Negative Interest Rates

Negative interest rates sounds crazy and I would never even have thought about it, but now it has become a reality. When you hold your current consumption by saving capital, you are expected to get something in return for this sacrifice. This is usually in the form of an interest you get every year and varies depending on the supply and demand. However negative interest rate seems absurd, as it means that you not only sacrifice current consumption but also pay someone. This means that it is better to store cash under your mattress, than give it to the bank which will take a portion of it each year. The unconventional polices started by central banks in 2008 have taken a turn for the worse, with the Japanese central bank recently reducing its interest rates to a negative 0.1 percent for new deposits. This was done as the central bank’s inflationary measures of buying hundreds of billions of dollars in government bonds has failed. The Japanese economy is going back into recession, while inflation is falling way short of its 2% target.

The central bank was out of policy measures and negative interest rate was the only new thing it could think of. Though this policy has been tried before, it was only done by some small European countries. Nobody knows what the outcome of this crazy policy will be. It penalizes savers and is unlikely to stoke growth, though it can bring on a currency crisis. Many people will be tempted to shift their assets out of the Japanese currency, as it is yielding negative rates. The Japanese banking system might also suffer, as people would much rather prefer keeping money with themselves.

Despite the zero interest rate polices failing around the world, central banks have not stopped doing these crazy things. The world is again facing a major slowdown after a tepid last few years of growth, in which all developed central banks had reduced rates to near zero or zero. Even China is following their footsteps as deflation hits that country. Currencies and banking systems are all losing their credibility and trust and it remains to be seen how these disastrous polices resolve themselves. Till then it would make sense to diversify your assets, with a heavy weightage towards safe assets.