Money is a commodity and interest rates reflect the cost to use it. Money is cheap, and has been for more than a decade, especially compared to historical levels. But what happens when the cost of money goes negative as a result of desperate monetary policy? It flips your perspective and distorts incentives, the structure upon which functioning capital markets are built. As this is written, many investors are buying and selling as if the Federal Reserve will push rates negative in the U.S. as early as 2021. In response, a handful of Federal Open Market Committee voters stated that negative rates are not a policy tool they are currently considering.
When the price of anything goes negative, including the price of money, you can throw your economic predictive ability out the window. There now exists $11 trillion in debt outside the U.S. trading at negative yields. When negative rates go negative, borrowers pay back less than they borrowed and lenders will be out of business if they don’t quickly adjust. This is something you would expect to find in Bizarro World, a fictional planet created by DC Comics in the 1960’s where everything is opposite of Earth. In one episode, a salesman does a brisk trade selling Bizarro bonds: “Guaranteed to lose money for you.”
Companies and individuals will factor in the cost of money before they pursue a new investment. But the idea that they are simply waiting for even cheaper money to conduct business is nonsensical. Money is only one part of the decision matrix. If a business sees unmet demand, it will build that factory or add the labor for that new production shift. They aren’t going to shelve the project because a 1-2% borrowing cost is too expensive. If an individual needs money to become even cheaper in order to buy that bigger or newer home, they might have pushed their finances too close to the edge in the first place.
Lower rates undoubtedly can have a positive effect on economic growth by spurring demand, but that depends on where you started. Going from 5% to 3% or even 1% can have an impact on spending or investing decisions. But pushing interest rates past zero reduces dramatically, or eliminates entirely, the incremental benefits to be had by lowering the cost of money to induce economic growth.
The European Central Bank introduced negative rates in 2014 to stimulate their economy and Japan adopted negative rates in 2016. Lacking an equal fiscal policy push from elected officials and feeling pressure to act, monetary policymakers from both banks felt compelled to do everything they could, including the adoption of negative rates. Negative rates helped little, if at all. Even before Coronavirus, their economies remained stagnant. Monetary policy is a blunt tool in pursuing economic growth and cannot carry the entire load. With the CARES Act and associated lending programs enacted recently in the U.S., the Federal Reserve has a willing fiscal policy partner, and shouldn’t feel forced to adopt negative rates. If they do, it will be a sign things have gotten worse rather than better.