Welcome to the Weird World of Negative Interest Rates

Central banks are doing what was once unthinkable. Will it save their economies?

It was long thought that interest rates could never go below zero. People would surely hoard cash before they paid banks for the privilege of holding it for them. But this year the European Central Bank, the Bank of Japan, and others have officially ventured into negative interest rate territory. It’s a bold experiment in economic stimulus—with big risks to global investors.

Right now there are a whopping $10 trillion in total negative-yielding sovereign bonds outstanding worldwide, according to a report by Fitch Ratings. Just as startling: 26% of the total value of J.P. Morgan’s global government bond index has a below-zero interest rate. The dynamic has even trickled into the corporate sector, where there are more than $300 million worth of negative-yielding bonds.

That has caused serious headaches for money managers, especially pension funds and insurance companies in Europe, which must fight over the increasingly scarce supply of relatively safe but positively yielding assets. The U.S. is also affected, even while the Fed maintains positive rates. According to Alex Roever, head of U.S. rate strategy at J.P. Morgan JPM -4.13% , 48% of the positive-yielding sovereign debt not held by central banks is U.S. Treasuries, meaning competition to buy U.S. debt is tougher than ever before, and demand could drive Treasury rates even lower.

All this would be manageable if the negative rates were seriously juicing the European and Japanese economies. But there’s not much evidence that it’s actually leading to more lending or higher growth. Meanwhile, signs of distortions in the system are growing, like data showing that sales of cash safes are surging in Japan, as households lose confidence in the banking system to protect their savings.

Torsten Slok of Deustche Bank Securities argues that better results would come from targeted stimulus of governments. Central banks have done what they can, he says, and “now the politicians need to do their job.”

Amid Brexit, China Gets a Dose of Economic Worry Along With More Power

As Chinese leaders tally up the losses and gains from Brexit, they likely have mixed feelings.

Beijing may be 5,000 miles away from London, but China cannot escape the shock waves of Brexit.
Prior to the June 23 referendum in the United Kingdom, Chinese leaders had maintained a studious silence on the issue because of their long-standing policy of non-interference in other countries’ domestic affairs. Now that the British voters have spoken, Beijing has to take a serious look at how Brexit will affect its economic and geopolitical interests.
Economically, Brexit is terrible news for China. Even though the UK, which had $78.5 billion in bilateral trade with China in 2015, is not among China’s top trading partners, Brexit could have an outsize impact on China’s future export performance.
If there is one message broadcast to the world by Brexit, it is the end of globalization as we know it. Political leaders in Western countries will likely roll back free trade in response to the anger and frustrations of their voters who have felt threatened, if not victimized, by globalization. As the greatest beneficiary of globalization and the world’s largest exporter, Beijing could see its future economic prospects dim as the world retreats from free trade and China’s export engine sputters.
The anticipated adverse consequences of Brexit for the UK economy will also force China to readjust its commercial strategy in Europe. In the last few years, Beijing has been wooing London with investments and potentially lucrative commercial opportunities. In his visit to the UK last year, Chinese President Xi Jinping announced deals worth $57 billion. Many Chinese companies have made the UK one of their favorite destinations of direct investment. In 2015, Chinese companies completed 22 major acquisitions in the UK. The biggest was the $9 billion purchase of a 33.5% stake by China’s General Nuclear Power Corporation in Britain’s Hinkley Point nuclear power plant.
If the UK economy deteriorates because of the uncertainty and loss of access to the EU market following Brexit, the value of Chinese investments will be impaired. Even more worrying is that should Brexit fatally damage London as a premier global financial center, China will have to shelf its plan to use London as a linchpin for the “internationalization” of the Chinese currency, the renminbi. In 2015, Beijing took several initial steps to execute this strategy. The People’s Bank of China floated 5 billion yuan-denominated bonds while the Agricultural Bank of China, a major state-owned bank, sold $1 billion in dual currency bonds in London. In the aftermath of Brexit, many major global banks may move their capital market operations out of London, which will lose its luster as a global financial hub. China needs to look for an alternative.
Nevertheless, China’s potential economic losses could be offset by some political gains from Brexit. Ideologically, Brexit is a godsend for China’s propagandists, who have lost no time in portraying the event as a convincing example of the dysfunction of democracy. Geopolitically, China could also benefit handsomely from the aftershocks of Brexit. Until roughly a decade ago, Chinese leaders viewed European integration positively since they believed that a strong Europe would be a counter-weight to American hegemony.
However, as rapid economic development has made China the world’s second-most powerful country, Chinese leaders have rethought European integration. A united and strong Europe is no longer in China’s interest because of the risk that the United States and Europe could form a strategic alliance to gang up on Beijing in the same way they contained the Soviet Union.
Subsequently, China’s European strategy has undergone a subtle but important change. It has shifted to cultivating ties with individual European countries and often pitting them against each other. So far, Beijing’s new strategy has been a resounding success. And the EU has not developed a unified response to Beijing’s “divide and conquer” tactics. Nearly every European country has its own China policy, which subordinates human rights concerns and security issues to commercial interests. It is instructive that these days no European leaders dare to meet the Dalai Lama anywhere in their countries. It is even more revealing that when China announced the establishment of the Asian Infrastructure Investment Bank (AIIB) last year, all the major European countries, led by the UK, rushed to join, apparently against the wishes of the United States.
Now with British voters opting to exit the EU, the UK will be weaker, and the EU will be even weaker. A diminished EU will not be able to stand up to China, and its internal woes will reduce its value as a strategic partner of the U.S.
As Chinese leaders tally up the potential losses and gains from Brexit, they likely have mixed feelings. If they could choose, Beijing’s pragmatists would undoubtedly prefer the certainty of the pre-Brexit world.
Minxin Pei is a professor of government at Claremont McKenna College and the author of China’s Crony Capitalism.

