Negative Interest Rates: Too Good to Be True?

By Steven Van Solkema– WBI Chief Investment Officer

We know how the saying goes; sometimes, things are “too good to be true.” Is this the case with negative interest rates? WBI CEO Don Schreiber recently said negative interest rates look “like an absolute disaster from a financial system standpoint.” That’s because when a central bank targets interest rates with a negative value, lower than zero percent, this can be a strong signal of recession. 

Let’s put this into perspective, say a borrower takes out a $10,000 loan at an annualized 3% interest rate, at the end of the year the borrower would have to pay back the $10,000 plus $300 in interest. With negative interest rates, the borrower would take out a $10,000 loan at an annualized -3% interest rate, meaning the bank pays the borrower $300 after a year. We’ve seen this happen before, once during the Eurozone crisis and again during the 2008 subprime mortgage crisis. In both of these instances, the interest rates were brought down to near zero.

This sounds ideal for the consumer, but what is in it for the lenders? This is an incentive for banks to lend money more freely and for individuals to have the ability to invest and spend their money. In some senses, upholding negative interest rates can be the final effort to boost the economy and spur growth. If interest rates are low, consumers may likely opt to borrow or take out larger loans to aid in purchases, which leads to increased consumer spending. 

When the markets look grim, investors don’t want to take the risk of losing their capital. The banks want to entice the borrowers to spend their cash as opposed to holding onto it. Central banks may charge a fee to commercial banks for individuals who opt to hold onto their money and make deposits. Banks would prefer not to be charged a fee so they desire lending at a negative interest rate over paying a fee to hold cash. 

Within the latest episode of Bull|Bear Radio, WBI CEO Don Schreiber, Jr. and I discussed a Danish bank that recently implemented this policy. They’re willing to give investors a 30-year mortgage at a negative interest rate. It’s hard to believe that a bank would pay the consumer to take their money.

All in all, negative interest rates are an act of pure desperation. Negative interest rates harvest the potential to weaken a nation’s currency, which can bolster exports and trading. The bottom line is, negative interest rates increase inflation and bolster consumer spending. While much of this sounds good, it’s been difficult for participants to quantify the effects of implementing negative interest rates. If commercial banks charge a fee for customers to keep their cash in the bank, the customer may likely withdraw their cash. If the banks absorbed the cost, profit could be severely cut into. This will do the opposite of what negative interest rates were created to do, allow the free flow of monetary exchanges between banks and the consumers.  

It’s similar in the bond market. When bond rates are negative, the creditor pays the issuer the additional interest with the understanding that they will receive the principal at the end of the term.

Let’s put this into perspective, say a borrower takes out a $10,000 loan at an annualized 3% interest rate, at the end of the year the borrower would have to pay back the $10,000 plus $300 in interest. With negative interest rates, the borrower would take out a $10,000 loan at an annualized -3% interest rate, meaning the bank pays the borrower $300 after a year. We’ve seen this happen before, once during the Eurozone crisis and again during the 2008 subprime mortgage crisis. In both of these instances, the interest rates were brought down to near zero.

This sounds ideal for the consumer, but what is in it for the lenders? This is an incentive for banks to lend money more freely and for individuals to have the ability to invest and spend their money. In some senses, upholding negative interest rates can be the final effort to boost the economy and spur growth. If interest rates are low, consumers may likely opt to borrow or take out larger loans to aid in purchases, which leads to increased consumer spending. 

When the markets look grim, investors don’t want to take the risk of losing their capital. The banks want to entice the borrowers to spend their cash as opposed to holding onto it. Central banks may charge a fee to commercial banks for individuals who opt to hold onto their money and make deposits. Banks would prefer not to be charged a fee so they desire to lend at a negative interest rate overpaying a fee to hold cash. 

Within the latest episode of Bull|Bear Radio, WBI CEO Don Schreiber, Jr. and I discussed a Danish bank that recently implemented this policy. They’re willing to give investors a 30-year mortgage at a negative interest rate. It’s hard to believe that a bank would pay the consumer to take their money.

 All in all, negative interest rates are an act of pure desperation. Negative interest rates harvest the potential to weaken a nation’s currency, which can bolster exports and trading. The bottom line is, negative interest rates increase inflation and bolster consumer spending. While much of this sounds good, it’s been difficult for participants to quantify the effects of implementing negative interest rates. If commercial banks charge a fee for customers to keep their cash in the bank, the customer may likely withdraw their cash. If the banks absorbed the cost, profit could be severely cut into. This will do the opposite of what negative interest rates were created to do, allow the free flow of monetary exchanges between banks and the consumers.  

Important Information

Past performance does not guarantee future results. The views presented are those of Steven Van Solkema and should not be construed as investment advice. Steven Van Solkema or clients of WBI may own stock/sectors discussed in this article. All economic and performance information is historical and not indicative of future results. This is not an offer to buy or sell any security.No security or strategy, including those referred to directly or indirectly in this document, is suitable for all accounts or profitable all of the time and there is always the possibility of loss. Moreover, you should not assume that any discussion or information provided here serves as the receipt of, or as a substitute for, personalized investment advice from WBI or from any other investment professional. To the extent that you have any questions regarding the applicability of any specific issue discussed to your individual situation, please consult with WBI or the professional advisor of your choosing. This information is compiled from sources believed to be reliable, accuracy cannot be guaranteed. Information pertaining to WBI’s advisory operations, services, and fees is set forth in WBI’s disclosure statement in Part 2A of Form ADV, a copy of which is available upon request.

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