Modern finance has seen many innovations in the last 20 years. The Black-Scholes-Merton theory promised risk-free investment if it was properly hedged, or insured through market based options. That spawned a whole new category of investment in derivatives, or re-selling of insurance that nearly anything might go wrong. There were always new places to put money through the last generation as new concepts of “investment” were created. But through it all, there was one constant: there is a time value to money, which is to say that money today is paid for tomorrow plus a little bit more – call it “interest”.
No longer. Debt from large, secure nations is being sold at net negative interest rates, meaning that those with money are actually paying to lend it. Money today is worth less than money in the future. The implications of this are staggering.
The phenomenon has only taken off this year, starting with Germany and spreading to the UK. As it stands right now, some investors have paid a net negative interest on US Treasuries (T-Bills) in the secondary market where they are re-sold, but our government has not benefited from this. But sales of T-Bills at net negative rates from the outset are being contemplated, meaning that a source of revenue for the US Government might soon be how much it needs to borrow.
If that sounds like bizarro world to you … well, it is. And it may be a sign of serious trouble to come, mainly as Deflation.
The reason this is being considered is not simply that the Treasury thinks it can get away with it. They want to encourage investors with a lot of cash to go out and take risks in the world, investing their money in opportunities that will boost the economy, create jobs, and so on. Investors, however, are scared and want to sit on their money and wait, hoping that some day there will be better investments than they can find now. So they tend to park it in T-Bills, using them as big warehouses for money. And they may have to start paying for that privilege.
Note that in days long gone this is money that would probably be stuffed into a mattress somewhere, but it is not today. This is money that has never been in printed form, but is only a set of digits in a computer. If it is not parked somewhere, it does not exist.
Traditionally, there are two kinds of money on any balance sheet – capital investments and expenses. One of the great innovations recently has been creating liquid markets where money can move back and forth between these two easily, blurring the distinction – and making arguments for lower tax rates on investment a lot more dodgy than they used to be. We are seeing something like a new category of money on balance sheets – idle money that has no place to go at all. It is neither invested nor spent, generally liquid but set aside, simply waiting.
Manufacturing and other productive sectors of the economy used to have a fair amount of this kind of money sitting in their vaults, but it was smaller in scale, scattered, and always in support of their operations. Farmers liked to have cash when they could as a reserve, and manufacturers typically kept a few months’ payroll on hand. These reserves were often stripped from companies if they started to look too large by predatory “capital management” firms when the assets of an operation became larger than their net value as a going concern. This is how Mitt Romney, among many others, made a lot of dough in the 1990s.
Today, the idle capital is not sitting in the hands of farmers, craftsmen, and manufacturers who make stuff. It is in the hands of the financial industry, and they have no idea what to do with it. They are actually willing to pay to keep it safe, which gives us negative interest rates. The final innovation in finance appears to be breaking the cardinal rule of finance in order to wrest money back out of the hands of an industry that innovated itself to uselessness.
There are many reasons why negative interest is appealing to the government, but it is still a sign of financial apocalypse. That’s why the Treasury announced they were considering the idea first – to see what happened to markets and opinion generally. It appears likely to be implemented – timidly at first, and then who knows? But the point remains that money tomorrow is more valuable than money today, which is to say that there is nothing deemed worthy of investment right now. That, alone, is scary enough.
Barataria - The work of Erik Hare 
This is totally mind-blowing. Part of me says “why not have negative interest?” but there has to be a million things that can go wrong. I don’t know if it has ever happened before either.
Yes to everything! I can’t find an example of this historically. The ask.com page on interest says, “I cannot imagine nominal interest rates ever going negative,” which is a wonderful confession the author probably never thought would be important.
This is an incredibly dense blog. I guess there is no other way because there are so many implications to negative interest but this actually makes it harder for me to understand the implications. I will have to think about it.
Sorry I made things hard on you, but this has to be thunk out a lot before anyone can even pretend to grasp it. There is just way too much to this to summarize in 800 words or less. Please, think about it – and let us all know if you come up with something else. This is totally uncharted territory and the greatest minds of this and every other time have not gone here. Scary stuff, no?
I have to agree with Dale here but in my case it probably comes from too much media overload and a need to exercise more. Anyways I think there has been some negative interest rates on overnite exchanges or perhaps I misheard it on MPR. One other thing some of this whole mess was made possible by the computer. I could be wrong but now there is some sort of financial registry of deeds and itles where before it was handled at the county and state levels.
I guess there have been spots of slightly negative rates on some overnight charges – I do remember Japan going slightly negative briefly in the 90s, for example. But it’s never been more than a quick fluke to my mind. Just because I haven’t heard of it doesn’t mean it hasn’t happened, tho, so I’m always game for a good example.
As I consider this, I just see this as another symptom of incredible wealth concentration. As those with resources command more and more (and more and more and more and more) average small to medium sized businesses (and their clients and employees) have little cash reserves to make important improvements or investments that could spur consumption of their products and/or services.
And those with the incredible wealth, keeping their money parked and idle, have no incentive to do anything, as we don’t have a functional government to encourage investment or public spending to spur demand.
If I were king for a day, I’d deal with this by saying that liquid assets over a certain threshold get taxed at a much, much higher percentage for every month they aren’t spent on something related to job or demand creation. Attempts to move those assets overseas or into other financial instruments would have an even higher tax rate. Or, the liquid assets would be earmarked to pay down the budget deficit so government spending would not have to be severely curtailed amidst a delicate recovery.
