Here is a thought experiment: You go to your local bank today with $100, and you open a one-year term-deposit for $100. One year passes, and your deposit is about to mature, so you head back to the bank. They warmly welcome you and tell you what a pleasure it was to do business with you. You open the envelope and find $99. At this stage, you are flummoxed about why the bank hasn't paid any interest on your deposit.
You should know that in some parts of the world this is not just a thought experiment, but a looming reality. Welcome to the world of negative interest rates! Central banks of some countries are charging commercial banks for deposits. This is an ongoing, curious, monetary policy experiment that they have embarked on to kick-start their stalled economic activity. This is the infamous "negative rates" about which we are increasingly hearing.
Here are some deposit rates: The Swedish Central Bank has an interest rate of negative 1.30 percent for deposits. In Denmark, it is negative 0.6 percent. The European Central Bank (equivalent of the Fed for the Euro area) is charging a rate of negative 0.40 percent. Switzerland charges negative 0.75 percent. On the other side of the Pacific, Japan has set its deposit rates at negative 0.10 percent.
This potentially affects every saver while encouraging the spenders, and it is precisely the thought process behind a policy like this. The central banks want more spending so that economic activity will increase.
There are many questions that need to be asked. Not all of them have a clean-cut answer, though.
First, with negative rates, why should any depositor leave money at the bank? After all, the proverbial mattress doesn't charge for storing money. This hasn't happened in earnest as banks in these countries have not reduced the consumer deposit rates down to negative rates. Also, corporations can't really do this because they will need a lot of storage space.
Second, how has this affected banks' profitability? Banks really can't intermediate well between the savers and spenders when the savers have no incentive to use the banks. There has been some erosion of bank profitability.
Finally, will the results of these quirky policies reach the shores of the U.S.? In an interconnected world, when the rest of the world is purposely being drowned in this forced liquidity, the international investor will look to invest in U.S. bonds, and in the process, drive the yields down. We saw a glimpse of the rate moving down in January. So, we can't preclude the possibility, however improbable it may seem at this moment. When the Federal Reserve (Fed) announced its 2016 stress test for the banks, the severely adverse stress included three-month treasury rates at negative 0.50 percent.
If rates go negative and if the Fed is forced to set the rates lower for a sustained period of time, there could come a time when the population could lose faith in the Fed. We have to remember that the greenback is a fiat currency and is only collateralized by the noble intentions of Chairwoman Yellen. Any loss of faith might drive us back to look at alternatives for money, and suddenly, that barbaric relic — gold — might look like a much better store of value and exchange.
Bank of England has also started thinking about negative rates and the repercussions of hoarding of money. Indeed, Andy Haldane, the chief economist at the Bank of England, has proposed looking at abolishing cash altogether in order to fully implement a negative rate policy. A cashless society? That is an interesting thought.
Now, that is a topic for another day and another blog post.
Kalyan Madhavan is executive vice president and group head of Members and Markets at the Federal Home Loan Bank of Dallas, where he oversees Treasury operations, Member Sales and Community Investment.