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Negative Interest Rate Policy Explained By Barbara Streisand

Negative Interest Rates. It’s not exactly a glamorous topic but it definitely deserves a closer look. There are several problems this policy is attempting to fight. It is designed to fight deflationary pressures and currency manipulation and ultimately act as a fiscal stimulus. When a big player sits on cash it does no one any good. When a bank loans that money out it helps the economy grow. So if you want to compare a bank to a big pot of money that metaphor works. If when someone deposits money in the bank and the only thing that happens is the pot gets bigger and bigger it does no good for the economy.

I avoid the use of showbiz allusions, it’s a bit cliche’, but it works well here. Barbra Streisand once played the lead in the iconic “Hello Dolly.” It’s over the top, campy, boisterous and she had a very memorable line, at least for me anyway. At one point in the play/movie the topic of money came up and Dolly Levi shared her insight with all “Money, pardon the expression, is like manure, it’s not worth a thing unless it is spread around, encouraging young things to grow.” That’s kinda what the Bank of Japan just said but in a far more reserved and dignified manner. I don’t think we want our central bankers doing show tunes. Or maybe we do. It could make it easier to understand. It’s certainly doing big things for Alexander Hamilton.

Negative Interest Rates. I have to admit I really didn’t get it the first few times I heard it. It’s not very likely the couple at the next table at dinner are discussing the ins and outs of it. It made me think about it and do a little research after the BOJ (Bank of Japan) instituted them last year. Everything and everybody gets reduced to an acronym these days. I will do my best to stay on topic but there are so many moving pieces it is always necessary to keep things in context. Negative interest rates are when a bank actually charges the depositor a small fee for holding their money rather than paying a nominal rate for savings.

Most adults in the US don’t really understand exactly what the Fed funds rate is and why it is important, so introducing a new idea is very confusing. It leaves it to nerds like myself and financial professionals, actually I am both, to think and talk about the policy. The Fed funds rate is the rate that banks charge each other overnight for borrowing funds. No US citizen will ever have access to rates of .050 percent. In theory, it benefits consumers, in reality, it simply means the banks make a fractional amount more return on their loans. Trickle down is a myth. Same is true for negative interest rates, it impacts large depositor’s but will have a nominal impact on small accounts. But yes, apparently you can go lower than zero.

Negative Interest Rates Policy. It is an experimental fiscal policy that has only recently been tried. Historical analysis will be helpful here. The Swiss did it in the 1970’s, Sweden did it in 2009 & 2010, Denmark in 2012 and then the ECB did it in 2014. ECB is the European Central Bank. The Swiss did it to fight currency appreciation, inflation was high which is another word for depreciation, not in Switzerland but in neighboring countries. Multiple currencies in Europe led to many issues. Inflation in neighboring countries would lead to an influx of cash. That, in turn, meant one currency got stronger while another got weaker. Stable currencies and growing economies are always the primary goals.

When someone uses the term currency manipulation it always has negative connotations. It’s all about the big players and whether it is multinational corporations or a nation’s central bank it doesn’t matter to me. Sweden and Denmark used negative interest rates to stem what was termed “hot money flows” into their economy. It basically is a back door way of investing money and covers multiple bases, but it can be very destabilizing. Let’s say you are a euro holder and you like the Swedish economy and their incredible growth rate. You can invest in their economy almost risk-free simply by making large deposits in the banking system which then lends the funds internally. It has an additional benefit of if you think their currency will rise relative to yours it is an instant win if you are correct. Think about it, you get a nominal interest rate, say one-half percent but then the currency rate changes say 2 percent. You just made a 2 1/2 return with almost no risk.

One of Japan’s closest neighbor is China, if as is commonly suspected that when their currency is will be devalued the Japanese Yen will become a haven, actually it already is. Chinese investors, holders of the Yuan could actually make money simply by storing their capital in another currency. If there is a negative return it will give them pause and possibly force holders of the Yuan to seek the Dollar or the Euro or even physical stores of value like gold. All those things are bad for economic growth. All economies face similar problems to varying degrees. Inflation, deflation, employment, unemployment, GDP growth, regulation, development; no two economies are the same but some have stronger similarities than others. As Chinese investors invest abroad they flee their capital markets and need to put their cash somewhere. It conjures up images of elderly people stuffing cash in their mattresses, most people probably don’t know it is actually illegal to store cash in your safety deposit box.

Thank you, Ms. Streisand, for your valuable lesson. Negative Interest Rate Policy (NIRP) is an attempt to stimulate the economy by encouraging loans to businesses and individuals by dis-incentivizing holding assets that are not performing or in this case costing money to do nothing. It is an attempt to encourage economic activity on a micro as well as a macro level. As capital markets professional we are all aware of the idea of cash sitting on the sidelines waiting for a buying opportunity. This is a very direct attempt to force the banks to make loans and prevent imbalances from developing. Remember what flows in can flow out and can be quite destructive to an economy. We only have to look at the price of oil to see how destabilizing a negative influence can become.

I do not think the US economy is in danger of following this trend. I think that for a very fundamental reason, our economy and our currency are sound and very divested. Perfect? Never! But that is a fool’s quest. The closest comparison is the UK and the British Pound, also a global destination of money from around the globe. It creates very specific problems, for example, New York City and London real estate prices are obscene, but nothing is without a price. Our economy absorbs these monies and then funnels that money out to the greater economy. Central Bankers know that Dolly Levi was right you need to spread that money around and encourage young things (new businesses) to grow.

Robert J. Hardy
I was born in Camden, NJ, the oldest of eight and graduated from Villanova University with a BA in PSC/ENG (Political Science and English) with a pre-law concentration. Originally the plan was to go to law school but I had an opportunity to work on the trading floor at the Philadelphia Stock Exchange (NASDAQ-omx) for what is now Goldman Sachs. I worked for a boutique clearing firm and helped to build our office from the smallest to the largest clearing firm on the exchange. The more moving pieces the more I enjoy it. My background is primarily sell side and have hands-on experience in risk and compliance, KYC, AML, regulatory and client management. I’ve traveled extensively and am a passionate rugby player and fan. I enjoy contrasts and what they tell us about ourselves and others. I am a polished senior executive comfortable in any boardroom and yet I enjoy a good rugby match and getting banged around a little and meeting people I otherwise would have no contact with. I am actively seeking a new role and enjoy writing an article once a week or so to keep my skills sharp. My greatest hesitation is exposing my innermost thoughts to complete strangers, but quickly realized I had nothing to bring to the table without an honest dialogue. Once I opened that door and walked through it I realized I had far more to gain than lose.

5 COMMENTS

  1. This brings me back to my Canadian economics class in university. I liked the class because it was located at the bottom floor of my dorm. I could just roll out of bed and attend. I remember when in class we talked about what would happen when there were no taxes or interest. Based on the models as we understood them, everyone would get wealthier. But the moment interest was introduced, either positive or negative, the effects reduced everyone’s wealth. When taxes were introduced, everyone’s wealth drastically reduced.

    Conclusions from the discussion, reduce taxes for a healthier economy. Don’t touch interest.

      • My understanding is that each adjustment sends a signal to the market. The announcement sends a signal to trigger one set of behaviors while the implementation of the interest change sets another set of behaviors.

        Lower Interest -> spend more, borrow more, higher inflation.
        Higher Interest -> spend less, borrow less, lower inflation.

        Based on this, I’m wondering if negative interest rate would eventually yield to hyper inflation.

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