I want you to STOP and start to imagine a world where the banks pay you to borrow money. Yes, you read that correctly. But I’ll say it again just to let it sink in.
A world where the banks pay you to borrow money
No, this isn’t some science fiction novel, it exists in many parts of the world and this could happen in the UK.
Among the many weird and not-so-wonderful monetary policy innovations that the 2008 financial crisis helped usher into the public realm, fewer are stranger than the idea of negative interest rates.
Interest rates have already gone negative in Japan and in many parts of Europe
But now, as the global lockdown crisis rumbles on, the possibility of negative interest rates in the UK and the US is growing closer by the day. Donald Trump has been calling for this to happen since March.
So how does it work, and what would it mean for investors?
Imagine getting paid to borrow money
In many parts of the market, lenders are already being charged to lend money to governments, as we’ve seen with negative bond yields.
However, when we talk about negative interest rates in this context, we’re talking about the central bank deliberately setting its key rate below zero.
Japan, the eurozone, Switzerland and Denmark already have negative rates. Sweden had them for five years but ended the policy at the end of last year.
So what is a negative interest rate?
It’s exactly what it suggests: you get paid to borrow money and you get charged to lend money. So if you took out a 25-year mortgage with a negative interest rate, then at the end of the 25 years, you’d repay less than you’d originally borrowed.
Why do central banks turn rates negative?
Simply to boost the economy during times of economic crisis. The point of negative interest rates is exactly the same as the point of ultra-low interest rates: they are designed to persuade those with capital to take more risk with their money in the hope of earning a return.
In other words, you’re essentially forcing people to speculate, because otherwise their money will be eroded over time due to inflation.
There’s one obvious problem with negative rates
If I start to charge you a significant amount for holding your money in a bank account, then you could always just pull it all out and stick it in cash under the mattress.
But the skilled economists have a solution for this. Governments could take the hit for shielding everyday depositors from negative rates. And at the larger scale, to prevent institutions from sticking banknotes in their safes, you introduce lots of new regulations.
Phasing out large-denomination banknotes should
There are so many problems with negative interest rates that it’s hard to know where to start. It’s terrible for the banking sector, given that it’s hard to have a healthy economy without a healthy banking sector.
It’s clear that Banks would be more interested in buying other assets, corporate bonds, property and perhaps even equities.
The fact that negative rates are coming up again is just yet more evidence to me that policymakers are past the point of caring.
They will do whatever they feel is within their power to ignite inflation and keep the show on the road.
But when negative loans arrive, my advice is to take advantage and grab as many as the banks will let you.
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