Wasteful saving and the curious case for negative interest rates
Oscar Wilde’s whimsical 1800’s quote “money was made to be spent, therefore, to save it is a waste of money” recently became true. This is the result of the growing global phenomenon of negative interest rates.
Interest rates play a key role in our lives because they denote the cost of money and, like any cost, obey the laws of supply and demand. If money is scarce the cost it is high, and if money is abundant the cost should be low. Negative interest rates are therefore the natural consequence of an oversupply of money relative to its demand. This sounds a bit strange because most of us are not used to the idea that money is too abundant in the world today.
At the time of writing this note (October 2019) the amount of money yielding negative interest rates has climbed to over $17 trillion and continues to increase. This means that depositors are actually paying banks to hold onto their savings. Until now this has only really played out at the level of banks and central banks, but interestingly the phenomenon is now starting to directly affect individuals. Some German banks have started charging negative interest rates on retail deposits. For example, one of the country’s largest lenders now charges retail clients -0.5% on deposits exceeding 100 000 euros, and other banks are expected to follow. In these instances, the customers could actually be better off stashing their savings under their mattress or beneath the squeaky floorboard. Weirdly, the mattress is back in play as an alternative to a bank account as a savings instrument.
So how did the world get itself into this situation? It seems there are two key reasons, and you are probably using the second right now.
The first reason is that until quite recently money has been relatively scarce. Savers are normally rewarded for saving because on the other side of their savings have been borrowers who have found money hard to come by and have been willing to pay a premium to use somebody else’s savings for a while. However, over time savings have built up and have accumulated a lot of interest, with many saving pools now having earned huge sums of interest (and even interest on interest earned a long time ago). In this way the mathematical law of compounding has added a lot to the amount of savings in the world. Under normal circumstances borrowers are able to pay for the privilege of using somebody else’s money because they invest it in the economy to get a return, and if they are skilled or lucky - a profit. The difference at the moment is that, at the same time as savings have become way more abundant, the number of opportunities to invest money into the economy for a profit have become scarcer. This introduces the second reason we are seeing negative interest rates on deposits, the internet.
The computer, tablet or phone you are looking at right now uses technology that has fundamentally changed the way goods and services are acquired and consumed. This is because the internet is very good at taking the ‘middlemen’, or intermediate steps, out of transactions. Take your own shopping experience as an example. Before the internet you would be forced to physically shop around for the best price. This may mean having a look at the phone book or Yellow Pages, making a few phone calls, spending money on getting to at least one mall or market, probably paying for refreshments during the outing/s and possibly adding in a few other incidental purchases along the way. That night you might travel to a video store to choose a video for entertainment and pick up a takeaway to celebrate the great deal you got yourself that day.
However, these days you probably shop online to browse hundreds, if not thousands, of suppliers to get the best price almost instantly, and then have the good/s delivered to you within days or hours. In the evenings you might rent a movie on Netflix and order an Uber meal, all from the comfort of your home. It’s just so much more convenient and efficient since the internet, which is why it works. But removing the middleman has consequences for the middlemen. It reduces the aggregate amount of economic activity and the number of opportunities to turn a profit in the economy. These opportunities are mopped up by more efficient internet-based operations, some of which aren’t turning a profit yet either.
Have you ever wondered why some technology companies like Facebook and Uber could list on the stock exchange without producing positive earnings growth yet? One reason is the excess supply of money and the relative scarcity of opportunities to invest for a profit. Investors have been more willing to invest in businesses on the promise of potential future profits and in the hope that other investors do the same and bid the price of the company’s shares up. So far this has worked out quite well for many of them, although it does not necessarily help to increase the number of opportunities to make a profit in the economy, and hence, lift the demand for money relative to its supply.
The implications of all this for interest rates is that the demand for money remains low relative to its supply, which is driving the cost of money lower. Some think that negative interest rates will eventually solve this problem by gradually reducing the amount of savings while at the same time incentivising savers to rather lend their money into the economy. This could work because instead of growing by a positive compounding effect, savings pools could eventually shrink by negative compounding thus reducing the supply and increasing the cost of money over time. But what if this doesn’t happen? What if instead of just reducing savings to more ‘normal’ levels through negative interest rates, central banks also step in to pump more money into the system through different channels as a way to try and fire-up economic activity and the demand for money? (As I write this the Federal Reserve, the Bank of Japan and the European Central Bank are pretty much doing just that, and at a massive scale.)
Both options could help to restore the value of money through returning the balance between its supply and demand. Yet, in the age of the internet the ability of central banks to spark demand for money in the rest of the economy remains to be seen.
The long and short is that until we know more about how technology plays out for the economy’s demand for money ‘wasteful saving’ may, curiously, be a sensible way to restore its value.