What does a negative interest rate imply? - The Daily Reckoning

What does a negative interest rate imply?

Oct 29, 2015

- By Bill Bonner

Bill Bonner
Normandy, France

"Now, I think I've seen everything" is an expression - like 'this is the end of history,' and "I'll never leave you" - that usually turns out to be premature. But it is what we found ourselves saying yesterday. Not out loud. We just moved our lips in mute amazement.

On Tuesday, the government of Italy sold a 2-year note yielding MINUS 0.023%.

We don't know what is more preposterous, that the Italians were able to borrow money at a negative interest rate...or that the press reported this transaction with a straight face. It should have provoked howls of laughter, withering scorn, and unvarnished derision.

But here at the Diary, we will not point the finger and chuckle...we will not invoke our usual tone of sarcasm...we will not damn the whole thing to Hell with loud and blustery cussing. Instead, we'll take the high road in this matter; we just want to know what it means.

Before we get to that, however, let us pick up the news. Here's the latest, from Bloomberg:

    Federal Reserve officials pivoted toward a December interest-rate increase, betting that further job gains will lead to higher inflation over time and allow them to close an unprecedented era of near-zero borrowing costs.

    The Federal Open Market Committee dropped a reference to global risks and referred to its "next meeting" on Dec. 15-16 as it discussed liftoff timing in a statement released Wednesday in Washington, preparing investors for the first rate rise since 2006.

    "The case for a December liftoff continues to build," said Ward McCarthy, chief financial economist at Jefferies LLC in New York. "Even with the weaker data of late, it is hard to make the case that the economy is still in an emergency" that requires rates near zero.

"To pivot" has become the latest fad verb. It seems to mean "to move" or "to go towards." You can use it in practically any setting. Investors pivoted towards higher prices yesterday, with a 198-point increase in the Dow. You might tell your husband that you're pivoting towards buying a new Tesla. And we pivoted back to France last night...after a few days in Ireland.

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It is a gray day in Normandy this morning. But the leaves have pivoted to such glorious shades of orange that the effect is a profound and melancholy splendor.

But let us pivot back to our subject for today...

A negative interest rate implies an odd world. Maybe even a world that cannot really exist. In order to lend at less than zero it suggests you believe that the present value of cash is less than the future value (that is, in deflation...)...and you must assume too that the risk of default or inflation is near zero. This allows the Italians to go out and build roads or pay pensions with money that cost them less than nothing.

How long this will last, we don't know. But as long as rates remain below zero (and they could go lower!) money will be free.

Imagine that you are buying a house. Now, you can see the mischief afoot! If lenders are willing to grant a loan at a negative interest rate - secured by nothing more than the full faith and credit of the Italian government -- should surely be willing to lend you money against a house. That would leave you with curious mortgage - one that pays you interest, rather than costs you money. At the Italian rate, a $1 million house would come with an additional income of about $19.16 per month.

This raises profound metaphysical issues. If a mortgage carries negative interest, it implies that the house (an equal capital value) also has negative value. After all, you have to pay someone to live in it. And if houses are worth less than nothing, we have to wonder what a car is worth...or a diamond ring...or a luxury cruise?

Does that mean that money itself has no value? Or even negative value? After all, you can no longer give it to someone in exchange for a positive interest payment; now you must pay him to store it for you... as though it were furniture that won't fit in your house. You don't like it anymore. But you don't have the heart to throw it away.

And if money has no value, what happens when you hire, say, a gardener to pull out weeds? Should you pay him, or he pay you? How many hours should he have to work for you before you consent to take his money?

The whole thing is so contrary to nature we gasp when we think of it. We are flummoxed by it. But you are a smart person, dear reader: maybe you can figure it out for us.

And this is all prelude to taking up the strange case of Sweden. All we know about Sweden was what we learned by watching the film 'The Girl with the Dragon Tattoo." And all we learned from that was that Swedes tend to be murderers, sadists, lesbians, and pock-marked wimps. And maybe that accounts for the torturous financial system the Swedes are creating.

According to Business Insider:

    Sweden is shaping up to be the first country to plunge its citizens into a fascinating - and terrifying - economic experiment: negative interest rates in a cashless society.

    The Swedish central bank, the Sveriges Riksbank, on Wednesday held its benchmark interest rate at -0.35%, the level it has been at since July.

    Though retail banks have yet to pass that negative rate on to Swedish consumers, they face increased pressure to do so as long as the rates remain where they are. That's a problem, because Sweden is the closest country on the planet to becoming an all-electronic cashless society.

    Remember, Sweden is the place where, if you use too much cash, banks call the police because they think you might be a terrorist or a criminal. Swedish banks have started removing cash ATMs from rural areas, annoying old people and farmers. Credit Suisse says the rule of thumb in Scandinavia is: "If you have to pay in cash, something is wrong."

    A resistance is forming, and some people are protesting the impending extinction of cash. Bjorn Eriksson, former head of Sweden's national police and now head of Sakerhetsbranschen, a lobbying group for the security industry, told The Local, "I've heard of people keeping cash in their microwaves because banks won't accept it."

Alert readers will recognize this negative interest story as one we have been following...and a policy we are forecasting for the US. We think the feds will pivot to limiting the use of cash as much as possible in order to gain more control over the economy...and practically unlimited power to tax and spend, without Congressional approval.

Sweden is ahead of the feds on this one. We can only hope that it goes far ahead, fast, and blows itself up before the US pivots down that path too.

Bill Bonner is the President & Founder of Agora Inc, an international publisher of financial and special interest books and newsletters.

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1 Responses to "What does a negative interest rate imply?"

Mr. Shah

Oct 29, 2015

To pivot towards a more cerebral discussion of the implications of negative interest rates requires going beyond a mere derision of the ideology itself. For starters, real interest rates are still positive and will continue to remain so. From a depositor's vantage point, it is still cheaper to maintain a bank balance than hide money under a mattress. Borrowing "free money" may still be a disincentive if the returns on investment are subdued due to deflation. The point is that banks will most likely not pass this cost onto consumers so discussion is irrelevant. This strategy works if the currency depreciates increasing imports and inflation. What drives success is a foreign currency impact.

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