Economics, Videos

Tim Bennett Explains: Why negative interest rates are a non-event for most investors

Tim Bennett Explains: Why negative interest rates are a non-event for most investors
Published on Feb 29, 2016
This week I explain why the hullabaloo around negative interest rates shouldn’t distract long-term investors.

0:11welcomed this girl explains finance video this week while long-term
0:16investors should not worry about negative interest rates leave the
0:20worrying to journalists don’t panic and do not be tempted to change your
0:25investment strategy so first of all what is this negative interest rate world
0:30when our well it’s kind of through the looking glass is Alice in Wonderland
0:34because normally the world we know features positive inflation albeit low
0:39prices the goods and services tend to rise we expect to earn more money more
0:44employers next year as opposed to this year and so what equally you tend to
0:49expect to earn a positive interest rate on cash at the bank that’s the normal
0:54way of this however the new order or what could become the new order features
0:59a rather different world we’ve got zero inflation or even deflation prices
1:04gradually falling over time
1:06implication in theory should be negotiating a pay cut to the end of the
1:09year na pay rise and flat or even negative interest rates the bizarre idea
1:14you might put money on deposit and someone could charge you for putting it
1:19there well that’s kind of upside down topsy turvy is what’s going on
1:22well the normal world is an engine is this introduced three characters you a
1:27commercial bank where you might keep your money and a central bank behind the
1:31scenes and the relationship is fairly similar in both cases you would normally
1:35put your money you want to save keep for a rainy day for example into a
1:39commercial bank behind the scenes they keep medical reserves with central banks
1:44the Bank of England central bank the Federal Reserve’s in Andhra Bank the
1:47Bank of Japan’s central bank and so on and the normal cycle of paint is those
1:53banks can earn a small amount of interest admittedly on those reserves
1:57and you hope to add a small amount of interest on the money you’ve left with a
2:03everybody’s kind of
2:05now in a world of negative interest rates you get slightly weird thing
2:09happening money goes on deposit commercial bank those banks keep
2:13reserves with central banks then what happens is those central banks apply an
2:19interest charge of money that sitting with them so that is a bank putting
2:25money on deposit a big charged for leaving it there a little bit crazy so
2:30does that mean you might get charged for leaving your money whether commercial
2:35well let’s take a look at just a moment now three questions emerge from this how
2:40widespread is it why central banks doing this at the moment and what could the
2:46knock-on effect be over here take a look at those in order first of all it is
2:52getting more and more common for central banks are stressed central banks to
2:56apply negative interest rates if you look around the world in 2016 for
3:01example using Bloomberg data
3:02Sweden and Denmark glad negative right central bank to commercial banks on
3:06their reserves as it’s called the eurozone’s jumped in recently
3:10Switzerland kind of leading the pack and even the bank of japan’s come in and
3:14apply the negative rate the money left on reserve with it by other banks so
3:20roughly a quarter of the world’s GDP according to some estimates his
3:24generation in countries where the central bank has applied negative rates
3:28why what’s the logic or what they think will happen this is a central bank will
3:33do what they think is commercial banks will cut the rate that you and I and
3:39businesses going on deposits that will get us to shift money away from the
3:44public and spending it is borrowing so commercial banks need to make more loans
3:49why is that they can earn money on the central bank deposits gotta make up the
3:52money somewhere and banks will invest in riskier assets it won’t be worth I’m
3:58leaving money on cash deposit moved out into the wider economy and get it going
4:03equally savers won’t want to say who want to leave their money on deposit and
4:08actually be charged for doing that for spam or cash
4:12and take advantage of new loans economy moving everybody’s happy is sort of the
4:18theory but there are plenty of critics around you say hang on a minute okay
4:22let’s go back to that scenario whereby the central bank is charging a
4:27commercial bank leave money on deposit what will really happen over here i mean
4:31retail banks gonna start charging consumers to leave money with them and
4:36who’s gonna go first cuz it’s not really first-mover advantage being the first
4:40person to the market to make those headlines do banks actually wanna make
4:45risky loans over while encouraging them to make risky loans moved money into
4:48riskier assets but bank balance he’s been hammered hard enough after credit
4:52crisis most Madonna get their act together are they really gonna be forced
4:56into this by central banks and do consumers actually want more credit and
5:00ironically consumers my end up doing the exact opposite of what central banks
5:04think they’ll do in this scenario by more than just a moment here in the
5:09short-term risks then what is negative interest rates which is this weird world
5:13were not used to cause panic cash hoarding as people think well actually
5:17what I’m gonna do is sit on cash under the mattress or maybe something like
5:22gold for example because I know the worst that can happen is I just don’t
5:27own anything all that money but i get charged with leaving at a bank
5:31ironically consumers might spend my whole more instead and you might even
5:36get a suspending strike people think what is happening is it because prices
5:40for goods and services of falling so I’ll just wait a year to buy that new
5:44computer paper in a year and negative interest rates are indicative of a trend
5:48so this could all kind of backfired in terms of what central banks my name i
5:53think’s going to happen next
5:54now question that he’s well I’m a long-term investor I’m not a short-term
5:59panic or hold up what do I do with what information do I worry about the
6:03headlines no remember as a long-term investor it’s the long-term average real
6:09right post inflation rate of return on your money and how it compares to other
6:14places you could leave your money that matters with equity investor headlines
6:18about negative rate should be taken with a pinch of so look back the parties now
6:23going to the future
6:24over last 50 years with his attorney is the important points not the absolute
6:29number but they’ve turned in a consistently higher significantly higher
6:33real return annually than either government IOU’s in the UK or cash and
6:39then once promising that continue in the future but the point is how the negative
6:43interest rate impact a picture and the answer is they don’t really other than
6:47realizing that with interest rates and inflation close to or below zero nominal
6:53rates and real rates have to come down and moved close together will mean that
6:57people daily where can I get a percent right now we all struggle to get a
7:00percent let you take a lot of risk the board in the days we get 8% inequities
7:04inflation was probably 30 our time was five if you can get 45 percent normal
7:10and inflation is zero or even negative there’s your life you know I’m saying so
7:16people just go just their expectations down through the kind of new normal in
7:21that sense negative rates and negative inflation matter but in the broader
7:25picture sense they absolutely do not now
7:29conclusion that yes you’re gonna see a million headlines speculating on why
7:34central banks are doing this what it means for savers what happened next they
7:37could indeed be a short-term can’t reach it activity panic with say it isn’t so
7:43let’s just have a central banks to ponder if you like but for long-term
7:49online picture hasn’t fundamentally changed because of those headlines and
7:54you know sort of sorts brings to mind some people say that the increasingly as
7:58I do these videos I look more and more like Yoda so there is I would say think
8:02about changing what you can control managing what you don’t know the
8:08you can’t change the short-term experiments being conducted by central
8:12banks you can manage the way you react to all this noise around negative
8:17interest rates and that’s the important message to take away from this video you
8:22like to know more as I covered a lot of ground there and quite some jargon do

Negative Interest Rate

Get our newsletter and our in-depth investor case studies all for free!