Here Are The 2 Smartest Ways To Use A Reverse Mortgage

What are the smartest ways to use a reverse mortgage if you are considering these lucrative home loans for older Americans?

A reverse mortgage is becoming a popular way to access your home equity and use the funds to provide an added vehicle toward retirement security. Recent studies have found that most retirees have about half of their wealth held in their home’s equity as they do in other savings accounts and retirement funds.

A reverse mortgage has been lauded in recent years because it can deliver steady income many years following retirement, throughout key golden years of age 62 (when you become eligible for one) through age 70. This, in turn, can enable retirees to defer Social Security payments, allowing them to reach their maximum payout level. What’s more, reverse mortgages don’t rely on current market conditions to pay out, and help increase cash flow to the recipient by eradicating home loan payments.

Lump Sum

By far, this is the most popular delivery method for reverse mortgages. It enables the elimination of the monthly payment, thus increasing cash flow and reducing overhead monthly expenses. It also results in a lump sum cash delivery that can offset unforeseen expenses and provide a financial safety net that covers anything that could suddenly arise, like unexpected medical bills.

Line Of Credit

You can also consider an HECM line of credit that is held in reserve. This gives you the option to take out funds only when you need it. For instance, it can enable you to protect savings in a bear market without having to sell your investments or deplete your portfolio. When the market recovers, returns on stocks can be used to pay down said line of credit. In addition, an unused line can grow over time, and it is not able to be frozen by the lender; provided that you adhere to the guidelines of the home loan.

There are many things to consider when getting a reverse mortgage. These are all topics that should be brought up with your financial advisor beforehand. Simple rules do apply. These include that you be the qualifying age of 62 or older; are the primary occupant of your home; have substantial home equity available; can demonstrate that you are able to maintain the home and pay property taxes and insurance.

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The Land Below Zero: Where Negative Interest Rates are Normal

In Copenhagen, bicycles take undisputed priority over cars and even pedestrians. A sizzling restaurant scene has made foodie fetishes of moss, live ants, and sea cucumbers. Despite a minimum wage not far below $20 an hour and some of the world’s steepest taxes, unemployment is almost the lowest in Europe. Parents happily leave infants unattended in strollers on the sidewalk while they stop in to cafes.

