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Negative Interest Rates for Dummies

My reaction to the thought of negative interest rates is that before buying a bond with negative interest rates, I would just keep the money in cash. So I’ve never had any interest in this, but I see that President Trump has advocated going to negative interest rates here in the US. The Fed has been resistant to this and doesn’t appear to be jumping on board.

One thing that I have not understood is -

Does the negative interest rate bond have a negative coupon rate? Or is the purchase price just being raised (thru Fed buying) to the point that the positive coupon rate is insufficient to offset the Premium?

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Re: Negative Interest Rates for Dummies


@PN wrote:

My reaction to the thought of negative interest rates is that before buying a bond with negative interest rates, I would just keep the money in cash. So I’ve never had any interest in this, but I see that President Trump has advocated going to negative interest rates here in the US. The Fed has been resistant to this and doesn’t appear to be jumping on board.

One thing that I have not understood is -

Does the negative interest rate bond have a negative coupon rate? Or is the purchase price just being raised (thru Fed buying) to the point that the positive coupon rate is insufficient to offset the Premium?


Not sure about the precise workings of longer bonds.  But short term T Bills have already "traded through" zero on several occasions.  They could also have a negative coupon or be sold at a premium to be redeemed at or below par or something.

But the idea of getting paid to take out a mortgage seems like a mirage, as you would still need to amortize the loan (pay off the principal).

But my concern about negative interest rates is that there is no real world evidence that they produce any desired results, only the elegant math and beautiful theory of PhDs like Ken Rogoff who have little contact with the real world.

Negative rates have been a trap that has deeply harmed the economies of Japan and the EU.  And they destroy the profitability and incentives of the banking system, also removing the link to transmit central bank policy to the real economy through the multiplier effect and such.

But the main problem to me is that in their attempt to send the time value of money to the trash heap, they are trying to invert reality in ways humans won't obey.  And the time value of money is the basis for all real world economics and valuations.

Their basic theory is that by taxing savings (charging interest to save) people will spend like mad before their purchasing power declines, increasing aggregate demand and fixing the economy.  But people don't do that and they won't do that.  They save even more and become even more cautious, which causes the velocity of money to crash, dampening the animal spirits and risk taking that drive economic growth instead of strengthening it.     

This is the kind of stupid that only comes from really brilliant people with very high IQ's, people who are almost functionally illiterate, and diehard debt lovers like real estate guys.  It. Just. Doesn't. Work.

Despite the supposed "reassurances" from a lot of talking heads that the Fed isn't currently considering negative rates so everyone should relax, I think it is a fundamental overhang unless and until we get a miracle vaccine and a big strong bounce back in the economy reasonably soon. 

If we don't have such a swift and happy ending with the virus, I think liquidity problems likely turn into solvency problems and the banks take a turn for the worse.  The fear of negative interest rates in such a scenario as a last ditch attempt at a solution is what scares me to death.  I think it might lock us into a long term depression.  

If the Fed would now declare that negative interest rates are a bad idea and they will not consider them under any circumstances, I think the worst case scenario for the banks and potential economic disaster is taken off the table.

I think Powell probably gets it, but the career PhDs at the Fed and Trump would go ballistic if he made such an announcement.  So there we are.  A union of geniuses and dunces likely preventing him from doing the smart thing.  But as the saying goes, common sense is not so common.

 

“The purpose of studying economics is not to acquire a set of ready-made answers to economic questions, but to learn how to avoid being deceived by economists.”
— Joan Robinson 

 

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Re: Negative Interest Rates for Dummies

The coupon rate may be positive or zero. Any bond can be made to have negative rate if the purchase price is high enough. Negative rates are creations of central bank policies. Only institutions play in that market. Many deposit protections that apply to retail investors don't apply to institutional investors and if institutional treasurers are handling millions and billions, they are stuck playing in whatever rate environment exists.

In ancient times, an example of negative interest rate was kings' annuity. Rich could deposit money with kings' treasury [voluntarily or involuntarily] and basically get their money back in installments. It was safer than keeping lots of money under the mattress. But the risk was that the king wasted money on wars or grandiose monuments or the king was overthrown by another king.

