Negative interest rates turn saving, borrowing upside down
Imagine a mortgage that pays you the interest, not the other way around. Or a savings account where it’s the bank, not the saver, who collects interest.
Welcome to the upside-down world of ultra-low and negative interest rates that is taking hold in many parts of the world.
Now more than a decade old, economists think it could be a feature of the global economy for years to come and change the way people save and invest.
“This will mean that we must save more, work longer, and expect less,” said Olivia Mitchell, an economics professor at the Wharton Business School at the University of Pennsylvania.
The latest chapter is the drop in interest rates on some bank deposits below zero as central banks, particularly in Europe and Japan, try to support the economy amid uncertainty about trade by making borrowing cheaper to spur spending and investment.
Economists think there are also longer-term factors causing low rates such as aging populations in rich countries and high rates of savings in China and other emerging economies.
Low rates first hit in the wake of the global financial crisis. The United States Federal Reserve, Bank of England, Bank of Japan, and European Central Bank slashed rates close to zero. In 2014, the ECB went negative.
In Germany, some banks are now telling companies and others with large amounts of cash that they must pay a rate on large deposits instead of accruing interest. The penalty typically applies to big accounts, such as more than €500,000 (US$555,000), according to financial website Biallo.de.
Banks are doing this because they themselves have to pay a 0.5 per cent penalty on deposits they hold at the European Central Bank. If banks can’t find a home for depositor money, it winds up in their ECB holdings and results in their being charged.
The low-rate environment raises questions about preserving wealth, especially for those trying to save for retirement. German newsmedia are full of stories about “penalty rates”and criticism of the European Central Bank for, as they put it, expropriating savers.
Gerhard Michel, a financial coach in Duesseldorf, says people need to be aware that inflation eats away at savings even in more normal times, though people may be less aware of it when rates are above zero.
“If you look at it historically, people with savings accounts never had any kind of interesting performance,” he said.
“The inflation rate ruins any returns on the government bond market or the savings market - and it has always been that way historically. What shocks people now is that people must say the word zero, or even negative, interest.”
Michel, who is 53, teaches his coachees about value investing, a more time-consuming approach that analyses financial statements to look for companies the market may be underestimating.
His approach with his own money: “I will buy stocks until the end of my days.”
Pushing people to invest in riskier assets is part of the stimulus effect central banks are trying to impart. But there are also fears that by doing so, very low rates can cause markets to bubble up, and crash back down with painful consequences. So far, the dire predictions haven’t come true. The current bull market in US stocks turns 11 years old on March 9.
Some €4 trillion worth of government bonds of the 19 countries that use the euro now yield less than zero. Trillions more in Japanese and other government bonds trade below zero around the world.
Even Greece, which defaulted on government bonds in 2012 and carries the highest debt load in Europe, was able to sell three-month notes at a negative rate.
Why, in fact, would anyone pay for the privilege of buying a bond?
One way of viewing the phenomenon is that the investor is paying for the safety of the investment. Or buyers may hope to sell the bond at a profit. That is possible if rates go even lower - as some analysts think they will.
Negative rates have not yet appeared in the United States, but they could if the economy stumbles into recession, some economists say. The Federal Reserve would almost certainly cut the short-term rate to nearly zero, as it did for seven years beginning in the Great Recession.
Since the US 10-year yield is already very low by historical standards, at 1.6 per cent, it wouldn’t take much to push it below zero, said Ryan Sweet, senior economist at Moody’s Analytics. The Fed may try to prevent it from happening, possibly by selling Treasuries, but it’s not clear they would succeed.
“We’re not immune to it,” he said. “That’s a kind of Alice in Wonderland-type world that we don’t want to go into.”
So far, Federal Reserve officials have downplayed the potential for negative rates in the US.
“That’s not a tool we’re looking at,” Federal Reserve Chair Jerome Powell said last Tuesday during a congressional hearing. He cited research that negative rates can hurt banks’ profits and restrain their willingness to lend.
The German Economic Institute in Cologne studied multiple factors believed to cause low rates and concluded that it is not just due to central banks but represents a longer-term trend.So low or negative rates could be around for years.
With that in mind, Mitchell, the professor, persuaded her two daughters to save 18 per cent of their salaries when they found their first jobs.
“We’re in a very different capital market regime now than in the last 30 years,” she said.