The Trap of Negative Interest Rates - May 29, 2016

The Trap of Negative Interest Rates

Negative interest rates are becoming a common thing among federal banks, and this may change the world of economy and investment. The reason is simple: if interest rates are close to zero (or below that) people with long-term bank savings will realize that their accounts are not growing with time, they may even shrink.

This could also lead them not to raise their consumption which is an important factor in economic growth. Instead, they will look for investments that might be able to grant them returns.

Altogether, negative interest rate is a crippled device, since it doesn’t help economic growth, but supports higher number of investments, sometimes even the ones with unnecessary risks. This can already be seen in probable asset price bubbles. On the European, American, Australian and New Zealander real estate markets this is already a reality: the prices are getting higher and higher, since people feel that this is their chance to achieve returns.

All this might lead to a situation alike to the one preceded the crisis in 2008. We can already see the signs of risky loaning, as for the first time since 2007 Barclays is offering a 100% mortgage again. The reason might be that since the competition-based pricing is over and the market for loans is flat at the time, banks are trying to reach out for clients with lower financial ratings to raise their profits.

We still believe that an interest rate closer to 1-2% would be better for the economy in many ways, plus the longer this situation exists, the bigger the distortion might be in the economy.

At the moment, federal banks are running out of effective monetary tools, while they are not willing to leave zero or negative interest rates behind. Although, in FED’s communication there is a chance of a rate hike, they are still just following global events so even if they decide to raise, that will not make a real change as strengthening dollar may create recession anyway. This would prolong the era of zero interest rates too.

But what can we do in a situation like this? The best solution might be to create a well-diversified portfolio that is based on stock market and other instruments, according to the owners’ risk-taking willingness.

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