Negative Interest Rates Bad Idea, Analyst
A distinguished financial blogger has labelled negative interest rates policies (NIRPs) as bad news that signify central banks’ “insanity, impotence and desperation,” and which are likely to prompt profit-seeking lenders to resort to “modern-day Bernie Madoffs,” other than stuffing their life savings under their mattresses.
“I feel less comfortable with the notion that central bankers know what they are doing and that we should trust them with our economic fates,” Aswath Damodaran, Professor of Finance at the Stern School of Business at New York University, wrote in a blog article posted this month. (Source: “Negative Interest Rates: Impossible, Unnatural or Just Unusual?” Blogger, March 11, 2016.)
The 59-year-old expert predicted negative interest rates would have negative consequences as countries representing almost a quarter of global gross domestic product (GDP) now have sub-zero interest rates–including the eurozone, Switzerland, Denmark, Sweden, and Japan.
Damodaran said the lowering of rates by central banks can have unpredictable and often perverse consequences, lowering financial asset prices, reducing real investment, and making a currency stronger rather than weaker.
“As I watch central bankers preen for the cameras and hog the limelight, I am reminded of the old definition of insanity as trying the same thing over and over, expecting a different outcome,” he wrote. (Source: Ibid.)
“After six years of continually trying to lower rates, with the expectation of economic growth just around the corner, it is time for central banks to perhaps recognize that this lever is not working,” he added. (Source: Ibid.)
Earlier this month, the European Central Bank (ECB) further loosened its monetary policy, cutting its key lending rate from 0.05% to zero. The Federal Reserve, meanwhile, decided to leave its benchmark interest rate in the range of 0.25% and 0.50% and trim the number of expected interest hikes from four times this year to two. The latest country to adopt a negative interest rate policy was Japan, when the Bank of Japan trimmed interest rates in January to -0.1%.
The Indian-born economist said that with rates hitting zero and going lower, there will be some investors, in need of fixed income, who will look in “dangerous” places for that income.
“A modern-day Bernie Madoff would need to offer only four percent in this market to attract investors to his fund and as I watch investors chase after yieldcos, MLPs and other high dividend paying entities, I am inclined to believe that is a painful reckoning ahead of us,” he wrote. (Source: Ibid.)
Madoff is an American fraudster and a former stockbroker, investment advisor, and financier. He is the former non-executive chairman of the NASDAQ stock market and the admitted operator of a Ponzi scheme that is considered the largest case of financial fraud in U.S. history. (Source: “Ex-Nasdaq chair arrested for securities fraud,” CNN Money, December 12, 2008.)
Damodaran said he does not believe that investors will keep their money under their mattress, because that choice will increase their exposure to theft, let alone the fact that there are transactions that are extraordinarily cumbersome to get done with cash, such as buying a million-dollar house and counting out the cash for the payment.
He also expects that negative interest rates will be an opening for digital currencies, including bitcoin.
“The more central bankers in conventional currencies play games with interest rates, the greater is the opening for a well-designed digital currency with a dependable issuing authority to back it up,” he wrote. (Source: Blogger, op cit.)
Aswath Damodaran is best known as author of several widely used academic and practitioner texts on valuation, corporate finance, and investment management. He holds an MBA and PhD from the University of California, Los Angeles, along with a BComm in accounting from Madras University and an MS in management from the Indian Institute of Management Bangalore.