There’s never been a bet­ter time to bor­row

The Pak Banker - - OPINION - Matt O'Brien

ONCE upon a time, peo­ple ac­tu­ally got paid to lend money. It was some­thing that early hu­mans called "in­ter­est." The way it worked was that I would loan you money and you-get this-would prom­ise to pay me back more than that. Why would you do some­thing so crazy? Be­cause that was the only way to con­vince me to part with my money in the first place. Not only that, but there'd be plenty of other peo­ple who'd want me to lend to them in­stead, so you'd have to out­bid them too.

That, at least, is how it was for the first cou­ple mil­len­nia of fi­nan­cial his­tory. In other words, up un­til a few years ago. But now cen­tral banks are do­ing what didn't seem pos­si­ble be­fore: cut­ting in­ter­est rates into neg­a­tive ter­ri­tory. Switzer­land has gone the fur­thest with a neg­a­tive 0.75 per­cent rate; Den­mark isn't far be­hind at neg­a­tive 0.65 per­cent; Swe­den ac­tu­ally just cut its rate even deeper to neg­a­tive 0.5 per­cent; the eu­ro­zone is at nega- tive 0.3 per­cent and maybe more soon; and Ja­pan just joined the club last month with a neg­a­tive 0.1 per­cent rate. This has not only pushed short-term bor­row­ing costs below zero, but, in the case of Switzer­land and Ja­pan, even 10-year rates too. In all,over $7 tril­lion worth of debt has a neg­a­tive yield now.

Up is down, black is white, and peo­ple are pay­ing for the priv­i­lege to lend, not bor­row. It's about one step away from dogs and cats liv­ing to­gether-mass hys­te­ria. So why are cen­tral banks do­ing this now, and why would any­one ever buy a bond that pays a neg­a­tive rate? Well, they're cut­ting rates for the same rea­son they al­ways do: be­cause growth and in­fla­tion are both too low. Neg­a­tive rates should help that by not only low­er­ing bor­row­ing costs for house­holds and busi­nesses, but also by boost­ing ex­porters with a weaker cur­rency. Af­ter all, who wants to pay a Euro­pean bank to hold your money in euros when an Amer­i­can bank would pay you to hold it in dol­lars? No­body who can help it. And sell­ing your euros to buy dol­lars is just an­other way of say­ing that there's less de­mand for euros, so its price falls.

That brings us to the big­ger ques­tion, though: why on earth would any­one pay their bank to de­posit money in it? That's what was sup­posed to make neg­a­tive in­ter­est rates in­con­ceiv­able. Peo­ple would just start hold­ing their money in cash that didn't cost them any­thing in­stead of a bank ac­count that didright? Well, it turns out cash does not mean what you think it means. At least not for neg­a­tive in­ter­est rates that are only slightly so. As Paul Krug­man points out, keep­ing your money in cash isn't free as­sum­ing you don't just stuff it in your mat­tress. Safes cost money, and as long as neg­a­tive in­ter­est rates cost less, peo­ple will keep their money in banks. No­body knows where that is, but some­where around a neg­a­tive 2 per­cent rate seems right.

The only prob­lem with neg­a­tive in­ter­est rates is that our fi­nan­cial sys­tem wasn't built with them in mind as even a pos­si­bil­ity. Banks, you see, don't like to pass the full cost of neg­a­tive rates on to their de­pos­i­tors for fear of los­ing them, but do feel like they have to pass the full ben­e­fits of neg­a­tive rates on to their bor­row­ers for fear of los­ing them to a com­peti­tor. That means that their in­ter­est in­come-the dif­fer­ence be­tween what they pay to and charge peo­ple to bor­row-is squeezed even more than it al­ready was when rates ven­ture into neg­a­tive ter­ri­tory. How big a deal is that? Just take a look at the chart below: Ja­pan's fi­nan­cial stocks have fallen 25 per­cent in just the two weeks since they in­tro­duced neg­a­tive rates. Who could have known: it's tough to make money from lend­ing when you have to pay to lend.

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