Kidnapping Benjamin – Negative Interest Rates Corrupt the Value of Money

Pablo Escobar was (and still remains) an intriguing figure.

He was one of the world’s most important drug dealers in the ‘80s, one who brought massive violence into Colombia.

But he also managed to gain the loyalty of the people in Medellin, Colombia through giving them cash, homes, built stadiums and a neighbourhood.

By the 1980s, his business cocaine empire supplied 80% of the global cocaine.

It made him one of the richest people in the world. In fact, his fortune and extravagant lifestyle landed him in the Forbes billionaire list several times.

The illegal drug trade also brought him in a lot of US dollars. So much so that he couldn’t launder them fast enough.

So, he started stashing them in safe houses, and burying it.

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He had so much cash around that he wrote off 10% of his profits to rats.

And, according to his son, he once used US$2 million in cash to make a fire to keep his daughter warm while the family was on the run.

How much money did he have?

His son says he once asked him that same question.

His reply: ‘I don’t know, I don’t want to count that.

Anyway, my point is that cash and US dollar play an important part in the illegal trade.

The reason why I mention this is that I came across something interesting from the International Monetary Fund (IMF) this week.

As the IMF notes, there are now more US$100 in circulation than ever:

A curious thing has happened in US currency: the $100 bill recently overtook the ubiquitous $1 bill in circulation volume, for the first time in history. In other words, the most valuable banknote in the United States became the most widely circulated.

As you can see below, the Benjamin’s in circulation have doubled since the financial crisis.

Top dollar US$100 bills have doubled in circulation volume since the global financial crisis, overtaking the US$1 bill - 3-08-19

Source: IMF

[Click to open in a new window]

As the IMF explained on the article, much of that demand is coming from abroad. 60% of all US bills and 80% of the US$100 bills are held outside the US.

So why is demand for Benjamin’s surging, at a time when the use of electronic payments are also rising?

The IMF thinks one likely explanation could be from an increase in activities in the criminal, underground and informal economy.

It could be. As we mentioned at the beginning, cash and the US dollar have always played an important role here…even though bitcoin is now getting all the bad rap.

Or because of geopolitical instability. That is, there could be more demand for US$100 bills from countries going through a crisis, like Venezuela.

But, in my opinion, I think Harvard University’s Kenneth Rogoff hit it on the nose when he said the following:

Underground demand for paper currency has been surely rising in part because interest rates and inflation are exceptionally low.

That is, people could be stashing cash — and in particular Benjamin’s — because of low inflation and low interest rates.

Rates are going lower, and even negative.

The European Central Bank, the bank of England and the bank of Japan all have rates stuck at zero or below.

It is also looking increasingly likely that the US is walking towards negative rates. The US Fed lowered rates for the first time since the financial crisis this week.

Negative rates act kind of like a tax on your wealth. Having savings in the bank will lose you money instead of paying your interest.

It’s why with negative rates, households will stash cash — usually in high denomination bills — at home instead of keeping it in the bank. I mean we saw this in Germany, when interest rates went negative and there was a surge in home safe sales.

It could be the reason why we are also starting to see countries getting rid of high value bills. Europe has stopped printing the 500 euro bill, and some European countries are setting up limits on cash transactions.

It makes it more difficult to use and store cash, and forces people into using the financial system.

The idea of negative rates is that it will increase spending and lending by banks. That it will spur the economy and create inflation.

But negative interest rates are…well, absurd.

We now have a whopping US$13 trillion in negative yielding debt. Bloomberg calls it ‘quicksand’, a ‘black hole engulfing the world’s bond markets.

As they wrote (emphasis added):

Negative-yielding debt topped $13 trillion in June, having doubled since December, and now makes up around 25% of global debt. In Germany, 85% of the government bond market is under water. That means investors effectively pay the German government 0.2% for the privilege of buying its benchmark bonds; the government keeps 2 euros for every 1,000 euros borrowed over a period of 10 years. The U.S. is one of the few outliers, with none of its $16 trillion debt pile yielding less than zero, but across the world, strategists are warning that the problem may get worse.

Negative rates are at odds with basic principles of the global finance system. “One important law of financial logic — if you lend money for longer, you should see a higher return — has been broken,” wrote Marcus Ashworth, a Bloomberg Opinion columnist covering European markets. “The time value of money has essentially disappeared.”’

I mean, it is the upside down world. One where you get paid to hold debt.

It’s great for governments who can borrow on the cheap and who need to pay for promises they’ve made, like pensions, when they don’t have the money for it.

It’s also great for zombie companies. That is, companies that are taking on huge debt but aren’t seeing any profits.

But how many investors will want to hold debt when at the end of the term they get less money than what they invested?

It doesn’t make any sense…

It used to be that the way to create wealth was through work, and savings. Low interest rates have pushed up asset prices, and punishes workers and savers. It pushes people into riskier assets and corrupts the value of money.

They force people to look for alternatives, things outside the financial system that will hold their value.

It could be why gold is rallying…it could be why cryptos are sparking even more interest…

…and it could be why there are more US$100 bills in circulation than ever.


Selva Freigedo,
Editor, The Rum Rebellion

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Selva Freigedo is a research analyst for The Rum Rebellion.

Born in Argentina, her passion for economic analysis started at a young age. Her father was an economist for the Argentinean governments and the family used to discuss politics and economics at the dinner table.

Argentina is a country with an unusual economic history. Growing up there gave Selva first-hand experience on different economic phenomena such as hyperinflation, devaluation and debt default.

Selva has also lived in Brazil, Spain and the USA.

Back in 2000 she was living in the US as the dot com bubble popped…
And in 2008 she was in Spain as the property market exploded and then collapsed…

She has seen first-hand what happens when bubbles burst.

Selva joined Fat Tail Investment Research’s team in 2016, as an analyst. She now writes from her vantage point in Australia, where she settled in 2015.

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