“Live for today and don’t worry about tomorrow…”
-“Live For Today” by The Grass Roots
With the domestic stock markets close to their recent all-time highs as of this writing, I thought it might be appropriate to turn some attention towards the ultra-low interest rates that have persisted for the past few years.
The title of this Global Glimpse is borrowed from one of my favorite Ernest Hemingway stories, The Short Happy Life of Francis Macomber. I’m not nearly as well read in the classics as I would like to be, but Hemingway has always piqued my interest. The irony of the title is that Francis Macomber wasn’t really a happy man until moments before his accidental death. Hunting on a safari in Africa with his wife, he cowered when a lion charged him. Humiliated in front of and by his wife, he finally found the courage and happiness he so desperately desired the next day as he chased down a wounded buffalo only to be accidentally shot and killed by his wife. So the medicine that was supposed to cure him, facing his fears, ironically ended up killing him. What’s the connection to investing? Negative interest rates, thought by central banks to be the cure for ailing, developed economies, seem to be the medicine that’s worse than the sickness.
It might be a bit early to call for the death of negative interest rates globally. After all, bonds with negative yields being issued today by countries like Germany, Japan, France and Sweden won’t mature for years, so they won’t disappear entirely from the investment landscape. But after watching Federal Reserve Chairwoman Janet Yellen’s testimony to Congress recently we now think it is fairly safe to say the United States won’t follow much of the developed world down that particular rabbit hole. This isn’t to say our monetary and fiscal policies in the coming years won’t be unusual by historical standards, but we believe central banks are increasingly waking up to the realities of what their policies are inflicting.
Academics originally proposed negative interest rates (meaning you pay the bank to hold your money as opposed to receiving interest payments as a reward for your deposit) as a hypothetical response to a potential high debt, low growth world — the situation we currently find ourselves in. Imagining an economy with so much debt that consumers didn’t want to borrow any more even if interest rates were so low that money was effectively free, they argued that punishing savers by denying them reasonable interest would encourage people to spend today and invest idle cash, thereby stimulating economic growth. This theory is the backbone of many central bank policies today.
In reality, the opposite has occurred. The inability to receive any truly safe income (bank deposit interest, treasury yields, etc.) on capital hasn’t induced people to “live for today” as The Grass Roots encouraged fellow youngsters to do back in the 1960’s. Instead, it’s forced the average pre-retiree to look at his or her nest egg and conclude the amount they need to save in order to draw safe interest income in retirement is significantly higher than they had previously projected under more “normal,” pre-2008 interest rate conditions. I guess “Sha-la-la-la-la-la plan for tomorrow” doesn’t quite have the same ring to it. In fact, in countries where the deposit rate has gone negative like Denmark, Sweden and Switzerland, the gross savings rate has actually increased. To put this in perspective, in countries where money is the cheapest (i.e. interest rates are the lowest), consumers still don’t want to borrow money and instead have strongly increased the amount they save relative to their discretionary spending. Admittedly, it will take a number of months and years to truly judge the efficacy of today’s negative rate policies, but increased consumer savings and decreased discretionary spending isn’t typically a recipe for economic growth in the near and medium term.
Another enticing theoretical side effect of negative interest rates was inflation (which the Fed has been trying to achieve for years). Economists view inflation like Goldilocks viewed porridge temperatures. Too little inflation (the current situation) is anti-growth while too much inflation devalues the currency and causes uncertainty which derails investment. Again, theoretical and real-world outcomes are at loggerheads. As interest rates in developed countries have gone to zero and then below zero into negative territory, inflation has actually followed interest rates downward, exactly the opposite of what academics expected. In Japan, the epicenter of the negative rate phenomenon, inflation hasn’t really budged. What has gone up instead are the sales of steel fireproof safes, which have skyrocketed. It looks like consumers in Japan are voting with their feet and preparing to hold cash rather than pay a bank to do the same should rates fall further. So even in Japan, which is led by the Bank of Japan, the wacky cousin in the family of developed-world central banks, it looks like negative rates are starting to reach their limitations.
What does that mean for US investors? A few things.
For one, as mentioned above, it appears increasingly clear to us at Arbor Wealth that the fad of negative interest rates being aggressively pursued by more “experimental” central banks than our own Fed appears to be losing admirers. The benefits of negative rates, if there ever were any, appear to have been fleeting. And now they actually seem to be hurting many economies more than they’re helping. Negative interest rates simply scared more people into hoarding money than it “nudged” others to spend tomorrow’s income today. In our view, the Fed sees this as well and has decided to “not go there” as kids say. Whereas implementing negative rates here at home was a serious topic of discussion among economic elites even a few months ago, the tone of the discussion has shifted significantly as other economies have served as real-time test cases and the results don’t look promising.
In our view, the Federal Reserve’s lack of desire to go into negative territory also relieves quite a bit of anxiety for domestic investors. The US and the US Dollar have, since the end of WWII, been historically seen as the country and currency of last resort. The good old greenback still settles a huge amount of transactions around the globe. The fact that the Federal Reserve is indicating that they have no desire to change the historical understanding of the value of money (I deposit money in your bank and you pay me interest) is welcome relief to many investors. By simply saying, “we’re not considering that possibility” the Fed has given a huge amount of clarity to the financial markets.
In an obviously strange financial world, this new piece of relative certainty is welcome news. While global interest rates will likely remain very low by historical standards for the foreseeable future, we don’t believe investors will accept negative interest rates much lower than what we’ve already seen.