PAYING TO PARK YOUR CASH
While it isn’t here yet, negative interest is gaining steam elsewhere and could be coming to a bank near you.
Picture this. You walk into a neighbourhood bank with the intention of opening a new account. You’re directed to a cubicle where a smiling assistant manager greets you and, after a few preliminaries, produces some papers for you to fill out.
“Oh, and by the way, you’re very fortunate to have come in this week,” she says as you pick up a pen. “We’re running a special — only half a per cent negative interest for the next six months.”
You drop the pen. What did she just say? Negative interest?
“Yes, that’s right. We’ll only be charging you half a point to keep your money safe for you,” she says.
Wait a second. You thought banks were supposed to pay you interest on your money, not charge you for depositing your money with them. Guess what? Times are changing.
The world of negative interest rates is expanding at a faster pace than anyone thought possible a year ago. We haven’t seen them yet in North America, but they could be arriving soon if the economy doesn’t pick up steam.
Already, Bank of Canada governor Stephen Poloz has mused about them publicly. In a speech to Toronto’s Empire Club in December, he said that while the bank doesn’t envisage going negative in the near future, the option is on the table if needed.
“The bank is now confident that Canadian financial markets could . . . function in a negative interest rate environment,” he said.
Federal Reserve board chair Janet Yellen has also publicly discussed the idea, saying negative rates could be “on the table” if conditions warranted.
Negative rates here would only happen if our economy stalled or turned negative for what appeared to be an extended period. That’s not likely at the moment, but could become a real possibility under a number of circumstances, including a new downward plunge in oil prices or the launching of an international trade war if Donald Trump is elected U.S. president.
In Europe, negative rates are already a reality at the central bank level and in several countries with strong economies. The European Central Bank (ECB) introduced them in June 2014, when it started to charge member institutions for placing money with it. The idea was to encourage the banks to lend rather than sit on cash, thereby stimulating the economy and giving a boost to inflation. So far, the effect has been minimal, so the ECB cut the rate again in March to -0.4 per cent.
In early 2015, Switzerland introduced negative rates in an effort to slow down the influx of foreign cash into the country, which was driving up the value of the Swiss franc. Other countries such as Japan, Denmark and Sweden have followed suit.
The impact of negative rates in Europe has spread to the bond market. Earlier this month, the yields on 10-year German bonds slipped briefly into negative territory and have been hovering around the zero level since. In a recent report, Bloomberg estimated that, as of the end of April, about $8trillion worth of global bonds were in negative territory.
Think about that. All those people will be getting less money back when the bonds mature than they originally invested. So why do they do it? Because the bonds are considered to be safe and in a world mired in slow economic growth and a lack of decisive leadership, preserving capital becomes the main priority.
So far, most commercial banks in Europe, except a few in Switzerland, are resisting passing on negative rates to their clients, recognizing it would be deeply unpopular. But if the situation worsens, financial reality may leave them no option.
To date, the effect of negative rates has been felt mainly at the lofty levels of central banks and bond trading desks. But if the situation continues to evolve, all of us could be on the firing line.
Paying banks interest on deposit accounts could be just the start. GIC rates could fall to zero or below. Money market funds would no longer be able to maintain their fixed $10 peg.
Pension plans, already under stress from low rates, would struggle to maintain solvency.
Mortgage rates could rise, which has happened in Switzerland where spreads on long-term mortgage loans have more than doubled.
This is not a scenario we want to see here but, as our own central bankers have warned, it could be coming.
Fingers crossed that it doesn’t. Gordon Pape is editor and publisher of the Internet Wealth Builder and Income Investor newsletters. His website is BuildingWealth.ca.