Interest rates

A Negative Approach

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Mortgagees will now start making money from their loans.
  • Why it matters

    Why it matters

    The ECB hopes its policy of negative interest rates, essentially taxing money, will put more cash in people’s pockets but the decision is hammering savers and pensioners.

  • Facts

    Facts

    • The ECB reduced its deposit rate into negative territory last July.
    • It means lenders have to pay borrowers to take their money.
    • The move could have serious long-term consequences, and decision-makers should reverse it, the author argues.
  • Audio

    Audio

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The world of finance has gone crazy. The Danish branch of the Swedish Nordea Bank has announced that it is becoming one of the first financial institutions ever to offer a mortgage with a negative interest rate.

The loan has a negative interest rate of just 0.03 percent, but the message it conveys is shocking: In the future, debtors must pay back less money than they borrowed.

Bankers are happy to get rid of their money, which, with the advent of negative interest rates being set by the European Central Bank, they otherwise have to pay the central bank to hold — at a rate significantly higher than what they pay the loan recipient.

Everything that we learned over decades, practically imbibed along with our mother’s milk, is no longer true. Wealth can be built up almost risk-free by means of credit.

The capital market has turned topsy-turvy. With a stroke of the pen, rules that were valid worldwide have been discarded because of a new central-bank policy.

Everything that we learned over decades, practically imbibed along with our mother's milk, is no longer true.

At the moment, no one can grasp the consequences of the situation. Experiences of such a loan are simply lacking. Can the world of economics be so easily altered without causing new damage? No one knows.

The fact is that we must reorient ourselves. The real consequences of this new financial world will only be visible in a few years, probably only after decades. The new era of very low interest rates and quantitative easing might alleviate problems in the euro zone in the short term, but its risks are being shifted onto the next generations.

The children of today will be the ones who suffer if the framework conditions remain as they are currently. This may be most evident in the issue of retirement provisions.

The strategy of stimulating growth with a flood of money and penalty interest for banks, and thereby reducing the long-term consequences of the 2008 financial crisis, has been practiced in Europe for a good while now.

Its success is uncertain. What is clear is that prudent savers are the dumb ones. The strength of the German economy of yesterday has today become its weakness. Because with interest rates near zero, wealth is destroyed after the rate of inflation has been factored in.

In the short term, none of this has to be a huge problem. Professional investors such as mutual funds, for example, evaluate the success of an investment with regard to its liquidity, i.e. how quickly they can buy but also sell their securities.

Thus they include German government bonds in their portfolio, even if at their redemption date they are worth less than their purchase price. The investment experts try to compensate for the disadvantage with regard to yields by including other securities, through a broad range of investments.

But this can only work to a limited extent, unless investors take on significantly higher risks. More severe risks, however, carry the rising danger of incurring a loss.

Many citizens must save today for the pensions of tomorrow. But living standards cannot be maintained indefinitely by government-provided social security.

What remains are stocks. In the current situation, they are doubtlessly the only realistic alternative to bonds. But how sustainable is an investment in stocks if it is no longer based on fundamental company data, but fueled by the fact that no other feasible alternatives exist?

What is more, stocks currently offer an attractive overall return of about 5 percent in the long term. But we are speaking here of many decades. Who has so much time?

Many citizens must save today for the pensions of tomorrow. But living standards cannot be maintained indefinitely by government-provided social security. Demographic developments make it clear Germans will have problems in the future: In 1950, 6.26 workers financed one pensioner. In 2050, the figure will be 1.54, if predictions are correct.

Negative interest rates make it almost impossible to provide security for the elderly. Up to now, additional provisions for old-age came via a life insurance policy, a pension fund or bond investments. But at the moment, they aren’t providing enough.

In the short term, that isn’t a problem as retirement plans run over many years. But if the situation remains as it is, then it will become a problem — a big one.

If the political establishment wants to guarantee the welfare of future generations, then the phase of negative interest rates must remain a phase, and a short one at that.

 

To contact the author: landgraf@handelsblatt.com

 

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