Negative Interest Rates are Not Positive

September 25, 2019
If you’ve followed the financial news over the past year, you may have run across a curious term – negative interest rates.  It denotes the situation where one lends money to another entity, does not earn interest and eventually may receive back less than what they loaned.

At first blush, negative interest rates seem strange – why would you lend money, not charge interest, and /or be agreeable to accept less than your original loan amount?  Yet this phenomenon is prevalent in global government debt markets today. Due to an inability to otherwise juice economic growth, countries like Japan and many in Europe have indeed driven down the cost of their sovereign debt to such a degree.  In fact, so much so that in August 2019, Deutsche Bank estimated there was over $15 trillion of global government bonds with negative rates in circulation.  Due to a worsening economy, Germany is on the cusp of issuing negative rate bonds too.  The purpose of this policy is apparently to force cash into the respective economy and spur spending and investment by consumers and businesses.

While zero or negative rates may sound great for borrowers, there are plenty of downsides that proponents of the strategy (such as our President) should consider.  First of course, is the point of view of those on the other side of the transaction; namely savers and lenders.  Those who deposit their money with lending institutions (such as banks and finance companies) should and do expect some kind of return for their monetary commitment.  You have likely winced at the paltry interest paid over the past decade on your bank savings accounts and certificates of deposit.  As we’ve seen in the investment world, negligible earnings from savings/CD’s are causing some consumers to turn instead to more risky investments than they otherwise would be comfortable with, such as the stock market.  Even large investors such as pensions and insurance companies, who invest heavily in government bonds and other income securities, also expect (and need!) a return on their money.  The potential demand for negative-rate US Treasuries may be far less than proponents might hope for.

Negative rates turn the normal functioning of capital flows and economic finance upside down.  They also hurt lenders – rather than earn the spread between what interest they pay depositors and what they earn by lending, banks are forced to pay central banks to hold their cash or push it out into the economic system.  Bank profit margins are also squeezed, forcing banks into more risky lending and to seek profits through more services fees; something consumers have complained about for some time.

Negative rates also have the potential of triggering inflationary pressures by pushing up values of financial assets and real estate, sometimes beyond what is reasonable in a normal environment.  Critics point to recent equity prices and values of real estate in high-end parts of the country as potential examples of this consequence.

Lowering rates too far to zero or negative also remove a potent tool from central banks, such as the Federal Reserve, to stimulate their economies by lowering rates.  Once rates go negative, pushing them further down may be ineffective in motivating spending to invigorate the economy.  

In sum, the advent of negative rate bonds is truly uncharted territory.  While the consequences over time are not known, the best defense for consumers and investors may be to suffer with lower savings yields for now, remain diversified, and manage risk even more diligently than before.