Negative Interest

Could negative interest rates be bad for the global economy?

Global publically traded sovereign debt. Source: Humble Student of the Markets

Around the world, the use of negative interest rates is growing. Starting with Denmark in 2014, central banks have started to charge banks for keeping reserves. Now the central banks of Switzerland, Sweden, the Eurozone, and Japan have joined the negative interest rate club. Of the $40 trillion in sovereign debt outstanding, about $13 trillion now trades at a negative yield to maturity. Even some corporate debt has been issued at a negative yield, and some consumers in Switzerland have seen their adjustable mortgages reset to negative levels.

The theory behind negative yields is standard central banking dogma: low rates stimulate borrowing and put cash to work in the economy. If the cash cycle of consumer spending, corporate profits, additional hiring, and greater income accelerates, this should lead to higher employment and an economy that is growing closer to its economic potential.

But what if the theory doesn’t work?

Negative rates are a tax on the banks. The central banks are charging commercial banks money for holding reserves. This lowers bank profitability. So some commercial banks are increasing rates on bank loans to make up for the losses imposed by their central bank. Moreover, companies and individuals need to save more when nominal rates are lower in order to meet their retirement goals. Additional savings can short-circuit the cash cycle designed to jump start the economy. If loan demand is inelastic, negative yields would have the effect of lowering aggregate demand, not lifting it.

Magnetic Levitation. Photo: Mai-Linh Doan. Source: Wikipedia

In physics, matter behaves differently as temperatures approach zero degrees Kelvin—absolute zero. In finance, consumers and banks are acting unconventionally as interest rates approach zero: holding more cash, buying gold, increasing savings. We’ve had a war on drugs followed by more illegal drugs and a war on terror followed by more global terrorism. Are negative rates a war on savings? And what will they lead to?

Douglas R. Tengdin, CFA

Chief Investment Officer

By | 2017-07-17T12:21:43+00:00 September 13th, 2016|Global Market Update|0 Comments

About the Author:

Mr. Tengdin is the Chief Investment Officer at Charter Trust Company and author of “The Global Market Update”. The audio version of each post can be heard on radio stations throughout New England every weekday. Mr. Tengdin graduated from Dartmouth College, Magna Cum Laude. He received his Master of Arts from Trinity Divinity School, Magna Cum Laude and received his Chartered Financial Analyst (CFA) designation in 1992. Mr. Tengdin has been managing investment portfolios for over 30 years, working for Bank of Boston, State Street Global Advisors, Citibank – Tunisia, and Banknorth Group. Throughout his career, Mr. Tengdin has emphasized helping clients manage their financial risks in difficult environments where they can profit from investing in diverse assets in diverse settings. - Leave a comment if you have any questions—I read them all! - And Follow me on Twitter @GlobalMarketUpd

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