How Negative Interest Rates Are Having Strange Effects on World Economies

It’s not exactly a sign of a healthy economy when people are resorting to stashing their cash in secret vaults.

Nevertheless, this is what has been going on and even the Swiss pension funds are reportedly considering it.

What would drive them to such extremes? Simply put, it’s a negative reaction to the requirement to pay to keep their money in regular bank accounts; what’s currently known as ‘negative interest’.

Yep, it has reached the point in some parts of the world where the banks are so concerned about inflation rates, that they are now actually charging financial institutions to invest with them. The savvy among you will have noted no doubt that that’s not investing.

This isn’t just more unscrupulous behavior on the part of banks but makes sense in a topsy-turvy kind of way if you dissect the plans. The idea here is that by charging bigger institutions to park their money, banks will then again be able to afford to lend more money to households and small businesses.

In fact, in some cases, banks are even paying people to borrow!

Is it working? Well, in March lending to small businesses rose to its highest in three years in the Eurozone.
But banks shouldn’t rest on their laurels. Things could just as easily turn sour as negative interest rates run the risk of encouraging riskier investment strategies.

In other words, if organizations can no longer gain interest by investing in banks – and if individuals are now being paid to borrow money – they might start putting more funds into their own investment portfolios. If this were to go wrong, then this could have widespread and negative implications on the broader economy.

Silvia Merler is an affiliate fellow at Bruegel (a think tank in Brussels). She said of the situation:
“Very low rates may push agents in the financial markets to take on excessive risk.

“It is very important that the supervisory architecture in the Eurozone is now significantly stronger and that supervisors are a lot more focused on financial stability.”

Meanwhile, economies such as Switzerland and the EU are seeing depositors store their cash in vaults. This is less likely to be an issue in some economies such as the UK. Why? Because in the UK, the highest denomination for notes is significantly lower. This means that it actually costs more money to store the same amount of cash! Simply put: smaller notes mean you need more of them.

Hanspeter Konrad, director of ASIP, says that this is now ‘clearly’ impacting upon pension funds.
What’s perhaps most interesting of all, is the impact that negative interest rates have psychologically. It’s such an alien seeming concept, that it attracts a lot of attention. And it may affect the way that some currencies are perceived:

“Negative rates may well have had an impact on the exchange rate,” said Dirk Schumacher, an economist at Goldman Sachs. “It’s the psychology of them: that you have to pay money to hold euro liquidity.”

The hope is still that this action can help to finally inflate the economy with more readily available and affordable cash for small businesses and families. Whether or not it will turn out this way though, will remain to be seen.