Negative Interest Rates? Really?

So let me get this straight: I borrow money from you…and YOU pay ME interest?   You give me money AND you give me interest?  Really?   Cool?

Or not.  These are definitely unusual times.   The number of Central Banks sporting ‘negative’ interest rates is growing.  First, in June of 2014, the ECB ‘pushed’ their ‘policy rate’ below zero.  Months later, Sweden’s central bank followed suit.  And then Switzerland…Denmark…Austria…Germany…and the Netherlands.   And then, in a surprise move, Japan’s central bank jumped into the fray.

Let me be clear on what a negative interest rate means.  In a nutshell, say you were to inclined to purchase a $100,000 German 2-year bond (known as a ‘Bund’).  Today’s rate on this bond is a negative 1/2 percent.  So, you would ‘pay’ Germany about $101,000 for the bond and in 2 years they would return to you $100,000.

Huh?   Yep.  You would lose money.  No doubt about it:  This is NOT part of a solid retirement plan.

Rest assured, negative interest rates are more rare than a viewing of Halley’s Comet.   Even during the ‘Great Depression’ interest rates remained positive.   During the 2008 crisis, a few bond yields did briefly fall below zero, but this was more transitory, not structural.   Conditions today seem different.

Negative interest rates on the reserves deposited at a Central Bank have one objective:  It’s a message the commercial banks – “Make more loans!   If you leave your money here, we’re going to charge you a ‘penalty.'”   Negative interest rates on government bonds are more about the investor’s perception of risk, their desire to make a risk-free investment, an inherent scarcity of government bond investments, and their belief that no viable alternatives where the risk/return relationship is palatable.

Very odd.   Said another way, there’s a lot of cash chasing an insufficient number of low risk or riskless investment opportunities.

Does this mean soon you will be able to borrower money from your local bank and they will pay you interest?   Probably not.  But wouldn’t that be cool?

Unusual times indeed.