Will the spread of negative interest-rates lead to a ban on cash?

Last Friday saw a new front opened in the world of negative interest-rates as the Bank of Japan joined the club by declaring an official interest-rate of -0.1%. At the time we discussed the possible rationales for this leading to two intertwined themes. The first involves an outbreak of currency war in the Far East between Japan and China and South Korea. The second involves the Bank of Japan preempting a further move lower from the European Central Bank. Let’s face it the ECB has been heavily hinting that it will plunge even further into the icy cold world of negative interest-rates in March. Thus -0.3% seems set to become -0.4% or -0.5%. Today I intend to look at some consequences of all of this.

Bond yields

This has been the most obvious move and this morning has seen an intriguing development. From liuk on Twitter.

MNI: #GERMANY SAYS NEW 5-YR BOBL DUE FEB 3 TO HAVE 0% COUPON || … and price ABOVE 100… the beauty of #NIRP (Negative Interest-Rates)

We should not forget how significant a development this is. After all the point of bonds was supposed to be that they pay interest and thereby acquire a value! This has no coupon or interest and even worse is priced above 100 so holders to maturity will be guaranteed a loss. On this road the business model insurance and pension companies faces an IED. Thus investment depends on a combination of the safe haven status of Germany and for foreign investors the strength of the Euro which of course is the same Euro the ECB is trying to push lower.As we stand the five-year yield in Germany is -0.3% and the two-year is -0.47%.

Japan has seen its bond yields plunge since its own announcement and there has been a similar picture where yields up to the five-year maturity dip to -0.1% as markets test the limits of what the Bank of Japan will buy at. The ten-year JGB yields a mere 0.05%. In fact if we raise our sights we note this new world as summarised by the Financial Times.

The BOJ’s action, which sets the stage for further central bank stimulus later this year, spurred investors to buy government bonds and pushed the universe of outstanding negative yielding bonds in Japan and Europe to a new peak of $5.5tn.

Personally I find the fact that Italian two-year debt has a negative yield ( it keeps dipping in and out of it) the most extraordinary. But those who used to use bond markets for yield now have a problem. You don’t get much in the UK ( ten-year 1.62%) or US ( ten-year 1.93% either. I guess everyone has piled in.

Who’s next?

If we use one of Pete Townsend’s album titles we find ourselves wondering who might be next. I have long argued that the Bank of England would be on the case should there be any dip in the UK economy which was reinforced by the words of Andy Haldane last September.

It involves finding a technological means either of levying a negative interest rate on currency……….here could be a need to loosen rather than tighten the monetary reins as a next step

Gertjan Vlieghe has headed in that direction too so there are two probable votes on a dip.

The United States would seem most set against it but even there this year we have had the words of Stanley Fischer.

Another possible step would be to reduce short-term interest rates below zero if needed to provide additional accommodation.

An odd point to make when you have just raised interest-rates and then promised another four increase in 2016! The theme here is that even in the US thoughts are congregating in this area and on this subject.

Gold

An attraction of gold in the current world is that negative interest-rates do not apply to it. Markets seem to be shifting back in its direction as the dip to US $1050 in December is replaced with US $1126 now. Not a surge but perhaps a shift after four years of declines.

Actually holding gold does have costs such as insurance and storage which is one of the reasons why I think that the state of play with negative interest-rates changes fundamentally at around -2%.

Banning cash money

This concept was raised by Andy Haldane of the Bank of England last September.

A more radical proposal still would be to remove the ZLB constraint entirely by abolishing paper currency.

He was followed by Stanley Fischer this January.

That observation has led some to ask whether it would it be possible for the financial system to operate effectively without physical currency provided by the central bank.

Then there was this from Andy Haldane

it has the added advantage of taxing illicit activities undertaken using paper currency, such as drug-dealing, at source.

Please keep that in mind as you read the next bit.

The 500 Euro note

It was only on Friday that I pointed out that according to Gabriel Sterne that via the 500 Euro note then you could hold the equivalent of one billion US Dollars in the smallest possible space. In case you are wondering it is 3 metres cubed as opposed to 12 in US Dollars, 16 in Japanese Yen and a bloated 21 in UK Pounds.

The use of high-denomination notes, in particular the €500 note, is a problem reported by law enforcement authorities,” according to a draft of the plans seen by the Financial Times. “These notes are in high demand among criminal elements . . . due to their high value and low volume.”

Well maybe not only criminals as this next bit from the Financial Times shows.

The €500 note, beloved by gangsters and Greek savers, is now being investigated for ties to terrorism.

Ah yes the Greeks trying to flee possible haircuts on their savings. Is that considered a criminal act these days? One for my financial lexicon for these times I think. Actually to do anything about this the European Commission needs to persuade the ECB which controls the supply of notes and coins. So what does ECB President Mario Draghi think?

“We want to make changes,” he said, adding that “we are determined not to make seigniorage a comfort for criminals.”

Again we wonder if a Orwellian style definition of criminals such as those trying to avoid ECB monetary policy is at play here.

Some of this is the law of unintended consequences as back in the day I thought that the Euro 500 note was introduced to help demand for the Euro. It always was the highest denomination note around amongst the major central banks and this  lead to demand  for it, some of it genuine but some of it was always going to be from criminal activities. These “criminal activities” were effectively encouraged but now 16 years later Europe has suddenly spotted it? The best reply is from Ajm to the Financial Times article.

If you see a €500 note in your wallet acting suspiciously, do not attempt to move it, but report it immediately to the authorities …

Pension Funds and insurance companies

Much of the business of these organisations relies on their being a positive rate of interest or at least return. Who would invest/save for the long-term when you are offered a loss? The World Bank tries to skirt the issue but cannot avoid it.

through funding problems for some non-bank financial
institutions, and through excessive risk-taking by
investors seeking a higher rate of return.

This bit is clearer though.

As discount rates of zero or less have no economic meaning, a prolonged period of negative interest rates would create large ambiguities for the valuation of assets and liabilities.

What could go wrong? Well this.

Under negative interest rates, some non-bank financial institutions—especially pension and life insurance companies—may struggle to meet their long-term liabilities, such as pensions or life insurance policies, offered at fixed nominal rates

Comment

I wanted to cover today the development of negative interest-rates so far and the risks going forwards. The intellectual debate and yes you could call the use of intellectual in this context an oxymoron is clustering around the issue and as even the supporters are considering what’s next after it? You can see that there is little confidence in it working. That is hardly a surprise as to be a supporter you have to argue that interest-rate cuts of the order of 5% have not worked. That is an odd line if you think that 0.1% of negativity will to say the least.

So they are on the march both in size and geographically and on that road there is a point where those with savings will be singing along with the Rolling Stones.

The floods is threat’ning
My very life today
Gimme, gimme shelter
Or I’m gonna fade away