Negative interest rates turn the world upside down. Should we expect negative salaries down the line as well and is this the end of the world as we know it? And how long can we expect it to last?
Siesta Homes uses Nykredit as a preferred partner in banking. This article has been brought to you by Sune Worm Mortensen, Director, Nykredit for our blog readers.
Imagine a world where you are paid to consume and you pay to work. Each month your employer sends you an invoice whilst the local supermarket credits you for last month’s shopping: the more items that ended up in your basket, the bigger the compensation.
This would be a world gone awry or a logic right out of Alice in Wonderland. It is also the reality of what goes on in the mundane world of loans and interest rates.
Hitherto a hypothetical abstraction, negative interest rates are here among us. Depending on the specific loan, its terms and duration, you now get paid to take up a loan whilst paying to offer it. So in theory, you can build a fortune merely by taking on bigger and bigger loans so long as you stack the money at home and refrain from lending it.
Supply and demand
It all seems to defy the logics of economics and everything you ever learned in school. In fact it is just a matter of supply and demand.
When demand for money exceeds supply, meaning there are more requests for loans than lenders willing to provide them, interest rates soar. Should the balance reverse, rates will fall.
Negative interest rates are the result of supply exceeding demand and it is the work of central banks flooding the markets with money to drive down the cost of borrowing and spur economic activity. But the phenomenon also has a demographic component: the baby boomer generation is now retiring with healthy savings, shifted from stocks to bonds in order to reduce their overall portfolio risk. As a result, there are now more lenders than borrowers and more money offered than asked for, and lenders therefore compete with ever lower rates for someone to take their money.
For years economists have been referring to the zero lower bound as a logical floor for how low interest rates could go. When you are no longer paid to lend but have to pay for others to take your money, lending activity will cease, the reasoning went.
Where’s the floor?
But refraining from lending means keeping your money in cash, which is not only inconvenient but also either costly or risky. Stacking money under the bed puts you at risk of theft and if your house is involved in a fire, you lose not only your house but your savings as well. Renting a bank vault could be an option but try paying your phone or utilities bills in cash, not to speak of making a down payment on a house, and you realise that cash is not at all as liquid as you might have thought.
So interest rates might well be negative, since the cost of keeping money in cash is not zero either. At some point holding cash will be more attractive than paying others to borrow it, so logically there is a floor for how low we can go. But that floor does not start at zero.
What’s in it for you?
As a house owner and mortgage holder, low or negative interest rates give you unique refinancing opportunities, and if you are taking up a new loan, you can opt for a fixed-rate mortgage and extend the current low rates many years into the future. But a floating rate mortgage might be not be a bad pick either, as low rates are expected to stay with us for a long time to come. At some point central banks will stop pumping money into their markets but baby boomers, thanks to longevity and healthier living, will stay in the game for many more years, hoping that someone, just someone, should be interested in holding their money, rates or no rates.