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.

Advertisements

The Federal Reserve and Their Near Zero Interest Rate Policy

The stock exchange seems to be making new all time highs daily. Instead of congratulating yourself for what a trading guru you are, it may be time to think about the Federal Reserve’s extreme rate policy

The financial catastrophe of 2008 relieved the global banking system of around one trillion U.S. dollars. Therefore, in an effort to recapitalize itself, the world wide banking system has to make around 1 trillion US dollars.

Regrettably, recapitalization doesn’t come cheap. The Fed is utilzing artificially low rates near zero to bridge the gap. Recent predictions say we’ve made up $300 to $400 billiion, but that still makes us over $500 billion short.

The remaining $500 billion will be much more challenging for the banks to recapitalize because of the new rules and regulations. While the Volker rule and Dodd/Frank were put together with the best of intentions, as so many laws and rules and regulations are, the real effect of these new rules and regulations will be on the bank’s bottom lines.

At their core, the Volker rule and Dodd/Frank obstruct the breadth of bank’s business opportunities. In barring their business possibilities, these regulations limit their ability to completely recapitalize the banking system. Consequently the Federal Reserve will be required to preserve its near zero interest rate policy past current predictions in order to drive the system to recapitalization.

Now lets discuss the existing U.S. government debt issue. The current U.S. deficit is now over 16.5 Trillion and growing every second. Despite the fiscal cliff being avoided and the sequester, the U.S. government continues to operate in the red for Fiscal year 2013 by an projected $800 billion. The CBO has comparable predicted deficit estimates for fiscal years 2014-16. These deficits will take our national debt to at least the 20 Trillion dollar level. TWENTY TRILLION DOLLARS!

Someday in the near future, the United States government will minimally need to balance the annual budget deficits in order to stop the total debt expansion, as well as make a true concerted effort to bring down the total national deficit in an effort to balance itself. This suggests the US will need to take $500 to $800 billion of government spending from the U.S. economy. This spending hole is going to lead to numerous quarters of negative growth. This is without doubt not great for the U.S. stock markets or the global stock markets for that matter.

Our only saving grace is that maybe the U.S. economy will grow its way out of this dangerous debt obsession. Regrettably, this is largely a pipe dream. The Federal Reserve will undoubtedly be forced to keep interest rates at cheaper levels to help keep the U.S. economy from struggling with the reality of recession.

While the stock market is trading close to all time highs, the Federal Reserve must persist its near zero interest rate policy to recapitalize the World Banking system and to support the financial system as spending cuts and tax hikes eliminate money from the economy to help stem the threat of another recession.