Monday, May 11, 2015

The Curious Case of Negative Interest Rates

From the New York Times' DealBook:
Anthony Scaramucci is founder and co-managing partner of global investment firm SkyBridge Capital and host of the television program “Wall Street Week.”
For people who grew up in the last four decades of the 20th century, it is hard to grasp the concept of negative interest rates. How is it even possible? If interest rates are the price of money, is the marketplace broadcasting that money is on sale? Are we just giving it away? Ask practically anyone on the street about negative interest rates, and the response will be bewilderment. We’re used to paying for loans and getting paid for savings. Suddenly, the world is topsy-turvy and, well, it’s all so confusing.
Here are the basics that you need to know about our new world:

 Negative rates imply that the money in your pocket today will buy more goods tomorrow. Think of money as just another fungible asset: A $20 bill today is still a $20 bill tomorrow or two $10 bills a year from now. Interest rates, on the other hand, reflect the opportunity cost of spending that money today relative to tomorrow. When rates are negative, the $20 bill is still worth four $5 bills in the future, but its utility value (i.e. what it buys) increases with time. When money appreciates, it implies that its purchasing power is expected to increase. And that’s precisely what’s occurring today -- the world is awash in a glut of labor, goods and energy with little economic growth. Negative interest rates are symptomatic of a slowly growing (or no-growth) world in which demand is deferred and, as a result, prices and wages become depressed. 

Powerful forces unique to our time are affecting the overall global economy. John Keynes, you see, was actually wrong. His famous utterance, “In the long run, we are all dead,” isn’t true. Like it or not, the long run is upon us, and we are all very much alive (aside from Keynes). Keynes reasoned that governments could use the mechanism of borrowing to reprime the growth pump and smooth out cycles. For the most part, that approach has worked for 75 years. But today, we’re up against the wall as borrowings continue at full tilt and growth stays basically stagnant.

We also face a demographic explosion of people worldwide that want to consume like those in the West. These billions of people are triggering a confusing development. They are creating excess labor, goods and other services with widespread slack in factory capacity. This confluence, in tandem with the energy revolution, has created sluggish prices and a slowdown in growth. This is puzzling, because typical policy measures to spur growth haven’t worked. We can’t lower rates any more and the world is awash in sovereign debt. Former Treasury Secretary Lawrence H. Summers terms this conundrum secular stagnation. So is Mr. Summers’ thesis of such stagnation correct and we’re stuck in this muddle? The answer: a resounding maybe. Once again, everything depends on the United States....MORE
HT: Levine@Bloomberg