How Low Can Rates Go?

In North America at least, we are used to most interest rates being positive.  We go to the bank for a deposit and we are presented with an upwardly sloping set of rates.  We get some interest for making a deposit for 1 year, a higher rate for 2 years, and an even higher rate for deposits with longer terms.  The same is true when we negotiate mortgages on our homes.  Most of us are familiar with choosing between lower rates for short terms or paying higher rates to lock in for longer terms.  An upwardly sloping interest rate seems normal, but as some central banks in Europe are demonstrating now, interest rates on bank deposits and loans don’t have to be positive.  They can just as easily be negative and it all makes sense.

Remember the origins of banking. Specialist groups built physical vaults where depositors could store their excess wealth.  This tradable wealth in the form of precious metals, coins, and other notes needed to be stored in a secure location and accessed from time to time as the capital was needed.  Depositors paid banks to safeguard these assets and were charged for this service.  The arrangement is similar to the precious metals deposit and leasing businesses of today.

Leap forward to contemporary Keynesian central banking. Central banks around the world are trying to manage their economies by managing rates of interest. Central banks believe lowering interest rates will give market participants an incentive to borrow and invest. But in a world of free floating exchange rates this incentive disappears. At any moment of time, everyone remains at square one in an era of instant global communications. The failures of central banking have been apparent for decades, but those committed to the idea that a central government should control and manage our lives won’t allow the central banking process to end.

So as central banks keep lowering interest rates, their policies will continue benefiting borrowers at the expense of savers.  Those with excess financial capital will continue to see the value of their capital eroded by artificially negative real interest rates. Since the wealthy are by definition always in the minority, it remains politically popular to bleed their savings with low rates. In addition, with since fewer citizens understand how markets function and more citizens are committed to social democracy, we can expect this trend to continue.  My suggestion for the poor, borrow to invest (in education, in business, and in financial assets) since you have nothing to lose (you’re already poor).