Who could complain about low interest rates? More people than we think...

One may legitimately wonder whether negative interest rates are veritably good for treasurers, in particular, and for the world economy, in general. Despite the benefits of negative rates, there are many more drawbacks. Perhaps the middle ground would be more adequate and a return to zero rates would perhaps be the means to satisfy the greatest number.

When the unthinkable becomes a reality...

A few years ago, the unthinkable became a fact. Investors could no longer rely on financial dogmas alone. The financial manuals should be revisited because principles of finance have been rushed. New policies such as “quantitative easing” (i.e. “QE”) have been invented from scratch by central banks. As with everything, there are positive and negative consequences for these below zero interest rates in EUR. Low rates are not only positive for everyone. The consequences are also indirect and can weigh in the long run. The simplest would seem to start with the "pluses" and benefits. For example, Governments can or should deleverage, or to be more precise, they should ease debt service (deficits have risen since the crisis, but the cost of debt has fallen thanks to negative rates). All-in increases of debts have been offset by interest reduction. Corporates also took the opportunity to gradually deleverage and restructure their debts. For example, has ALTICE not reduced its cost of debt by $ 700 million a year?

Lowest level of financing cost for years

According to the IMF, the lowest level of financing cost has been reached since 1975. Distributed dividends have increased because companies do not want to accumulate cash and destroy value. Some dividend pay-outs are amazing. No shareholder will complain. In terms of taxes, we should also be able to deduct a negative interest (as a charge) and as well as positive interests are taxable. The interest in crypto currencies, which do not generate interest calculation (but do not cost either) has increased, despite a volatility that remains strong. These low rates have the merit of boosting interest for alternative products (funds) and the so-called "dynamic" investment products. Corporates are revisiting their investment policies to allow other asset management instruments. Lastly, these negative rates have allowed many people to acquire their house at a more attractive price.

However, these benefits cannot hide the disadvantages that this "abnormal" situation creates. These “very cheap” rates also have their dangers. They are creating a possible real estate bubble that we hope will not burst. We can now borrow at 20 years at less than 1 percent fixed in EUR. ALM management has become extremely difficult for private banks with a unilateral "floorage" (at zero) that is not sustainable for banks. Of course, they have floored in the meanwhile all borrowings to ensure minimum margins. This is weakening banks, insurance companies and pension funds. The guaranteed minimum rates, imposed by the States, penalize them. They must seek returns and yields in alternative funds, real estate or "private equity" to offset the shortfall. A mission almost impossible in the medium term.

The excess of cash has misstructured the financial management and by the destruction of value it forces to take more risks or to invest in operating assets, which in principle generate positive returns.

Private Equity funds (PE's) also see their IRR (i.e. Internal Rate of Return) fall while remaining in attractive relative value. PE's “dry powder” continues to increase and is ready for investments. However, it is difficult to find investments at attractive prices, with high multiples. Even cash pools are affected by Transfer Prices. Cash-pooling deposits, for example, should be taxed at negative rates, minus the benefit of belonging to a cash-pool (which should be shared among participants.

The Swedes finally did it, well done!

The Central Bank of Sweden, aptly named "RIKS BANK" has decided to end the experience of negative interest rates. It reduced its main policy interest rate interest rate to zero percent. The ten-year bond rate fell from minus 0.40% to plus 0.08%. Placing at ten years to gain rather nothing, this remains very disappointing in terms of return. Such a longcommitment to simply recuperate your principal. Isn’t it weird? But the fundamental question that pains us all is whether the other Central Banks, including the ECB, will dare to follow the Swedish. What are or remain the advantages of having still negative interest rates? I always wonder if there are still advantages of remaining below zero percent. Going back to zero percent in the EUR zone would change everything. Banks suffer excruciatingly from this persistent negative side. Going lower would be even worse and would not change anything if it did not even sink the already damaged stakeholders (e.g. banks and insurance companies). After 5 years of negative Swedish interest rates, what have been the results? We still wonder. Inflation should not be our worst enemy. It is rather under control in the Western countries. The Swedish gesture may surprise while their economy is still suffering. True. The Swedish economy slowed down badly in 2019. So why this move against the tide? What if the Swedes were better inspired? The business confidence is weak, the state of industries remains weak, trade tensions look strong, the outlook is bleak, and inflation is limited to 2%, which seems more than reasonable. In my opinion, the negative elements caused by rates below zero percent have largely supplanted the positive elements. The negative consequences hurt more than the positive consequences. Perhaps the solution would be situated in an intermediate level, at zero rate. Individuals (via retail banking) have been impacted in their savings, the financial sector has seen its profitability plummeted and seriously affected, at the risk of destabilizing the whole sector. Mortgage loans are exploding (as they are become so cheap), possibly creating financial and real estate bubbles and high household debt.

