The Abnormal Is Becoming Normal: Negative Interest Rates

The highly abnormal is becoming uncomfortably normal. […] There is something vaguely troubling when the unthinkable becomes routine.

Claudio Borio, Bank of International Settlements

Claudio Borio made this statement almost five years ago, in December 2014, as volatility spiked. In case you are not familiar with the Bank of International Settlements (BIS) it’s essentially the bank for central banks.

Back then, central banks were pushing sovereign yields to mind-boggling lows.

Now the unthinkable — negative rates —are becoming the new ‘normal’. Only a few years ago having negative interest rates was something deemed impossible.

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But in the last week we have seen efforts in the mainstream to justify this madness.

There is nothing weird or abnormal about negative rates…we hear.

Negative rates are justified because there isn’t enough demand for debt, they say.

It makes sense to pay to store your wealth, they tell us.

Remember, when you deposit your savings in the bank the number you see on the screen is an IOU from the bank. This still means risk. And in some countries you are now paying for this risk instead of receiving compensation.

It’s all nonsense. Absurd. It’s trying to justify the unjustifiable.

Trust me, nothing good will come out from having negative interest rates. In Borio’s words, it’s very worrying when what was considered impossible becomes normal behaviour.

Looking at my parents’ generation and those that came before them, it’s clear they built wealth from working and salary increases, from compounding savings and investing.  Now the first two income streams are basically gone, which has slowly chipped away at our purchasing power.

Risks are mounting on the third one.  Much of the increases in wealth we have seen in recent years have been from assets increasing faster than salaries.  That’s not sustainable. Assets are bubbling, and a collapse would wipe out even more wealth.

This is all the result of central bank manipulation and the distortion of the economy. It’s what happens when central banks try to eliminate cycles.

Germany, France and Switzerland among others are offering negative yielding 10-year bonds.

How long will this negative yielding debt appeal to investors? It may not be for too long.

Germany’s 30-year bond offer bombed this week. Appetite may be starting to wane for these types of assets.

The idea with negative rates is that it promotes more debt taking and more spending.

The fact is negative rates haven’t done much for Japan or Germany to spark growth. Germany is now at the doorstep of a recession. Japan has been flatlining for decades.

We are going down the rabbit hole with negative interest rates.

And I have news for negative interest rates advocates: It won’t work.

Once negative interest rates went negative in Germany people rushed to buy safes, and started stashing cash. Negative rates are effectively a tax on your savings. So it makes sense that most will try to avoid them by storing cash or gold.

But that’s not all they did.

Here is an extract from an article published in The Australian in 2016, after Germany imposed negative rates:

When Ms [Heike] Hofmann, 54, heard the ECB was knocking rates below zero in June 2014, she considered it “madness” and promptly cut her spending, set aside more money and bought gold. “I now need to save more than before to have enough to retire,” she said.

That’s right.

When interest rates go negative, people spend less because it means they need to save even more for retirement.

Zero rates is an indication that there is no growth coming, and when people are pessimistic about the future, they spend less. Negative interest rates, the prospect of decreasing savings and low growth don’t exactly exude optimism.

Central banks are lowering rates to try and create inflation to get rid of our massive mountains of debt.

As our population ages, they are fighting deflationary forces. Deflation is when people put off spending because they think that prices will get cheaper in the future.

But central bankers aren’t having much luck.

Central banks have done — and will do — the impossible to fight deflation and keep the boom going.

After the last crisis we saw them take on quantitative easing and lower interest rates down to negative.

These unconventional policies were supposed to be temporary. They are now becoming the ‘new normal’.

The Fed is trying to hold off on more rate cuts…for now. But at some point it’s likely they will cave.

The latest US Federal Reserve meeting minutes released this week shows a divided central bank with some members looking to decrease interest rates by a larger amount than the 25 basis points they decided on. There was also more talk on unconventional policies.

The abnormal is becoming normal.

How long will people trust this story is possible? How long until this new normal becomes uncomfortably abnormal?


Selva Freigedo Signature

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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