I am with you on this, it is all about wealth concentration in the hands of people who have no idea what to do with it. We used to hear arguments against “taxing the rich” that they knew better than the government as to what to do with it. Now they apparently have no idea what to do with money while we have failing infrastructure and high unemployment. There has to be some way to tax them and get this money back to where it will do everyone some good. It makes me rethink everything I have ever thought about how an economy works.
Having gotten to know you a bit, Jim, I have to say that this is a pretty big statement from you in particular. I wonder how many people are starting to believe, as you have, that things are different enough to warrant very different action than you’ve been in favor of before. I applaud your openness, BTW.
Yes on all counts. If we are going to pursue a policy of lower taxes on investment income (although such a policy is looking stupider all the time) the LEAST we can do is tax the bejayzus out of idle capital. But the flight overseas to avoid such taxes is a very real possibility these days given how incredibly liquid everything is. Not sure how to do it effectively, to be honest. Negative interest may be the only tool we have to make investment happen.
Erik: This is one of your most compelling posts–of the ones I’ve read, anyway.
Negative *real* interest rates–net of inflation–aren’t so unusual. Negative *nominal* interest rates–what I think you are talking about–are unusual but apparently not quite unprecedented.
If we take this literally and suppose our systems are assigning a negative value to capital, on top of our done-deal devaluation of labor, where does that leave us? I don’t know how to think about it–the assumption that money has a positive time value is so built into a “standard model” of how our world works. Likely there is a lot of educational value in doing that thinking, so I hope you will pursue this.
Surely, though, it’s another indication, if more were needed, that our financial systems need to be simplified, de-automated, brought back into a rational relationship to human needs. Or maybe we are getting a signal about reliance upon “growth” as a universal driver?
Thanks. Yes, negative *real* rates have happened quite a lot, but negative *nominal* rates are at least extremely rare – and I don’t know of any incidents that were not quick flukes but were actual policy of some kind. Any examples are appreciated because if we have some guide as to how this has worked before we can make some guesses as to how it might work today. Hopefully. 🙂
I also agree that assigning a negative value to capital is a truly stunning development and worth looking at in far more depth. As you know, I have been taking on various aspects of “Supply-Side” (ie, tax and other policies designed to create more/bigger pools of capital) and “Socialized Risk” – both are linked to up in there somewhere. You’re right to think about the devaluation of labor (part of high unemployment) and the true meaning of a “Depression” at this point in time.
There is a LOT to think about here. I do intend to keep after it. I really want to see the January jobs report that JUST NOW came out in some detail – something strange is going on and we are indeed creating jobs. Where/why/how/what?
When there is no time value to money I think our whole system breaks down. I don’t see any other way for this to work. I wonder about amortization schedules and how they would have to adjust them to make sense as equipment and other capital items are worth more with time. I can’t see how this can possibly function.
If we get into a long-term regime of this things will have to change. One example of a world without interest is Arab Banking, based on the prohibition against interest in the Koran. They form something more like a business partnership for nearly everything – I have no idea how home loans work, however.
Our move towards venture capital is more or less along the same lines. Of course, ordinary credit is still very important, but I think we’ve seen this trend coming for a long time the more I think about it.
No idea what it could mean for amortization – excellent question! You’re the accountant, yes? 🙂 But we’d have to be in a long-term regime of zero to negative interest before we have to worry about that. We’ll see if that is in the cards. The concentration of wealth has led us to some very bizarre breakdowns in the Middle-Class system we built up over the years.
Negative interest rates can be thought of as a new tax, one on those lending to the federal government. The rich people lending get to diversify their porfolio–but it is not free. The government can use it to pay salaries or to redistribute. It is a good bargain in my view, particularly since long term price of worthless stuff like gold is uncertain. In any case there is too much exuberance about gold. Negative interest rates would be just another option for scared investors.
In the medium term the only thing that will restart the US economy is defense spending, war and federal spending on R&D. Cuts to defense will be contractionary and will only show weakness to Iran. That is one reason I support Governor Mitt Romney.
If it functions only as a tax, I am very much for it. There seem to be so many potential ramifications here that it’s worth talking through at great length before we “go there”. I think the Treasury feels the same way, too, which is rather wise of them.
Gold? Feh. It might stay about where it is for a while, but with decent job growth, a declining ^VIX, and some sense of confidence returning it really can only go down (unless, of course, Europe blows up – always have to have that caveat).
I see your point on defense spending – cutting it too rapidly would cause problems. However, cutting mostly overseas won’t affect our economy. I think there are ways to show Iran we mean business (or, at least, Israel does, ahem!) and dramatically reduce our overseas deployment. That is what I read Obama as wanting to do, and I support it. But I understand that cutting military now is dangerous, at least without some other job creating spending in other areas. I still think there are ways that we can speed up the economic Reform with strategic government spending which would be far more effective than what now goes into Defense.
There is something here I don’t understand. How do they set the interest rates for these bonds?
The short answer is that they hold an auction. The long answer can be found on the Treasury website.
The effective rate is determined by how much people pay for a T-Bill that comes into the auction with a face value of the bond and a set payment schedule. To make it come out negative, they’d have to offer the bonds with a face value and a net payment in from the potential investors, which would be very strange. It has to be done deliberately up front.
Thanks, that explains it.
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