Is Banking Better in Bed?
Interest rates are the lowest ever—lower than zero in Japan and parts of Europe. Records go back only to Mesopotamia in 3000 B.C., but it’s unlikely anyone before then would have dreamed up something as weird as negative interest. Today some banks routinely charge for accepting cash instead of paying depositors for the use of their money. German railroad Deutsche Bahn can issue a bond with an ironclad promise to pay back investors less than it borrowed from them.
As envisioned by central banks, negative interest rates boost growth by encouraging people to borrow for consumption or business. They induce investors to finance promising ventures by suppressing the return they get on safer investments, such as Treasury bills. And they can give countries an edge in trade by suppressing the value of their currencies.
There are side effects, though. Negative interest rates hurt savers. They can inflate asset bubbles, since bond prices rise when interest rates fall. When used to depreciate currencies, they can be a “beggar-thy-neighbor” ploy that buys growth in one country at the expense of others. Very low but positive rates also have these drawbacks, but negative rates run the extra risk of starving financial institutions. You can’t force people to earn less than zero on their money. If customers are punished for saving, they will stash their cash in zippered mattresses. Banks and other institutions will be deprived of the funds they need to do business.
Are negative interest rates painful but necessary, like a tooth extraction, or painful and unnecessary, like getting hit on the head with a mallet? Either way, is this really the best idea for encouraging economic growth an advanced post-Sumerian civilization can come up with?
Legendary bond investor Bill Gross made the case against negative rates in his March newsletter to customers of Janus Capital Group. His words were adorned with a depleted-looking sun, perspiring and lolling out a big red tongue. Central banks, he wrote, are like the sun in that both will eventually run out of fuel—but the central banks’ mojo will end much, much sooner. Using another energy metaphor, he wrote that “central banks plumb deeper and deeper depths, like drilling rigs expecting to strike oil, if only yields could be lowered another 10, 20, 50 basis points.” Except there’s no oil to be found.
Mega-investor Larry Fink said in April that efforts to stimulate the economy by making rates superlow or even negative are self-defeating because savers will become even thriftier to reach their nest egg targets. “A monetary policy intended to spark growth, then, in fact, risks reducing consumer spending,” he wrote in his chairman’s letter to shareholders of BlackRock, the world’s largest asset-management firm.
Negative interest rates are reviled on the right by the likes of David Stockman, Ronald Reagan’s budget director, who accuses central banks of inciting “lunatic speculations” on Wall Street, and on the left by economists such as Nobel laureate Joseph Stiglitz, who points out that they haven’t noticeably boosted growth or jobs. “Large corporations are sitting on hundreds of billions of dollars—indeed, trillions if aggregated across the advanced economies—because they already have too much capacity,” he wrote in the Guardian. “Why build more simply because the interest rate has moved down a little?”
In Europe negative rates are squeezing pension funds, annuity providers, and life insurers by reducing the difference between what they owe customers and the very little they can earn on investments. For now, life insurers have been able to bridge the gap by selling some bonds or other assets for big gains, since bond prices rose in tandem with the drop in rates. But selling bonds worsens their long-term financing problem because the sales prematurely end the attractive income the bonds were producing, says Charles Graham, a senior analyst for Bloomberg Intelligence in London.
“Allianz does not support the ECB’s negative interest rate policy,” Maximilian Zimmerer, a member of the board of management of Europe’s largest insurer, said of the European Central Bank in a March statement. “Instead of upping the dosage, it would be wiser to gradually withdraw.”
Negative rates also send a signal that the economy needs life support. “If people think negative rates are bad, then they become bad,” says Ethan Harris, head of global economics research at Bank of America Merrill Lynch.
So that’s the case against negative interest rates. The case for them is made with less conviction. Former Federal Reserve Chairman Ben Bernanke wrote on his blog in March that “the anxiety about negative interest rates seen recently in the media and in markets seems to me to be overdone.” He wrote that “economists are less put off” by negative rates than the general public because they’re accustomed to thinking in real terms—that is, after adjustment for inflation. It’s fairly common for interest rates to turn negative on an inflation-adjusted basis; a 5 percent interest rate is negative in real terms if inflation is 6 percent.
But even Bernanke couldn’t get too excited about the use of negative rates. In certain circumstances, he wrote, it “might be a reasonable compromise between no action and rolling out the big QE gun.” The “QE gun” refers to quantitative easing, or bond purchases by a central bank to lower long-term interest rates.
European Central Bank President Mario Draghi acknowledged the problems of pension funds and insurance companies at an April news conference. But, he said, “I would urge all actors in this sector to resist the temptation to blame low interest rates as the cause of everything that went wrong and [has] been going wrong for years with this sector.” His argument is that the ends justify the means: Eventually negative rates will ignite borrowing, spending, and growth. Rates will normalize, and the pension funds and insurers will be able to breathe. “As I said before,” Draghi said, “if we want to return to higher interest rates, [first] we have to return to higher growth and higher inflation.”
The bottom line is, negative rates aren’t as bad as Gross, Fink, and others would have you believe. As long as rates are only mildly negative, big institutions are willing to pay for the convenience of what’s essentially cash storage. (Rates for retail customers have generally remained at or above zero.) Another positive: Low lending rates make it easier for borrowers to keep up with payments, so default rates are superlow. In Denmark, which has had negative rates the longest (since 2012), the four major banks passed the European Banking Authority’s recent stress tests with flying colors.
Yet neither are negative rates especially effective. As Stiglitz argues, low rates don’t induce borrowing. A survey of chief financial officers from around the world by Duke University’s Fuqua School of Business found that almost 90 percent said they could stomach an increase of 1 percentage point or more in interest rates before they’d consider cutting back on investment plans.
What the world needs now, aside from love, sweet love, is fiscal stimulus, which would be more effective in present circumstances than the monetary stimulus that central banks can supply. It’s been known since the 1930s that cutting interest rates loses effectiveness below a certain threshold. Taxing and spending conversely become more effective because there’s a huge surplus of lendable funds. The government can increase its deficits, without pushing up interest rates and crowding out private borrowers.
Central bankers themselves say they can’t do it alone, and that fiscal policy needs to be part of the solution. There are signs that legislatures and heads of government are coming around to the idea. Analysts at Bank of America Merrill Lynch recently dubbed this trend the “fiscal flip,” which they said is part of a global “war on inequality.” In Japan, a new supplemental spending plan includes money for cruise ship port facilities and a high-speed maglev train line. The European Commission on July 28 refrained from fining Spain and Portugal for running excessive budget deficits. And in the U.S., Donald Trump said on Aug. 2 that if elected he would “at least double” Hillary Clinton’s $275 billion infrastructure plan.
Government spending isn’t wasteful if it’s for things that have to be done eventually anyway, like repairing roads and bridges, or for things that increase the productive capacity of the economy and its people, like education and research and development. Even better, these measures have a positive ring to them. Negative interest rates are just so … negative.