Generally speaking, 2019 has been a turbulent year for the markets. The market sentiment is overwhelmingly cautious due to uncertainty fueled by trade wars and political turmoil. Those factors aside, the United States economy is more robust than it has ever been and seems to be firing on all cylinders.
Much of the general population still looks to the Federal Reserve as the litmus test for the general health of the economy, and make many of their larger financial decisions (like whether to buy a new house, car or another major purchase) around that metric. And although the Federal Reserve has said that they will keep interest rates where they are for the short term, there have been whispers that they might dip into a fairly new and controversial practice, negative interest rates. Let’s talk about where that idea came from, current applications around the world, and whether it is realistic to think they can be used here in the states.
Original Conception of Negative Interest Rates
Let’s start with a basic understanding of what they are and what the implications would be of a negative interest rate scenario. Basically, this is an environment where cash deposits to a bank would incur storage fees to keep money in a savings account, rather than accumulating interest income. This fiscal tool is usually used in deflationary environments, or when banks and the general public is more inclined to stockpile cash, rather than spend or invest it. There are two ways that an interest rate can be considered negative. The first is if inflation exceeds the nominal interest rate, the other is if the central bank adopts a desperate monetary policy in order to stimulate spending. These policies not only affect the casual investor, they most notably affect the banks by incentivizing them to offer more loans rather than holding onto reserves.
The first countries to experiment with negative interest rates were in Europe, Scandinavia, and Japan. This served those areas with a somewhat heavy-handed tool intended to spur economic growth. Since these policies are still quite new, it is unclear whether they had the intended effect in these countries. One thing is clear, “$12.5 trillion of bonds globally – and fully 30% of the developed world’s sovereign debt – sport negative yields, thanks to central bank policies from the Bank of Japan and European Central Bank” (Reuters).
Punishing The Savers
The Fed has already cut rates 3 times in 2019, the first cuts since the great recession. This has added some fuel to an already strong economy and was intended to stave off the incoming headwinds caused mostly by the trade war with China. Now even the banks with the very highest interest rates are offering returns of less than 2%. Negative interest rates would exponentially increase this punishment to those who choose to save.
Is this a realistic tool for the United States?
Fed Chief Jerome Powell has the luxury of looking at other country’s experiments with negative interest rates as the acid test for possible outcomes with the United States economy. Fed-watchers agree that there is a long list of tools at the Fed’s disposal far before the prospect of negative rates begins to look appealing.
