The Non-Weirdness of Negative Interest Rates

Negative rates are showing up everywhere, seemingly turning on their heads traditional notions of lending and borrowing. Negative yields just don’t seem to make any sense. A lender is supposed to get paid to part with capital, while a borrower is supposed to pay to use that cash for some purpose. It seems crazy that anyone  would voluntarily part with their money, only to end up with less of it.

But what if negative rates are totally normal?

Here’s a thought experiment: Imagine, for a moment, a time before the existence of a financial system. Rather than people accumulating wealth in pieces of paper (cash, bonds, stocks, etc.), the main way to build up wealth is to buy lots of physical things. Mansions, art, stores of grain, and so on. It should be obvious that this kind of wealth costs money to maintain. It degrades. You have to pay security guards. It can all go up in smoke in a fire. You can keep your wealth in physical things, but you’ll constantly pay a price for that—a negative interest rate, if you will.

Of course, all this exists today. If you want to hold gold and watches and sentimental things at a bank, you pay to rent a safe deposit box. If you want to hold oil or grain to use it or sell it next year, you can pay for storage in a tank or some other facility. And if there’s a surge in the supply of oil or a bumper crop of grain, and storage capacity is scarce, then you can expect to pay even more for warehousing capacity. If you want to hold your wealth in land, then you pay in insurance and security and property taxes.

But this is money we’re talking about! Why are we even talking about a storage fee? We all know that money in the modern era is just an entry in some digital ledger on the servers of a bank. Why should that cost anyone anything?

Well, it’s important to remember that money in the bank isn’t really something you have. It’s something that you are owed. When you log into your bank and see that you have $10,000 in your savings account, what that means is that your bank owes you $10,000.

And where does the bank get the money to pay you? From the entities that owe the bank money. Maybe the bank holds government bonds (in which case, the state owes it money) or it holds its money in loans to households and businesses (in which case, the private sector owes it money). You get the idea.

In other words, to store money at a bank requires the existence of some other borrower who will pay the bank.  As such, just as you’ll pay more to store grain when grain is abundant and warehouse space is scarce, you have to pay more to hold money when savings are abundant but demand for borrowing is scarce.

This is the world we have today. Thanks to ever-increasing wealth concentration and meager growth across the developed world, you have some people sitting on incredible piles of cash and a shortage of people with robust opportunities to borrow and use that cash.

There’s a reason Europe is ground zero for the explosion in negative rates. Growth has been mediocre seemingly forever, there is still tons of wealth, and beyond that, there's a relative shortage of stable institutions in which to park money.

Think about Switzerland where, like Germany, the entire yield curve is negative—all the way out to 50 year bonds. It’s one of the most stable banking centers that has ever existed, and it's surrounded by a sea of people who have just been involved in scares relating to frail banks and risky government bonds. Naturally, if you're rich and in Europe, you’d like to hold your money at UBS. And since UBS doesn’t have unlimited capacity to pay you interest on your holdings, well, you’ve got to pay UBS for the privilege of holding your money there. Sorry about that. But then, what other choice do you have?

Beyond the imbalance of abundant savings and meager demand for capital, the concept of paying a fee just to maintain paper wealth shouldn’t be that weird. The wealth management industry is gigantic precisely because it’s not trivial to hold onto wealth and get access it at some point in the future.

Consider: Why is it totally normal to pay a “2 and 20”—that is, 2% a year and 20% of profits—to some portfolio manager for the service of hedging your wealth against fluctuations in the market and the economy, but it’s bizarre to pay 0.1% to the German government to hold a bond that historically has done a great job of hedging your wealth against fluctuations in the market and the economy? Even when rates were positive around the world, there wasn’t a free lunch for the service of holding your wealth over time. People have always paid the pros a lot of money.

If negative interest rates still seem odd to you, then it might be helpful to just turn the question around. Ask yourself why you think that at a time of limited growth opportunities in Europe, savers are entitled to get paid for their wealth in Switzerland or Germany. Why is that something worthy of remuneration?

Even if it’s totally natural, one can still sympathize with your normal German saver, looking for a safe and tidy return, who doesn’t want to have to choose between holding some negative yielding bond on the one hand or investing in a crazy growth stock on the other hand.

There are things we could do. Not all of them are necessarily appealing: Regulators could get sloppy and encourage banks to lend money freely to people with bad credit scores in order to help them buy homes, cars, and boats. That lending would allow us to build all kinds of AAA-rated securities that paid juicy yields. German banks loaded up on that stuff in the early 2000s—but the end result turned out to be not so great.

Another possibility for German savers is that the government spends more money, invigorating growth throughout Europe, thus enabling more opportunities for the productive lending of capital. Politically, German savers may not want to pay for that. But then, they’re paying already.

One thing that does seem clear is that while central bankers, who are now embarking on yet another global easing round, may be able to keep growth alive, they haven’t really figured out how to change the overall rate trajectory. So some new policy prescription probably needs to be tried.

In the meantime, there’s lots of money out there and a limited capacity to store it all. So increasingly, savers are going to have to pay for money storage services. And although it’s not much consolation, we can at least remember that whether it’s fees for oil tanks, safe deposit boxes, security guards, insurance, or wealth managers, there's nothing unnatural about being forced to pay to preserve your wealth.

©2019 Bloomberg L.P.