6 October 2015

The Path Towards Negative Interest Rates

As we outlined in the last article, the big enemy of the Central Banks right now is higher interest rates. In Europe, Japan, China and the US normalizing interest rates will be devastating for economies that have too much debt. As the Allianz Global Wealth Report 2015 outlined private debt rose in North America by 2.7% to 82.7% of the GDP. And this is „just“ private debt not to speak of the public debt. 

Even if the US Fed raises rates by one quarter of a percent later this year, the Central Bank will attempt to keep rates at low levels for a long time. However, the problem for the Fed is that the bond market is very likely close to a change in trend. 

Once this happens the Central Banks ability to keep rates at artificially low levels will be over. The market will eventually force the hand of the Central Banks and demand higher rates. Most investors know that the debt binge is unsustainable.

However, predicting the timing of a change in trend in the bond market is not always easy. As a result, we wanted to share with readers what Governments and Central Banks are likely going to try an pull off over the short term.

Banning Cash is the First Step 

The key to implementing negative Interest rates is to first ban cash. Central Banks have a „2% inflation“ goal as they think this is healthy for an economy having learned from the past about the devastating effects of deflation. However in order to reach this goal Central Banks need to stimulate the spending. And this is either done in the first step with lowering interest rates, which we have seen from 2008 until now. 

After this move is completed and the goal (2% inflation) is not reached the next step is to go negative to force people to consume and stimulate the economy.

Now this is the theory. Let’s have a look at the real numbers from the Allianz Global Wealth Report 2015: In 2014 Europeans added 6.7% to their savings despite low interest rates. Public debt rose moderately by 1.3%. So the idea of stimulating the economy

by lowering interest rates worked out only to some extend. People decided to save instead of spending own or borrowed money.

So the next step logical move is to eliminate all large bank notes as a first step in the process of banning cash. In an article in ZeroHedge a former Bank of England Official was quoted as saying: 

“Let’s get rid of all high-denomination notes as a starter,” Goodhart said. “If we were limited to low-denomination notes, at any rate because of the costs of stockpiling and all the rest we can drive interest rates a little bit further down”. (Source: ZeroHedge 2015 September 25th)

The justification of such a policy is to curtail the use of high denomination notes in drug trafficking. Its interesting how moving rates lower was also stated as an objective to removing large notes from circulation.

The problem for Central Banks is that when you move rates to negative it discourages people from having a savings account. Why would you pay a bank interest to store your paper money? Negative rates mean that lenders pay interest instead of borrowers.

By eliminating cash it prevents people from hoarding paper money. This paves the way for negative interest rates to become a reality. It will also protect financial institutions from bank runs. Cash undermines the fractional reserve banking system. In times of crisis, bank runs would be easier for policy makers to control if there were no cash.

The Move to Negative Rates

In an article in ZeroHedge as reported by the Telegraph, Bank of England Chief Economist has supported implementing negative interest rates in England, and suggested that cash could have to be abolished.

The reasoning for such an extreme policy suggestion is the deflationary forces that are gripping the UK economy. He pointed out that "there could be a need to loosen rather than tighten the monetary reins as a next step to support UK growth and return inflation to target”. (Source: ZeroHedge 2015 September 18th)

Its not just in England. According to a recent article in Bloomberg, one Fed official wants negative rates in the US.  

Bloomberg reports that for the first time ever, one monetary policymaker thinks the U.S. needs to move to negative interest rates until at least the end of 2016 to achieve full employment and get inflation back to 2 percent. (Source: Bloomberg 2015 September 17th)

By implementing negative interest rates Central Banks may force all citizens to have a bank account. With the introduction of negative interest rates bank accounts will automatically be reduced by the announced interest rate. For example if the interest rate is minus 1% then every 10,000 Euro will be deducted by 100 Euro at the end of the year. The account balance will then show: 9,900 Euro.

The Fate of Pension Funds

The big driver to force negative rates on society is that it would enable the Central Banks to fight deflation. The problem is that the world is too indebted to handle higher rates. Higher rates could cause a major financial crash, and policy makers no doubt know this.

However, lowering rates even more will also cause a major financial crash of a different kind. 

In an article in ZeroHedge, Moody’s has estimated that the 25 largest U.S. public pensions alone have $2 trillion less than they need. (Source: ZeroHedge 2015 July 18th) This is not just a problem in the US, many countries around the world are facing pensions deficits that will not easily be balanced. 

Many pension funds are required to invest a large portion of the funds money in highly rated securities. This is typically done by investing in Government bonds. With interest rates at zero, pension funds are not achieving their investment targets and many are experiencing extreme shortfalls.

So negative rates will push pension funds deeper into the red and many will eventually need to bailed out. And it is no secret, in the German main stream press CEO's of big insurance companies repeat themselves that the promises made can't be held with low or negative interest rates. Trillions in pensions are endangered any yet investors around the globe favour these investments. 

Gold and Negative Interest Rates

Should Central Bankers get their wish and be successful implementing negative interest rates, how would Gold and Silver perform in such an environment? A negative interest rate environment would mean that deflation is the primary problem that policy makers are faced with. 

In such an environment Gold may move sideways in price until a big systemic collapse hits. However, Central Banks will fight deflation with money printing and in all likelihood we will see quantitative easing like never before. This will add to the turbulence in the currency markets and destroy the credibility of monetary officials.

The positive aspect with this development is that everyone will clearly see that paper-currency systems and every product within the system are not suitable for saving or building the wealth. 

Hard Assets and Re-defining Money

By eliminating or putting restrictions on cash, governments are removing yet another layer of freedom from society. This will reduce the overall confidence many people have in the financial system and will likely increase the awareness and interest in hard assets like the precious metals.

In addition, as the next phase of the economic crisis unfolds the currency and bond markets are going to be very volatile and uncertain. Many people will turn to Gold and Silver simply because they are hard assets that have a history of maintaining purchasing power. These metals are money.

A Simple and Powerful Solution 

The disruption in the currency and bond markets will inevitably spill over into the banking system. It is becoming increasingly difficult to evaluate the safely of banks and financial institutions today.

As a result, reducing exposure to the banking system and adding physical Gold makes a lot of sense. There are a number of high quality secure storage facilities for Gold and Silver bullion. Gold is a very liquid asset that can be converted into paper currency easily.

Always remember that gold and silver do not carry any counter-party risk and they can’t go broke.


As one can see by reading the last two articles on interest rates, predicting how the next crisis will unfold is complex. Whether interest rates rise or fall the challenges coming to the global economy will be significant and even severe in some regions of the world.

Regardless of what happens Gold has a history of preserving wealth in times of crisis when compared to most other assets. 

Author: celticgold.eu

Older CelticGold Market Report 27th September 2015 Newer The Case for More Money Printing