The weird world of negative interest rates

Published on (Wellington), 6 August 2019

When the smallish Skatbank, a direct bank based in Germany’s east, started charging its wealthy private depositors interest in November 2014, it made international headlines. It was the first German bank to do so, and negative interest rates were still regarded as a ridiculous aberration.

Fast-forward five years, and negative interest rates have become an entrenched feature of German banking. Whereas in 2014, private Skatbank customers only had to pay 0.25 percent interest on larger deposits, today they pay 0.4 percent. Business customers pay Skatbank 0.5 percent.

Dozens of banks across Germany are now making their clients pay for the privilege of keeping their money. Holding German bunds is not a good alternative, either. Last Friday, and for the first time in history, even 30-year German sovereign bonds traded at a yield of minus 0.006 percent; 10-year bonds are even deeper in the negative zone at 0.5 percent.

Given that German consumer prices are rising at an annual rate of 1.7 percent, savers and bondholders are effectively losing around 2 percent on their deposits per year. The combined effects of inflation and negative interest rates are like a tax on financial wealth.

These market circumstances are unpopular with the German public, who are traditionally strong savers. Still, the situation is likely to escalate over the coming months.

The Eurozone economy is slowing down, not least in Germany itself, creating more pressure on the European Central Bank (ECB) to loosen its monetary policy.

The appointment of Christine Lagarde to succeed ECB President Mario Draghi signals a willingness to engage in ultra-dovish monetary manoeuvres. Unlike Bundesbank President Jens Weidmann, who was a contender for the job, Lagarde is not known for her hawkish views.

All this means negative interest rates will become a more common feature for German depositors. So far, most banks kept zero interest rates for the first few hundred thousand Euros, and charged interest for amounts exceeding thresholds. Over the coming months, banks will likely start charging negative rates from the first Euro. Banking representatives have already started preparing the public for this development with carefully worded statements.

The social, economic and political consequences are hard to predict but to move a big economy like Germany towards widespread negative interest rates is without precedent. Yes, Japan used to have widespread negative interest rates, but typically against the background of low inflation or even deflation. In Germany, meanwhile, consumer prices are likely to increase further, leaving ordinary savers with a very real and inescapable hole in their wallets.

While some German savers will remain passive and watch their deposits slowly melt away from their bank accounts, others will try to save them. Holding cash might be the obvious response. Expect a surge in demand for deposit boxes and safes.

Beyond such pure preservation efforts, savers could be tempted to put their money in alternative investments. Equities, exchange traded funds, property and even gold are likely to see a surge if penal interest rates become the alternative.

Negative interest rates will also push up asset prices. It is already happening in German real estate, which for decades was a haven of stability and where nothing ever changed. Now, with cash seeking an escape from the banks, more money may flood the property market.

If interest rates are predominantly negative, markets will also struggle to clear out bad investments. It will certainly keep afloat companies, which should either disappear or be taken over. That may be good for zombie companies, but not in a Schumpeterian sense. Markets can no longer do their jobs as creative destructors.

The real danger in all this is political, though. Not that Germany will see bank runs because of customers withdrawing their savings. In the current climate, it should not be hard for banks to find capital if they need it. There is no imminent need for a big bailout (touch wood).

The political complication is that millions of German savers will feel robbed of their life’s achievements. For people who have saved for years to prop up their pensions, the thought of having their safety net eroded by negative interest rates and inflation is terrifying.

The right-wing populists are waiting in the wings to exploit this issue. The Alternative für Deutschland (AfD) was founded as a protest movement against the federal government’s policies in the euro crisis. The AfD will now claim that the negative interest regime is a Southern European conspiracy to rob German savers to benefit foreign ailing governments and banks.

The reality is, of course, more complicated. But that has never stopped populist politicians from making noise.

Despite Germany’s (and the rest of Europe) slide towards turmoil, there is little public discourse about it. Mainstream politicians are too afraid to even talk about it. Not surprising, considering no one has a clue how to get out of it.

With Trump’s mercurial trade policy, preparations for Boris Johnson’s no-deal Brexit, and mounting tensions around the Gulf, it would be a miracle if the global economy did not lose steam.
But since the ECB has no conventional ammunition left to deal with the next recession (which may have already started), Europe will soon find itself in a bizarre economic landscape where savings are actively punished across the board.

Unless you have a mortgage or you are the Minister of Finance, it is a world you would not want to inhabit. But for millions of Europeans, that may soon be reality.

We can only hope that even after the RBNZ’s next cut, New Zealanders will not contemplate going into the topsy-turvy world the Germans are about to enter.

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