No more sub-prime crisis

Let us not relive the “sub-prime” crisis. Finally, the company that borrows at a "floored" rate will not be penalized since it already pays only the spread. This will allow for (slight) recovery in long-term rates. Would it be absurd to think that the Swedes could inspire Christine Lagarde and the ECB? The Swedish Central Bank was not the first to enter negative interest territory. However, it is the first to return to zero percent. Congratulations for this courage and this economic intelligence. The future may show that it was a wise decision. Even if it stays at zero, the zero is much better for all than the below zero. The Swiss have announced a possible even more negative dive (we are at minus 0.75%). The Danes have indicated that this negative character could last a whole decade and even further. On the other hand, for the ECB, this Swedish decision could constitute a very interesting experimental laboratory. The future will tell us whether it was a good decision or not. No one can say at this point. But I think States could continue to benefit from improved debt service, while the banks could avoid cruel decisions to tax current accounts and limit breakage and damages. Zero rates would enable the best of both worlds, to maximize the benefits for each other, or to prevent the benefit for one from being exorbitant in terms of cost to others. It would also avoid explaining to the general public and ordinary retail customers that their savings will be penalized at a negative rate and that they will lose money over time. It is too early to say that this decision was wise. But we can hope so. I hope that the European Central Bank will watch Swedish developments carefully and draw inspiration from them soon, before the damage to financial institutions, insurance companies and other pension funds is too great. These three sectors are suffering from persistent negative rates. Cross our fingers because otherwise it could generate a deep and systemic financial crisis.

When going back to zero (percent) is commendable ...

The case of Sweden is interesting in terms of interest rates. Sweden was once again a forerunner of what should be done. It's a sign of avant-gardism in my opinion. It was one of the first to have negative rates (i.e. deposit rate in 2009 at zero). Because as soon as you have reached the zero percent, what comes next below, cannot be useful or beneficial. In the long run, negative rates are a kind of vicious and sneaky “killer”. By the way, have you noticed that Sweden has been pinpointed by the EU for overvaluing its real estate market, and was therefore encouraged to stop its sub-zero rate? Admittedly, this was a symbolic but virtuous and courageous gesture. Because it takes courage to raise rates while modern economies suffer. People in the street are convinced that the zero percent rate is a very strange and "abnormal" thing, especially since this situation is trying to extend. We must never forget the people of the street because at this moment disputes and strikes spread all over the world. People become rebels and complain about the capitalistic economies and its so-called drifts. The problem is that negative rates for too long are doing more harm than good to the economies, but lots of people seem not to see the dramatic consequences derived from these types of sub-zero rates.

“You goota get on the floor” (J.Lopez)

When a bank is lending money, its loan is now "floored" to zero (in principle). When this same bank borrows (i.e. deposit of a customer), it tries to pay the real rate, based on the (new) ESTR, about [-0.50-0.60%]. Before we were "floored" on one side and "floored" on the other too. It was sort of symmetricity. Now, we understand them with the proposed asymmetry of floors; however, the pill will be difficult to swallow for individuals and even some companies. So less than nothing was zero; but in terms of rates, less than nothing, it is a negative rate which does not know how far it will be in the negative zone (e.g. ESTR, which is by the way further negative compared to the former EONIA by 8-10 bp’s). The ECB and its new Chairwoman will not be able to change the orthodoxy and the complex or dangerous strategy put in place by its predecessor.

Why less than zero is not beneficial?

Too low rates and potentially near-zero mortgage credit could be compared to purchases during “Black Friday’s” or sales. It is not because it's cheap that you should buy a house, but because you need it to live in. The economy should be re-calibrated, and the target set (back) to zero. What are the “negative” possible impacts of these very low rates? Negative rates create a real estate bubble unquestionably.

Companies in difficulty, the so-called "zombies" companies survive with very (too) cheap loans. Private banks are drained and desperate with their deposit rates they cannot charge for their rich customers. Pension funds and other insurance companies suffer martyrdom as they need to ensure minimum returns. Households and states have been over- indebted (even if the debt service is easier). Investors are flocking on hedge funds, alternative funds and other stock markets in search of better returns. Furthermore, the cost of debt is lower and would make us forget the increase in total debt. I'm certainly forgetting other reasons not to stay at sub-zero rates.

Negative rates are not good for the economy

Their persistence would be detrimental to the entire economy and the banks. Do not forget it. The consequences of this madness of rates and the inversion of any financial theory will only be measured after the fact. The awakenings will be painful. It is abnormal to be paid to keep other people's money, especially if you are not a bank with tamper- proof coffers. It would be foolish to see individuals keeping fiat money (i.e. bank notes) in chests or cabinet bottoms to have zero return because it is simply better than - 0.60%. Yet, we will come to it ... Have not malignant men speculated on gold? Are stock exchanges not overvalued? Let's never forget that the notion of “performance” is relative, even below zero percent. Eventually, Sweden may also be a pioneer with its “e-Krona” and a virtual currency (to avoid the exchange of notes and raising fraud, with shadow economies). Today, time no longer creates value, it destroys it.

Time is a killer

We could find another thousand other unfortunate consequences of such depressed EUR rates. The worst of all is a destabilization of the whole banking system. The banks begin to suffer heavily from these persistent negative rates. I am not sure, then, that these rates will not have an effect more perverse than it seems, more haunting, more devious and misleading. The economic textbooks will explain to our grandchildren that more than the crisis or the regulations that followed it, it was the negative rates that destabilized the financial edifice and “vampirized “the centennial economic principles. No, these negative rates are not always "positive", if I may say so. I personally see more "con’s" than "pro’s". They will force us to reconsider our fundamental and founding principles to adapt to a situation that is, to say the least, abnormal. "Time is a killer (or time became murderer)" in terms of interest rates, like the novel by Michel Bussi. I remember a period time was generating value... Time was money, but is not anymore.