 

Clearly the usual rules tend not to apply in Denmark. So it’s no surprise that the country in recent years has added a major new entry to its sprawling repertoire of eccentricities: Since 2012 it’s been a place where you can get paid to borrow money and charged to save it.
Scandinavia’s third-largest economy (the population is 5 million, and there are about as many bikes) is deep into an unprecedented experiment with negative interest rates, a monetary policy tool once viewed by mainstream economists as approaching apostasy, if not a virtual impossibility. Companies—though not yet individuals—are paying lenders for the privilege of keeping funds on deposit; homeowners, in some cases, are actually making money on mortgages.

The Copenhagen office of SEB, which, like other Nordic banks, must grapple with negative rates.

Photographer: Giles Price

Most private-sector forecasters don’t expect Denmark’s central bank to go positive again until 2018 at the earliest, making the country a long-term petri dish for what happens when the laws of financial gravity are inverted. Although some dovish economists have advocated negative rates as a salve for deflation and anemic growth, if Econ 101 is to be believed they should have stomach-churning consequences: asset bubbles, capital flight, and the frenetic manufacture of very heavy vaults to hold money pulled from banks.
Central bankers looking to Denmark for evidence of such trauma aren’t likely to see much. If anything, they might find the Danes’ approach tempting. A certain amount of financial weirdness aside, their country is mostly free of the distortions economic theory tells us to expect, suggesting negative rates may deserve to move from taboo to the standard monetary policy toolbox.
That might be the wrong lesson to draw. Instead, the takeaway may be that negative rates can work—but only for some purposes and perhaps only if you’re Denmark. “It’s not the catastrophe that some people would have thought,” says Erik Nielsen, a Dane and the global chief economist at UniCredit. “But you’re playing with fire.”
To understand how Denmark came to be the land below zero, some context is necessary. The country’s sole border is with Germany, its biggest trading partner. Yet Danes have historically been ambivalent toward the European Union and in a 2000 referendum rejected joining the euro.
Denmark’s currency, the krone, was pegged to the deutsche mark from 1982 to 1999, and to the euro thereafter. Maintaining the peg is the sole mandate of the Danish central bank, so crucial is it to the economy. As the European debt crisis reached one of its periodic crescendos in 2012, investors seeking a safe haven piled cash into Denmark, threatening to push the krone out of its trading band. The benchmark deposit rate was already at 0.05 percent, leaving nowhere to go but down to reduce the country’s appeal to hot money. Denmark thus resorted to negative rates not to spur inflation—as Japan is trying to do, unsuccessfully—but to drive away speculators.

Source: Bloomberg

The battle to safeguard the peg is led from an orthogonal hulk of stone and glass in downtown Copenhagen designed by Arne Jacobsen, father of the modernist egg chair. Danmarks Nationalbank Governor Lars Rohde, who took office in 2013, has known negative rates for almost his entire tenure. On his first day, the deposit rate was -0.1 percent; it now stands at -0.65 percent. In his telling, Denmark’s choice is simple: The peg must be protected, and negative rates are doing that without great disruption. The central bank “will do whatever it takes to defend the peg,” he says in an office decorated in Nordic tones of blond wood. “There’s no sharp, disruptive movement when you pass below zero. It’s just working like very low interest rates.”
In the broad sense, that’s proved true. Bank earnings are in line with those of European peers, with new fees making up part of the cost of low rates; the amount of cash in circulation has climbed only modestly. Still, some Danes find themselves contemplating bizarro-world challenges to the normal way of doing business. In the neo-baroque parliament building, Benny Engelbrecht relates some of them. The 45-year-old Social Democrat lawmaker was responsible for business and taxation until 2015, a role in which he was forced to contemplate dilemmas like whether it would be legal to tax negative interest payments to mortgage borrowers as income. (It is.)
Last year the central bank flagged another alarming possibility. Fearful of angering retail depositors, banks aren’t yet taking haircuts from individuals’ accounts. Large and medium-size companies, however, are subject to just that. But businesses that prepay their taxes in Denmark receive modest interest on the deposits, which is credited against what they owe or are refunded. With no limits on prepayments, might they start using the taxman as an unofficial bank? Rules had to be hastily struck to limit how much a business could deposit, removing the dodge before anyone took significant advantage of it, Engelbrecht says.
For companies, there aren’t a lot of options. “You get penalized these days for having cash in the bank,” laments Jens Lund, chief financial officer of logistics group DSV. The firm found itself in a tricky situation in November, when it sold 5 billion kroner ($750 million) of shares to fund a takeover of rival UTi Worldwide. Short of renting a huge vault, that meant sitting on most of the proceeds at negative rates until the deal was finalized in January, at a cost of about 4 million kroner. Apart from shopping around for the bank that would take the smallest cut, Lund says, “there’s not much you can do about it.”

