Just like in the Netflix blockbuster Stranger Things, we have entered ‘The Upside Down’ through a portal to a dysfunctional money system, one that has implications across all our lives, suggests
The ‘Upside Down’ has arrived in Ireland and we can expect collateral damage in a world of surplus capital chasing yields with top Government Bonds paying negative returns for storing money and an ECB openly toying with taking deposit rates under zero.
To illustrate, an example.
A €300,000 mortgage at -0.5%, in theory becomes €298,500 after just one year, even if you make no monthly capital repayments because the bank shaves the negative interest off the capital.
Meanwhile negative deposits would mean being charged to leave your money at the bank, so a €300,000 deposit drops to €298,500 after just one year at -0.5%.
In truth no one really knows how and deep long negative rates will persist but here are 25 possible outcomes if it becomes embedded:
1. Your money is made captive to banks who will impose strict limits on cash withdrawals because physical cash doesn’t lose value.
2. Savings will be attacked by stealth to reward big borrowers of capital across the Eurozone
3. On-demand deposits surge, a big challenge for banks trying to match deposit books to loan lengths.
4. Insurance Premiums spike as Insurers attempt to recover bond losses from consumers
5. Pensions are cut because weaker Defined Benefit pension schemes, compelled by regulation to buy bonds will cut them, take on more risk and could implode as liabilities surge
6. Conventional retirement planning fails, already the cost of pension annuities is exploding higher, forcing retirees to take higher risks.
7. Financial Regulators are forced to reassess rule books about investment risk which are imposed on financial firms because safety now equals losses.
8. Negative rates do not lead to a lending bonanza but to more conservative loan underwriting by banks hurting economic performance
9. Currency wars escalate as negative yielders fall in price to positive yielders like the US Dollar, creating tension in trade agreements
10. Gold, Silver and Digital currencies surge because Cash Deposits pay either nothing or are negative.
11. Central Banks enter the digital space to choke private currencies assisted by Government legislative handcuffs
12. Banks price against large depositors, imposing negative rates here first leading to flight and An Post is forced to follow.
13. Some credit unions may close to larger savers forcing members to save elsewhere like with Prize Bonds.
14. The human impulse to horde defeats the effort to encourage credit expansion, so the new global money experiments to exit the trap created by past rescues fails.
15. Eurozone banks, already enfeebled further weaken, leading to casualties.
16. Deposit haircuts are imposed on insolvent banks to avoid taxpayer bailouts.
17. Bank safety and security become the sole determinant of where to keep cash.
18. Cash ‘under the mattress’ flourishes, putting homeowners at risk.
19. Risk gets further mispriced, flooding shadow banking, private lending and unquoted companies with surplus capital. Too much risk is taken by too many for too few returns
20. Governments that have borrowing capacity will embark on big stimulus spending to take over the heavy lifting from failed Central Bank programmes.
21. Zombie companies who would otherwise have been replaced in the natural destruction and renewal of free markets plod on, restricting oxygen supply to innovators. Zombie failures are bigger.
22. ‘Wall Street’ grows fatter by shifting capital from negative to positive yielding sectors in so-called ‘carry trades’ while workers saving money, are priced against.
23. Political extremes continue to rise as populations seek new leaders creating more polarisation.
24. The USA eventually succumbs to negative yields to weaken the Dollar as its economy cools
25. Ireland’s largest deposit (€14.3 billion) likely to lose value in real terms if it hasn’t already
A negative yielding world I think does not address the fundamental problem that has remained unaddressed since the global financial crisis; too much debt and not enough economic growth to support it.
The ideal way out is by invention, technological advances that drive worker productivity and more, not less trade so real earnings and prosperity widens and grows.
But the human response to the upside down world of negative yields will be to save more not borrow more and so the experiment will fail.
The alternative exit from excess debt, other than defaults leading to catastrophic losses, will be to monetise it by inflation and that is where we will head thereafter.
Old conventions embedded in the education and training of financial advisors are unprepared for this climate or how balance sheets ought to be hedged.