YBB
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Re: Negative Interest Rates for Dummies


@yogibearbull wrote:

The coupon rate may be positive or zero. Any bond can be made to have negative rate if the purchase price is high enough. Negative rates are creations of central bank policies. Only institutions play in that market. Many deposit protections that apply to retail investors don't apply to institutional investors and if institutional treasurers are handling millions and billions, they are stuck playing in whatever rate environment exists.

In ancient times, an example of negative interest rate was kings' annuity. Rich could deposit money with kings' treasury [voluntarily or involuntarily] and basically get their money back in installments. It was safer than keeping lots of money under the mattress. But the risk was that the king wasted money on wars or grandiose monuments or the king was overthrown by another king.


Thanks yogi, that's what I suspected but was not sure of. A negative coupon rate makes no sense.

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Re: Negative Interest Rates for Dummies

Large financial institutions - banks, insurance companies, pension plans, etc. in Europe are stuck with these negative interest rate bonds.  They are required to hold a (high) percentage of their future liabilities in safe securities (in practice, that means Government bonds).  It does lead to interesting situations.  In Switzerland, depositors who held more than about a couple of million dollars equivalent in the bank had to pay the bank to hold their money, and in Denmark at least one bank was offering a negative rate mortgage loan. I'm guessing it was better for the bank to lend money to homeowners at -0.1% than to the Central Bank at -0.2%.  

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Re: Negative Interest Rates for Dummies

Even shorter term than bonds, the other part of this is the Fed Funds rate which directly effects what investors get paid as an overnight rate in MMFs, savings accounts, etc. Investopedia has some articles on this, and I started reading. This area seems complicated and you’ve got to wonder – When bad things happen you want to restore confidence to the financial system and the markets and what I’m reading here does not inspire confidence.

Excerpts on how it works -

'With negative interest rates, cash deposited at a bank yields a storage charge, rather than the opportunity to earn interest income. By charging European banks to store their reserves at the central bank, the policyholders hope to encourage banks to lend more.'

'In theory, banks would rather lend money to borrowers and earn at least some interest as opposed to being charged to hold their money at a central bank. Additionally, negative rates charged by a central bank may carry over to deposit accounts and loans. This means that deposit holders would also be charged for parking their money at their local bank while some borrowers enjoy the privilege of actually earning money by taking out a loan.'

https://www.investopedia.com/articles/investing/070915/how-negative-interest-rates-work.asp

https://www.investopedia.com/terms/n/negative-interest-rate-policy-nirp.asp

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Re: Negative Interest Rates for Dummies

This is the first time I’ve read up on Negative Interest Rates and I did not intend for any of this to be political. In reading how this works (my last post), it seems to be the equivalent of a tax on banks and investors who hold cash deposits as an incentive to get them to do something else. So holding cash with a Zero Interest Rate Policy (ZIRP) means you make no money and are just losing in real terms whatever the inflation rate is. The Negative Interest Rate Policy (NIRP) takes it a step further and may deduct money from your account for cash deposits.

I would think that this would have a negative effect on banks and other financial institutions and I’m wondering if this could explain some of the underperformance in OAKIX and DODFX, which are over weighted in Financials in some of these countries where Negative Interest rates have been applied.

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Re: Negative Interest Rates for Dummies

Negative interest rates would have 0 effect on intelligent investors who would simply eliminate excess savings subject to the negative rate tax. E.g.:

1. Replace dividend stocks that generate excess Income with growth stocks that don’t pay dividends, e,g, AMZN, NFLX, SPQI.

2. Convert TIRA Assets to Roth which has 3 Advantages: lower taxable RMDs that generate excess income, deplete excess savings buy using them for tax payments for The conversions which will build up Non taxable assets in Roth not subject to the negative tax penalty That can be withdrawn tax free. 

An investor could easily set up a program to funnel just enough money from investments to a bank account to pay Periodic expenses and taxes without being charged a negative rate and make additional payments from a TIRA or Roth Not subject to the negative tax.

One of the prominent reasons why negative interest rates wouldn’t increase US spending is that our consumers have a very low rate of savings,  7.6% in 2019,  compared to Japan where savings rate was 17%, down from 29% before government increased the Vat tax by 2% last year. Lower US savings rate accounts for higher consumer spending which is 70% of GDP, whereas consumer spending is only 60% of Japanese GDP.

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