Copenhagen’s Superkilen park is as eccentric as the Danes themselves

Photographer: Giles Price

Conversations in Copenhagen these days turn quickly to real estate. The city’s in the midst of a construction boom, its center of urban gravity shifting inexorably toward a harbor crammed with new apartment buildings. At one end a whimsical, bikes-only bridge, the Bicycle Snake, squiggles between gleaming new construction. The water here is perfectly swimmable, and when office workers hop in for lunchtime dips in fine weather, it’s as if a gang of energetic summer camp counselors had been given control of a midsize metropolis.
There’s no question negative rates have driven up the price of owning a piece of this urban vitality. Apartment prices per square meter soared 43 percent between the start of 2010 and the end of 2015, according to real estate broker Home; in early May the International Monetary Fund urged the government to rein in Danish house prices.
Keeping the boom from getting out of control is partly the job of Jesper Berg, who runs what’s almost certainly the world’s hippest banking regulator. The Danish Financial Supervisory Authority occupies a converted warehouse in the gentrified neighborhood of Osterbro; it feels like a late-stage startup, complete with hardwood floors and an open plan. From a balcony with a sweeping view of downtown’s construction cranes, Berg concedes “we have some froth” in the urban housing market, “but not a bubble.” Compared with New York, London, and even Stockholm, Copenhagen real estate is still a bargain: $500,000 buys a decent two-bedroom.
If Berg is correct, that’s largely because the country regulates the housing market to a degree unimaginable in the U.S. It’s nearly impossible for a foreigner with no connection to Denmark to buy property, preventing inflows of overseas money. Banks apply stringent financial criteria to mortgages for buy-to-let properties; it’s hard for Danes to purchase homes they don’t intend to live in. Regulatory guidelines require minimum down payments of 5 percent and stress tests of borrowers’ finances against runups in rates. With the encouragement of regulators, banks have hiked fees on flexible-rate loans, nudging buyers into fixed-rate mortgages. The rules are even tighter for properties in Copenhagen.
Real estate players also argue that Danes, temperamentally, are a risk-averse bunch—especially with memories of a 2008 property crash still fresh. “I think people have learned from the last bubble,” says Karsten Beltoft, chief executive officer of the Danish Mortgage Banks’ Federation.
One of those people is David Garby, a 36-year-old website editor whose mother saw her apartment plunge in value after that bust. He and his girlfriend recently bought a new home, an 800-square-foot apartment just outside central Copenhagen. They opted for a fixed-rate mortgage at 2.5 percent, even though far lower interest was available at an adjustable rate—the result “of my Calvinist upbringing,” Garby jokes on a sunny cafe terrace. “I wanted to be conservative.”
Beltoft’s concern: What happens if negative rates move from medium-term peculiarity to long-term reality, reversing the fundamental principles of debt and savings in a way that makes the change seem permanent? Since the Code of Hammurabi legislated interest rates in the 18th century B.C., and perhaps much earlier, capital has had a cost; in modern Denmark, it often doesn’t. “I believe it will change the psychology,” Beltoft says. “That could be dangerous.”

Berg puts his apprehension about staying below zero indefinitely in terms that Danes, who cram the country’s white-sand beaches in the brief Nordic summer, can easily understand. “There’s a difference between standing on the beach in dry sand and moving into the water,” he says. “The further you go out, and the longer you stay there, the more problems you can run into.”

Campbell is a senior reporter in London. Levring covers Nordic economy and government in Copenhagen. With assistance from Tasneem Brogger, Frances Schwartzkopff, and Christian Wienberg.