By Natasha and Ken Snow
Faculty Members, Accounting and Finance
Over the past two years, the European Central Bank, Japan and Switzerland have initiated negative interest rate fiscal policies in an attempt to stimulate the economy. Other countries, such as Canada, have been considering it as well. But what exactly are negative interest rates, how do they work and what does this policy mean for investors?
What Are Negative Interest Rates?
Most major economies are supported and governed by a single central bank. This central bank typically offers interest on any money deposited there by big national banks. If this interest rate is cut below zero, however, these banks would then be required to actually pay the central bank to hold their deposits.OK
The goal of this policy is to give national banks an added incentive to pump their money into the economy through increased lending and investing instead of hoarding it and generating interest.
But with economic conditions remaining weak or uncertain, it seems, so far, that banks are trying to recoup their losses in other ways. While many banks have passed on their extra costs to their corporate clients, some banks are testing the limits of lowering interest rates on personal savings accounts while simultaneously increasing banking fees. When this happens, the depositors get back less money than they put in and are effectively charged to keep these funds in their accounts.
All of this has brought out an interesting mixture of investor behavior. Not all of it, however, is going in the direction policymakers were anticipating.
The Fear Factor
A case in point: For some investors, safety seems to be trumping profit. This is particularly important for those who are looking down the road and preparing for retirement. These kinds of savers are in effect willing to accept negative interest rates as a kind of holding fee for their money.
One place where this has played out is in the government bonds market. In both Europe and Japan, buyers of those government bonds are essentially agreeing to incur a loss just to hold onto those assets. The Swiss central bank has also been having a hard time getting people to spend and invest more instead of stashing their cash.
The Movement of Investors Down the Risk Spectrum
As interest rates on standard savings accounts and “safe” investments (such as government bonds) drop to practically nothing or even come with a cost in order to get a decent return, investors will either have to take on more risk or seek out alternative investments. This is particularly important for retirees, pension funds and others who need positive cash flow.
One result is that equities have become a sort of “safe haven” — specifically the shares of so-called blue-chip corporations that operate on a global scale and have the resources to ride out the economic storm. In fact, in the U.S., where we have had a near zero interest rate for 8 years, there has been a staggering increase in the flow of cash into the stock market. The S&P 500 is up 215 percent since it bottomed out in March 2009.
Gold, Cryptocurrencies and Peer-to-Peer Lending
While investing in equities has become more prevalent, other investment options have been gaining traction. Gold, which has always had the status of a safe asset in difficult times, is a particularly attractive option for wealthier investors. The recent emergence of gold-based payment systems, such as BitGold, which allow account holders to buy, hold and sell gold bullion online, has made this asset class not only more attractive, but much more accessible.
There has also been the emergence and growing popularity of cryptocurrencies, such as Bitcoin, which is designed to circumvent national currencies. Finally, in a negative interest rate environment, some investors may be drawn to the potential high returns of peer-to-peer lending, a form of lending that bypasses the traditional banking system.
In short, negative interest rates have certainly changed the game plan held by many investors. Not only have the rules changed, but so have some of the goals.
About the Authors
Natasha Snow is an associate professor in the School of Business. She has a J.D. in law from the University of Alabama, an M.B.A. in business administration from Samford University and 18 graduate hours in accounting from DeVry University. Other academic credentials include a bachelor’s degree in English from Biysk State Pedagogical University in Biysk, Altai Krai, Russia.
Ken Snow is an assistant professor in the School of Business. He has an M.B.A. in contract management with 18 graduate hours in accounting from the Florida Institute of Technology and a B.S. in accounting from Athens State University.