Twisted logic of negative interest rates

Posted on September 9, 2016

Euro, Hong Kong dollar, U.S. dollar, Japanese yen, British pound and Chinese 100-yuan banknotes are seen in a picture illustration shot January 21, 2016. REUTERS/Jason Lee/Illustration/File Photo©Reuters

Business history, of a sort, was made this week. Sanofi, the French pharmaceutical company that makes blood thinner Plavix, and Henkel, the German consumer company that makes Persil detergent, between them sold more than €1.5bn of debt with an interest rate of minus 0.05 per cent. They are thought to be the first private businesses to charge bondholders for the privilege of lending them money.

We have grown used to this in the world of sovereign debt since the financial crisis, of course. About half of all eurozone government bonds, and most of that issued by Japan, now carry a negative interest rate, meaning the lender recoups less than the amount invested.

    There is a theory behind the seeming madness in all this. Low interest rates encourage companies to invest and consumers to spend now rather than later — a useful tool in a floundering economy. If the economies of Japan and the eurozone are stagnant, the thinking goes, it is because interest rates are not low enough. So long as inflation is under control, it is the duty of central banks to push rates lower still. The logical next step, when rates have fallen to zero and growth remains low, is to impose negative rates.

    But the implementation of negative rate policy has been thought to be limited by the fact that savers have an alternative: simply holding cash. Households may prefer to keep their notes under the mattress instead of spending — and the value of currency in circulation has risen to more than €3,000 per head in the eurozone, suggests that many have. But, while you can sleep fairly comfortably on €3,000, storing, say, €1bn is more difficult. Munich Re is reported to have explored the possibility of storing its cash pile in heavily guarded warehouses. The German reinsurance group knows better than anyone the likely cost of insuring such premises.

    But there are simply not enough notes to go around to substitute for holdings of debt. The volume of negative yielding bonds of the German government alone exceeds the value of all the euro notes in circulation.

    At any rate, this is not a theory that bears much scrutiny. It is not because interest rates are too high that eurozone consumption is sluggish but rather because expectations are so low. Fiscal austerity and the aftermath of the global crisis have dimmed the employment prospects of a generation of young Europeans. Low interest rates have as intended pushed up the prices of long-dated bonds and houses — but one unwelcome effect of this is to put buying a home beyond the reach of many and to render long-term saving more or less hopeless. To provide yourself with 70 per cent of gross your income for 25 years of retirement when real interest rates are zero requires setting aside 45 per cent of that gross income every year. Should you save more to try and make up the shortfall — or, since the goal of comfortable retirement is beyond reach anyway, should you save less?

    All told, the primary effect of monetary policy since 2008 has been to transfer wealth to those who already hold long-term assets — both real and financial — from those who now never will. This week’s debt sale reinforces this. Henkel and Sanofi are not borrowing at negative interest rates to invest in new productive facilities. Both companies have large cash piles, and the cash generated from their operations far exceeds their investment needs.

    Their borrowing deploys the strength of their balance sheets to make profits from their treasury operations — exemplifying the aphorism that people will lend you money so long as you can prove you do not need it. Henkel, secure in the knowledge that German consumers will always demand laundry products, benefits from the absurdity that its creditworthiness is far stronger than that of Deutsche Bank.

    It is these dysfunctional capital markets, rather than any excessively high interest rates, that are behind an investment shortfall across Europe. There are obvious requirements for investment in the eurozone — to provide power through cleaner energy plants, to improve roads and relieve overcrowding on trains, to build houses, to accommodate tens of thousands of recent refugees and above all to fund the new businesses that will promote innovation on the continent. But I have yet to hear a single business person say: “If only I could borrow at minus 0.05 per cent my company would be able to undertake some great projects.”

    Aversion on the part of governments to public debt and the additional costs associated with off-balance-sheet financing obstruct infrastructure funding. Short-termism pervades listed companies. European venture capital, never robust, has shifted focus from the funding of early-stage business to the buyout of established ones.

    As policymakers of my generation congratulate each other on the financial innovations they call unconventional monetary policies, we can only hope our children and grandchildren will think better of us than we deserve.

    The writer is an FT contributing editor

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