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By Charles Tan - October 2019
Even though interest rates in Europe and Japan have recently dipped into negative territory, the United States has never experienced negative rates.
Positive rates are a fundamental part of our financial system. Lenders get paid with interest payments for loaning money; borrowers are charged with interest until the debt is paid off. So, the current talk of negative rates feels like a monetary experiment—one that has several potential long-term consequences.
Negative rates upend the relationship between lenders and borrowers and could transfer wealth from savers to debtors. Furthermore, it could distort pricing in financial markets and erode our pension and banking systems.
So far, the Federal Reserve has resisted pressure to lower rates to zero or below. How will we get back to a normalized rate environment? Click on my video below for more insight.
I think negative rates are something that really is a monetary experiment.
It’s unconventional. If you think about our economy—our financial system—positive interest rates are really as fundamental as the sun rising from the East and setting in the West. Having negative rates—I think there are several potential, negative, long-term consequences.
One is, it will undermine our banking system because banking is all about borrowing at certain rates. The lenders get paid interest rates and the borrowers would pay interest rates. But what it does for the economy, really, over the long term is: it not only distorts price discovery in the financial markets. It is also an overt transfer of wealth from the savers to debtors. Over time, it will erode our pension system, our insurance companies, and hollow out our banking system.
The United States has never had negative interest rates in the past. As a matter of fact, negative rates are a pretty recent phenomenon. There’s a lot of pressure on the Fed (Federal Reserve) to lower rates all the way to zero—even negative—not only from the president but also from financial markets. But I think the Fed as an institution has done an amazing job of staying independent in conducting monetary policies. If you look at the September Fed meeting, they have made the decision to lower rates by 25 basis points (0.25%). They have been very independent as an institution, but also the individual voting members’ assessment of the economy.
To get back to a normalized interest rate environment, I think both the inflation and economic prospects have to improve substantially from where we are today. The Fed also mentioned the U.S.-China trade war, as well as global growth as the reasons why they’ve been cutting interest rates. So, for us to get back to a normalized rate environment, all of those conditions have to improve. I think that’s a pretty tall order for an economy that’s already experiencing the longest expansion on record.
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Generally, as interest rates rise, bond prices fall. The opposite is true when interest rates decline.
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