Getting Used to Sub - Zero

The Tokyo based safe manufacturer Elko, has reported that shipments of home safes have doubled since last fall.  The German insurer Munich Re has stashed some 10 million euros into its own cash vaults.  There also seems to be a recent appeal of hard assets like gold and silver.  These are just a few examples how individuals and companies are squirreling cash away.  But why?

One reason is the creeping imposition of negative interest rates.  This could make it more rewarding to bypass banks and using your own safe or vault is more secure than putting the money under your mattress. 

This is the new world of upside down world of modern monetary policy.  Borrowers are rewarded and savers are penalized.  Low rates are used to fund massive government deficits as politicians spend with abandon.  Now almost 500 million people in a quarter of the global economy live in countries that have interest rates below zero.  This new paradigm was unimaginable before the 2008 crash and no major economy considered it until two years ago, when the European Central Bank started the experiment.  They are actually charging institutions to deposit money with the central bankers. 

The overall goal is to create more inflation as more money gets out in the economy.  Inflation is currently running around 1% for developed markets, which is half of the 2% that authorities view as necessary for price stability.  The overall aim would be to goad banks into looking in other places to put their cash, such as lending to companies and consumers, who could benefit from the lower interest rates.  Also, in some countries, there is a hope that investors will put their money outside of their home country, thus causing the home currency to fall, which will make exports more attractive. 

The policy has risks.  Bank profits can get squeezed, money markets can freeze up, and consumers can end up with a bulging mattress full of cash to avoid paying a bank to keep their money there.  This could implode and make inflation even weaker.

Barry Eichengreen, and economist at University of California-Berkley quotes, “I’m skeptical about the efficacy of negative interest rates.  They increase the cost of doing business for the banks, which find it hard to pass on those costs to borrowers, given the weakness of the economy and hence of loan demand.  Weaker financial institution balance sheets are not ideal from the standpoint of jump starting growth.” 

Weaker banks are what we are beginning to see.  In 2015 Deutsche Bank had its first loss since 2008.  Analysts at Goldman Sachs believe that banks heavily reliant on deposits will see an earnings per share drop of at least 10% for each cut of 10 basis points.  Another issue that is brought out by UBS, is that loan demand is lacking no matter how affordable the loan rate is.  Sound businesses tend to not borrow if they are concerned with the direction of the economy.

This leads to the worry that central bankers are really clueless at this point in time.  Everything they are doing is a vain attempt to stimulate economic growth.  The fear in the back smoke covered rooms is that they have no control and that this is the new normal.  Already over $8 trillion of bonds now have rates below 0%.  Japan paid investors to buy 10-year debt this year for the first time.  Some companies like Royal Dutch Shell and Siemens have seen their yields drop into negative territory. 

The trend is to go even more negative.  JP Morgan expects we could see rates as low as -4.5% in Europe and -3.45% in Japan before the end of the year. 

Central bankers will have to reverse this policy if banks pass on the cost of the negative rate to the consumer, who in turn pull out their money out of the banks.  This could return us to the bank runs of the Great Depression.  A survey of 13,000 customers of ING found that more than ¾ of depositors would remove their funds if they had negative rates imposed on their savings.   Of course as we move toward a more cashless society, this increases the ability of the central bank to run a negative rate policy. 

Ultimately, I think this will end up being counterproductive.  Economics can be boiled down into four words, “People Respond to Incentives.”  If you take away the interest one has in savings at their local CU and imposes costs just to have the money there, you take away the incentive to save.