There’s a line in Joseph Helger’s classic book, Catch-22…
‘He was going to live forever, or die in the attempt.’
The book is full of great lines like this.
Absurd sentences to describe the absurd wartime situation our protagonist John Yossarian finds himself in.
The phrase ‘catch 22’ is still in use today. It describes situations that make no sense, but few seem to realise it.
Like the crazy world of negative interest rates, we’re careering towards…
How low can interest rates go?
‘“They’re trying to kill me,” Yossarian told him calmly.
‘“No one’s trying to kill you,” Clevinger cried.
‘“Then why are they shooting at me?” Yossarian asked.
‘“They’re shooting at everyone,” Clevinger answered. “They’re trying to kill everyone.”
‘“And what difference does that make?”’
This scene could be the world’s central bankers right now.
No country is trying to one-up anyone else, they’re trying to one-up everyone else!
Despite a decade of economic growth, record low unemployment, good corporate profits and a record high stock market, central banks around the world are cutting rates to emergency levels.
The Reserve Bank of New Zealand (RBNZ) surprised the market last Wednesday with a 0.5% rate cut.
The governor of the RBNZ even suggested he was willing to go into the brave new world of negative interest rates if needed, too.
As did the RBA chief on Friday.
Central Banks in India and Thailand joined in the party with cuts of their own.
‘Everything is fine!’ they said.
And yet they’re all acting like the sky is caving in. Joseph Helger would’ve had a field day.
But here’s the thing…
In the process of trying to prop up the economy, they’re actually destroying the very foundations of our financial system.
Consider these bombshells…
The end of the ‘time value’ of money
When you borrow money, you steal from the future to give to the present.
You pay interest for this benefit. Like a payday loan. Now when you reduce interest rates you encourage more ‘stealing’ from the future.
That’s why in times of crisis, cutting interest rates is the go-to move.
It’s an effort to stimulate present demand to get the economy back on an even keel. To fast-forward spending plans.
But why would we need to do this now?
As we discussed above, the economy is actually travelling OK right now. These cuts are pre-emptive moves to counter a potential economic fall.
There’s been no market crash, no property crash and no dramatic increases in unemployment.
These are some weird times we’re in.
And by going into negative territory, we’re taking it one step further.
We’re actually changing the investment playing field by changing the ‘time value’ of money.
What’s that you ask?
It’s economics 101. The idea that you’d prefer something now rather than at a later time.
For example, if I gave you a choice of $1,000 now or in six months’ time, you’d say you’d have it now, right?
You’re not alone. We’re all geared to want instant gratification.
In this world of negative interest rates though, $1,000 in six months’ time is actually worth more than $1,000 today. Because you don’t have to pay the bank to store it.
Rather than earning interest, savers pay it!
This is unprecedented.
Make no mistake…this topsy-turvy situation turns a lot of rules of finance on its head.
And it’s already having real world effects…
Banks and savers feeling the negative heat
You might think low interest rates would be good for banks. And they can be.
But when they turn negative, the situation turns.
We’re seeing that in Switzerland today.
As reported in FT.com:
‘Record-low interest rates are already weighing on banks’ profits as they have been forced to lower borrowing charges and, in some cases, pay to store money at central banks, without a similar reduction in the rates they pay to savers.’
In an effort to claw back some profits, Swiss financial giants UBS and Julius Baer have decided to pass on these charges to richer savers for storing their funds.
Julius Baer CFO Diter Enkelmann said:
‘We go to the client to ask: why don’t you invest (in shares of funds)? Or if not, then we will charge you.’
Will savers now be happy to pay the banks interest? Or will they put it under the bed?
Perhaps funds will flow into an already bubbly stock market? It could lead to a mega bubble of crazy proportions.
Or perhaps it will lead to a never-ending property boom?
For instance, a Danish Bank just offered 20-year interest free mortgages!
‘“It’s never been cheaper to borrow,” Lise Nytoft Bergmann, chief analyst at Nordea’s home finance unit in Denmark, said in an email. “We expect this to contribute to driving home prices higher.”’
Maybe this will all be one last hurrah before ‘the Great Crash’?
All this ‘fun’ could all be coming to Australia soon.
What will you do? Where will you put your money?
[Editor’s note: I’m seriously interested in where you would invest your money if interest rates went negative. Write to email@example.com with the subject line ‘Negative Rates’ and I’ll publish the best responses using your initials.]
It’s an odd world we’re living in, that’s for sure.
A catch-22 situation almost!
Editor, Money Morning
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