May you live in interesting times
In 1966 Robert F. Kennedy delivered a speech that included an instance, “There is a Chinese curse which says “May he live in interesting times.” Like it or not, we live in interesting times. They are times of danger and uncertainty; but they are also the most creative of any time in the history of mankind”.
I had always thought that this saying was an old Chinese proverb but there is no evidence that it originates from China at all. In fact, the earliest reference to the saying was in 1936 in the US. As for the Chinese curse this appears to relate to the stress of living through an interesting time of change. Of course, the present time is probably the fastest changing and most wide-ranging one ever in history.
One of the strangest changes in recent years has been the introduction of negative interest rates in some countries. Baffling as it may seem there are in fact reasons why certain governments have taken this unusual step.
Interest rates are the single most important monetary policy tool used by central banks to influence inflation throughout an economy.
A central bank attempts to combat deflation by reducing interest rates in order to encourage consumers and businesses to spend money and raise prices. In some cases, these conventional monetary policies don’t work and the central bank will lower interest rates into negative territory. The move is designed to incentivise banks to lend money and businesses to spend money rather than pay a fee (the negative interest rate) in order to keep it safe at a bank.
There are many different instances of negative interest rates throughout history, but more recently, these policies have been used to ward off deflation. The European Central Bank introduced its negative interest rate policy in 2014, and in January of 2016, the Bank of Japan unexpectedly did the same, cutting its benchmark rates below zero in a bold move to stimulate its economy and overcome persistent deflationary pressures in its economy.
Interestingly although inflation is feared it is in fact deflation which is a greater worry. So what exactly is deflation?
- Deflation is when the general prices levels in a country are falling – as opposed to inflation when prices rise.
- If deflation occurs, people choose to hold on to savings instead of spending it today, since prices will be lower tomorrow – and even lower next week – and even lower in a month, etc.
- As a result, a vicious cycle can ensue that drags an economy into recession or depression as economic activity grinds to a halt.
The impact of negative interest rates is difficult to quantify since the policy has been used sparingly in the past, but there’s some evidence it might be working.
Banks may be reluctant to pass on the cost of negative interest rates to their customers because doing so may encourage them to move their assets. In these cases, lower interest rates would lower the profits of banks and discourage them from lending to riskier parties. Consumers facing a cost of having cash in the bank may decide to take the money out of the financial system altogether – although that scenario hasn’t happened yet.
The impact of these policies on the foreign exchange markets has been much more favourable. When negative interest rates are in place, investors tend to search for better returns in foreign markets, which sends a currency’s valuation lower. Lower currency valuations help boost exports by making them more attractively priced around the world. The Euro has seen these dynamics with regards to its exchange-rate with the dollar since 2014.
These are the key points about negative interest rates
- Negative interest rates are designed to combat deflation by encouraging people and businesses to borrow and spend money.
- Negative interest rate policies have been implemented a few times in the past, but their effects are difficult to quantify.
- Some economists believe that banks will be reluctant to charge customers, which could hurt the financial system even more.
- Other economists believe that negative interest rates could send capital abroad and ultimately help lower a country’s currency valuation to bolster exports.
So if you would like advice on how to invest your money long term to beat cripplingly low interest rates on your cash deposits why not get in touch with us? You know it makes sense.