When one first thinks of negative interest rates from the perspective of a bond issuer it doesn’t seem to make sense. Bonds typically pay a semi-annual coupon and have a yield to maturity that is inversely related to price. In essence, this is an economic scenario of how money supply works.
The concept basically involves a charge to banks for holding reserves. That cost would be intended to spur them to lend more, which, along with lower rates more generally, would presumably drive economic growth. Such is one monetary theory.
Negative rates on government securities held by the public are another possible scenario. Former Fed chairman Alan Greenspan thinks this may be the case. He has recently mentioned to CNBC and others that there currently are “no barriers” to negative rates in the U.S. presently. The concept is not new, but hasn’t become policy in the U.S. Negative rates have been a distinguishing feature of the Japanese economy and many European economies for some years now.
Today, there are some $16 trillion in negative government securities worldwide, and the European Central Bank (ECB) on September 12 cut its interest rate 10 basis points to a record low of -0.5% and also ordered a new round of quantitative easing. The supply and demand curve works such that bond buying drives down yields and cuts borrowing costs.
Negative rates are uncharted territory in the U.S., so the verdict is still out on the long term economic impact. Some economists say negative rates could lead to a slow-growth environment from which it would be difficult to escape. Others contend the overall effect would be to stimulate the economy.
So how has the U.S. come into this new interest rate realm? The immediate cause for the U.S. is likely trade tensions, which have touched off an investor flight to the perceived safety of U.S. government securities. According to economist and legal studies expert Peter Conti-Brown, “The slowing of economic growth is sometimes blamed on secular stagnation.” Conti-Brown defines secular stagnation as “a prolonged period in which satisfactory growth can only be achieved by unsustainable financial conditions.” What is perplexing to economists like Conti-Brown is the fact that inflation is low, despite very low unemployment.
In brushing a broad stroke, your invested value, the money given to borrowers would have a value lower than the face value. Capiche? Savers should be the winners, not the borrowers! So how does this all affect you? Well, part of the reason is demographics. A huge swath of the baby-boomer workforce is retiring. According to Lisa Cook, a professor of economics and international relations at Michigan State University, “We have a population that is not only aging but leaving the workforce, and that is a drag on the economy.”
Yet to be mentioned is the Keynesian side and fiscal stimulus of priming the economic pump. This concept is only touted by the socialist left. With budgets deep in the red, and a prevailing mood against adding to debt, more spending would appear to be a non sequitur for now.
One wonders if the banking system will be able to hold its head above water in a negative rate environment, perhaps pushing the U.S. into another Great Recession. Economist Itay Goldstein notes, “Banks are used to positive interest rates. This is how they make their spread. They might face difficulties making money and generating profits in a new world like this. If they are charged for putting money with the Fed, and they can’t necessarily transfer the negative rates to their depositors that might cause big difficulties for banks.” The financial markets will have to wait and see.
Editor’s note: J. Thomas is the expert here, but to me this is a totally bizarre concept. I can’t help but think an economy that goes this way must be damaged to a great degree. Yet, Japan and Europe are already there…