic stuff. It works. But with negative interest rates this basic truth is upside down.

With negative interest rates the value of money goes into reverse. Now the value of that beer and burger is higher in the future.  Your $50 today becomes $52 in the future so your ability to acquire more stuff increases. Switzerland, a central bank to adopt negative rates, is experiencing deflation. The ECB and the euro zone are flirting with negative rates and deflation. Denmark has negative interest rates that now pay you interest on your mortgage.  If you add in persistent deflation, we might even assume a need for increased negative rates to cope!

If this were not enough for you, check out Japan’s Subzero Rates Cast Chill Over Markets on the front page of today’s US print edition of the Wall Street Journal. The article explains how Bank of Japan, the central bank, is flirting with increased negative rates to drive growth, even though the recent shift into negative territory shows now sign of driving growth and in fact is creating unintended consequences. The article reports “Every day is like being Alice in Wonderland. Interest-rate levels are having little effect on credit demand, the market function is declining. You can’t expect everything to go according to plan,” said Tomohisa Fujiki, head of interest-rate strategy at BNP Paribas Securities Japan.

The whole negative interest rate idea creates a fascinating line of thinking. It’s the kind of thinking that leads to new insights. One of my favorite insights of a similar nature concerns the idea that more information improves the quality of a decision: it does not.  

In More Than You Know (one of my favorite books), by Michael Maubouson, then chief investment strategist at Legg Mason Capital Management (2006), there is reference to an experiment with horse racing and tipsters. The experiment showed that as additional information was serviced to tipsters, their accuracy in predicting winners increased. However at some point the accuracy declined and the more data shared with tipsters, the worse their predictions.  

So we should not always assume more data is more useful. Equally we should not assume that what goes by economic orthodoxy remains constant. We are experimenting with large scale negative interest rates and we really don’t know what will happen. Maybe it’s time for something different.


Negative Rate Madness Continues

he headline on page 4 of my US print edition of the financial times read, Japan debates how to use negative rates windfall. The article highlights the perverse outcome from a government setting negative interest rates. Borrowers are paid, in effect, to borrow. And governments are the largest borrowers. And so the largest borrowers gain the biggest kickback for going further into debt! What a fiasco.
The intent of course is to encourage investment and spending. The problem is that firms have not responded to quantitative easing (QE), as it’s called. Research suggests that firms develop their investment patterns based on things like competitive strategy and overall economic climate. Firms have not responded to cheap money the way central bank’s wanted them too.  That is, other than to use  cheap cash to fund stock buy-backs, which elevates EPS that pay bosses bonuses, and increased mergers and acquisitions. In both cases such investments have nothing to do with economic or productive growth. QE has failed in this respect. Now the latest result will be increased public debt.  

And such debt will become crippling as rates start their journey toward normalization, if they ever get there. With significant debt and growing (positive) interest rates goes higher and higher debt service payments. This will eat into any tax income from growth, leaving less for big brother to spend as economies start to grow again. So our leaders are playing with a double edged sword.

Our profligate, ‘we know best’ leaders are now going to print themselves more money to reward their abusive behavior. And we can’t stop it. In fact we must not. The whole point of negative interest rates comes down to this perverse behavior. To not complete this foul circle would be silly.

The reality is that these policies have not worked. Soon enough a leader will get voted in, someplace, that is so anti-establishment. That leader will defy all ‘normal’ rules of the day and upset the apple cart. In so doing this leader will help right the mess we are now in. I wonder who is silly enough to run for office and try this? I wonder….

Negative Interest Rates Coming to Main Street?

There was an interesting article in today’s US print edition of the Financial Times, titled “Fear for lenders over deeper negative rates“. The article comments that banks have, so far, swallowed all the penalties created by central banks dropping inter bank rates below zero – i.e. negative.  The article suggests that bank profits are being hit from many different sides, and the implication is that banks may soon pass onto consumers the negative interest rates imposed on them.  This would mean you and I might be penalized for saving money.  This perverse action seems just a nod and a wink away and would be most damaging to the psychology for how consumer savings drive growth in economies.