Negative Interest Rates Are Coming and What This Means for You

The real reasons, your retirement, and the markets
April 20, 2016 Updated: April 25, 2016

After the financial crisis of 2008, American consumers had to grudgingly get used to receiving no interest income on their savings accounts. Many thought—and still think—that this will soon change with a recovering economy.

If the trends in Europe and Japan are any indication, however, and people like former Secretary of the Treasury Lawrence Summers have their way, savers will soon have to pay for putting money in the bank.

Most experts agree that the monetary experiment of having a negative rate of interest will come to the United States sooner rather than later. So before you have to pay for keeping money in the bank, Epoch Times looks at the real reasons for implementing the policy and the possible effect on you and your retirement.

The Reasons

Central bankers are obsessed with inflation. The Federal Reserve has the official target of creating 2 percent inflation every year in its mandate and says it’s good for the economy: “Although most Americans apparently loathe inflation, Yale economists have argued that a little inflation may be necessary to grease the wheels of the labor market,” Federal Reserve Board Chair Janet Yellen said years ago in a speech at Yale University.

However, the real reason the central banks need inflation is the mountain of debt in the private and public sectors that has accumulated over the years. As inflation robs money of its value, it also makes that debt easier to repay.

Every academic will suggest [that] the lower the cost of money, the more people will want to borrow and spend.
— Grant Williams, RealVisionTV

Take this example in regards to the federal government: Even if output adjusted for inflation doesn’t change over the year, but prices rise 100 percent, tax revenues should also rise 100 percent. All things being equal, the federal government would be able to eliminate the budget deficit and even repay some debt. The same is true for private debtors.

After the Great Financial Crisis of 2008, inflation in the developed world has been anemic and so has growth. But debt, whether public or private, hasn’t gone down significantly, so central banks have kept pushing interest rates lower in a concerted effort to create inflation.

“For a number of years, at every sign of a slowdown in the economy, the central banks have lowered rates to stimulate the economy. Every academic will suggest [that] the lower the cost of money, the more people will want to borrow and spend,” says Grant Williams, strategy advisor to Vulpes Investment Management and the founder of RealVisionTV.

They haven’t been very successful: Consumer prices in the United States rose only 0.85 percent from March 2015 to March 2016.

With interest rates at or near zero in the short term in most countries, central banks and commercial banks are now pushing the envelope to lower interest rates to negative: first, negative rates on deposits the commercial banks keep with the central banks; then negative rates on deposits the consumers keep with commercial banks.

Don’t believe it? This bank in Switzerland is already doing it: Alternative Bank Schweiz AG is the first bank in Switzerland to pass on negative interest rates charged by the central bank to the consumer. Clients have to pay 0.125 percent per year to keep their checking and saving accounts with the bank.

Alternative Bank Schweiz AG is the first bank in Switzerland to pass on negative interest rates charged by the central bank to the consumer

According to the proponents of this novelty, this will force people to save less and spend and invest more, thereby moving up prices. At least according to the theory, they will act this way—after all, who would lose money rather than spend or invest it?

The Consequences

Let’s assume you want to retire on $1 million in 20 years, do nothing, and accept the negative rate. Whether you want to have a lump sum at a particular point in time or choose an annuity, the mathematics of negative interest rates are the same.  

If the interest rate was a positive 5 percent, as it was not all too long ago, you would need to save $395,734 right now to make that happen. Guess how much money you would need right now at a mere negative 1 percent: $1,210,407, difference of $814,673, which you would have to get from elsewhere to make up for the difference. This is not even considering the loss of buying power of the $1 million if the central banks succeed in creating inflation.

Although, the -1 percent sounds inconceivable right now—after all, Bank Schweiz is only charging 0.125 percent—we could get there eventually if the central banks don’t generate the inflation they want. Already, shorter-dated government bonds in Japan have been trading at -0.6 percent, and Danish and Swiss Central banks had their deposit rates as low as -0.75 percent in 2015.

“Where do you draw the line, do you take rates to minus 4, minus 5?” Williams asks. At some point, human psychology breaks the academic models.

“What you have to put into the equation is human reaction. In a crisis, humans tend to hoard and pay down debt rather than spend more. Human behavior doesn’t fit in any model,” Williams says.