Negative interest rate is hard to get your arms around, mainly because they make no sense. As a lender, YOU are the one with the capital. YOU have the asset. It stands to reason that if you “lend” that asset to someone else you should be compensated for it.
This compensation is payment for a combination of 1) the loss of the use of your money while you lend it to someone else to use, 2) the loss of purchasing power during the loan period and 3) the possibility of default by the borrower.
When interest rates go negative, where you as the lender are willing, at the outset of the loan, to receive less than the loan amount, then the world of finance has truly gone insane.
Welcome to the crazy European world…
Right now in Holland, Germany, Denmark and Switzerland there exists a realm of negative interest rate. Buyers of bonds in these countries are agreeing to receive back less than they invest… and this is not a case of default. These are the strongest countries in Europe!
So why would anyone agree to such a situation?
It is simple: investors are paying for protection. Just as with the mafia, they are worried about being robbed.
The combination of factors above, which typically determines the interest rate borrowers pay to lenders, is being overwhelmed. Is it because of purchasing power concerns? Fuggedaboudit.
How about loss of the use of your money? Who cares? There’s plenty of money to be had by quality borrowers. These countries holding investors ransom don’t need your money. The only game in town is figuring out where a pension fund or large company can stash 100, 200 or 500 million euro (or euro equivalents) and have any hope of getting the money back.
Some things are certain. No one wants to put their money in Greece, or Spain, or Italy for that matter. Some other things are certain but not as obvious – no one wants to put money in a European private bank.
When you take out the weak sovereigns and then the European banks, it only leaves a few places to put large sums of money. Suddenly, the strongest countries in Europe are in the driver’s seat. They can demand that lenders pay them for the privilege of owning their debt because there simply isn’t anywhere else to go.
When this will end is anyone’s guess, but it cannot go on forever. The euro zone is frozen, with falling GDP and rising unemployment. The Greeks are not paying their taxes or their bills. The Spanish are just now feeling the cut of austerity. We’ll see how that pans out. Meanwhile, the euro keeps marching lower, having ducked below $1.21 per euro.
So what now?
Well, as we’ve said before, we think the U.S. dollar will get stronger… not because we do things so right on this side of the pond but because things are so messed up everywhere else.
Stay long the U.S. dollar (which we’ve owned in the Boom & Bust portfolio for some time now) and look for the euro to break $1.20 soon.
And the next time you feel like screaming because your paltry money market fund earns 10 or 15 basis points while inflation is 1.7%, remember that at least your interest rate is positive.
Ahead of the Curve with Adam O’Dell
The Euro is One Day Away From…
Market analysts and investors watch multi-year highs and lows closely because they act as clear “lines in the sand.” And when a stock, or currency, is in the “mushy middle,” they can debate its valuation.