Negative interest rates

Today for a change I’ll not bombard you with a string of data all neatly packaged in a lovely graph. No, this time it’s a Venn diagram illustrating what young and old find irritating.

The diagram is not based on a study, and neither does it refer to a consultancy specializing in statistics: it simply emerged from the mind of a Bloomberg journalist. On the left the subjects which annoy our elders (‘Kim Kardashian’ is of course an inspired choice), and on the right a series of subjects that young people hate (no WiFi: maybe I’m young after all?). In the middle, as you’d expect from a Venn diagram, the subject where both groups meet. This is a great way to present a pretty boring subject in a very accessible way. Because let’s be honest here, if a bunch of statisticians had done this, I’m almost certain that negative interest rates would definitely not have been in the top ten of major irritations. Probably not for seniors, but without doubt not among the young. It’s an oddity that you’ve probably read about, but it seems to me somewhat of an exaggeration to claim that it’s a live issue among many people, or that everyone is aware of the consequences.

However, the impact is actually far greater than people think. In my opinion, that has to do with the fact that the most visible portion of savings still enjoys positive interest rates. And if we’re talking of savings, many people think directly about the money they’ve set aside in an internet savings account. The fact that positive interest rates are still being applied there could well give you the impression that those negative rates are not much of an issue. But you’d be mistaken, of course, as for many people the largest portion of their savings is embedded in a pension fund or two. And, yeah let’s be honest, pensions are, well … yawn!

The interest rate is the return you receive on the money you save. So it’s not so hard to understand that you now need to save even harder for a decent pension, if the returns are lower in the run-up to retirement. If you save a 1000 euros a year for 40 years and only get 0% interest, after 40 years – yes, you got it – you’ll have precisely 40 thousand euros. If you had enjoyed interest of 4% on those savings over the same period, then the pot of gold at the end of the rainbow would be 98 thousand euros. So more than double. Enter the famous Einstein quote: “Compound interest is the eighth wonder of the world. He who understands it, earns it, he who doesn’t, pays it.” By breaching the zero percent threshold, we have basically destroyed one of the great wonders of the world. And by the way, it’s a load of nonsense that the ‘savings problem’ only arose when we breached the 0%: the decline of rates from 4% to 2% is of course also not without its consequences.

Countless books could be written about the possible solutions to low capital-market rates, so I’ll not bother entering that particular fray. Disinflation, central-bank buying sprees, regulators pushing financial institutions towards safety, imbalances in prosperity, too little growth: just pick your favorite theme. The second ‘graph’ I want to show you this week hits the nail well and truly on the head. On balance, negative rates simply mean that demand for bonds (read German government bonds) is outstripping supply. So if you want interest rates to rise again, you’ll have to look for the solution in one of two areas: either the supply of bonds needs to increase (Germany issues more debt and uses it to fund infrastructure projects, for instance), or demand needs to decrease. You might well ask yourself just how we could ever achieve the latter by strongly stimulating the economy: if we continue to save the same amount for our retirement, then demand for bonds will not be declining much any time soon. Aging – which involves the retired drawing on their savings and liquidating their pension funds – would be a more effective medium.

As an aside, the third arrow in this picture (negative policy rates by central banks) is a little confusing: I’m assuming that these should be positive rates. In that case, there is a credible and affordable alternative and demand for bonds would lessen.

But I doubt very much indeed that the ECB feels much like raising interest rates right now …


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