Since time immemorial, religious systems have dealt with the devastating consequences of usury and the suffering of the poor at the hands of moneylenders. Babylonian kings celebrated days of national debt cancellations.
The Gospel according to Luke (6:35) demanded to “do good and lend, expecting nothing in return”. The Quran (2:275) ascertains that “those who charge usury are in the same position as those controlled by the devil’s influence”.
But none of the great religions could have imagined a topsy-turvy world where debtors are not charged anymore but paid handsomely for their readiness to accept credit.
Yet this is what we witness today at ever increasing speed. Countries, companies and supra-national organisations get paid for raising credit, while savings and bank deposits are punished with ‘negative interest’. More than a quarter of all securitised debt on earth, a total exceeding $16 trillion as per today, ‘earns’ negative interest. It means that we lose money as we lend, and earn money when we borrow.
Sadly, this does not include our credit card debts which are today’s equivalent of the usurious evils condemned by founders of religions and moral philosophy. And it does not include countries on the brink of bankruptcy either, even if we and they could do with a little debt forgiveness. It enables countries like Germany, Switzerland and Japan, to name but a few, to borrow and earn money at the same time.
Why such historically unique circumstances are not used to invest in infrastructure, research and procurement of other public goods is a riddle. The shock of the Big Recession of 2009 has resulted in ever more frugal behaviour of public coffers, preferring to reduce outstanding debt to boosting income through wise investment.
It is the subject matter of economic discourse whether the extraordinary rise of negative interest rates is the consequence of a secular, ‘natural’ fall of interest rates since the 1980s or a phenomenon forced upon us by central banks flushing the financial system with ever bigger quantities of money to stave off the painful consequences of the recent – and the next – recession.
The idea behind central banks’ thinking was that the inter-bank markets, where banks lend their excessive deposits to other banks to keep the credit cycle going, had dried up as struggling banks stopped lending altogether. It would now be for the monetary authorities to step in to stimulate the economy with massive liquidity.
Without wading in this rather academic dispute, with both sides raising valid points, we are left with a situation that was meant to last no longer than the recession itself but came to stay. Our savings will pay nothing. Banks are still wary about lending to each other and prefer to park their excess deposits with the ECB at a cost of -0.4 per cent per annum.
It is only logical that banks, creaking asthmatically under the burden of new regulation and an outdated business model, want to pass on this cost to their own depositors. It is a difficult decision, as the financial crisis has taught them that deposits, not the wholesale markets, will help to avoid illiquidity. And they fear the wrath of their retail customers, small savers like you and I. Too engrained is the virtue of the savings account in our piggy-bank culture to gladly suffer financial punishment for perceived prudence.
For us savers and small investors, meagre or even negative yields can make sense, as a premium to be paid for safety
This leaves big savers on the hook – like cash-hoarding corporations, saving pension funds and insurance companies. Swiss banks, already suffering negative interest of one per cent, have shed their timidity and begun to charge their biggest depositors. The Swiss tax authorities, perhaps the biggest bank depositors in Switzerland, have therefore asked their citizens to NOT pay their dues immediately to avoid costly deposit built-ups at the beginning of the financial year.
German and other European banks will soon have to follow suit. German insurers have already started to plan for the construction of secure vaults to store cash physically should charges creep up any further.
So far the costs of bank deposits reflected in negative rates do not surpass the costs of storage and insurance of cash. But it is a matter of time. It would be anything but surprising if an exchange-traded fund were to soon start offering participation in a stash of physical money, not dissimilar to gold ETFs.
Where does this leave us retail investors? As the ECB seems adamant on yet again starting to gobble up governmental and corporate bonds, it will put yields under further pressure. Securities of good credit-standing are not only yielding nothing these days, they become loss making by design. And they are becoming rarer, further boosting their price and therefore suppressing yield.
Like all other investors we’ll have to risk more to achieve a desired income – a strategy annihilating the price of risk and steering savings and investments into the danger zone. In the search for yield, countries on the fringe of sensible investment, like Kyrgyzstan, Tadzhikistan, Lebanon or Mali, seem worth the wager nowadays.
I’d wish to argue that investment into negative-yielding securities is not as foolish as it may seem at first glance. For many an investor, investing in negative yields makes sense. Negative nominal yields are a novelty for sure, but negative real yields have existed before. When inflation rates are higher than nominal yields, the result for the investor will be negative all along, as happened in the 1970s when inflation distinctively exceeded nominal yields. Yet we saved in our saving accounts and invested in bonds without ever hesitating. It just looked good to see savings double in seven years or less, even though the purchasing power of our Maltese pounds deteriorated way beyond our proud saving results.
For life insurers and pension funds, falling yields result in higher coverage needs. As interest rates fall, they diminish the present value of their investments. As a result, they have to save more to cover their payout obligations. Investing in meagre or even negative yields arrests this corroding process, as bond prices, even the most negative-yielding, will rise. A bond paying two per cent when interest falls to one per cent is just that much more valuable.
Two years ago Austria issued a 100-year bond promising interest income of a miserly 2.1 per cent. What looked insane a while ago suddenly makes sense when compared with the 50 per cent price rise of this bond over the last few months. Investors in such debt, which our great-grandchildren may hopefully see repaid, made a killing matching the most successful stock market IPOs. Who said that bonds are boring?
All along, astute investors subscribing to the Austrian bond avoided higher credit risk and the pitfalls of illiquid investments. As the banking crisis has shown, leaving cash in one’s bank accounts carries huge risks. Banks cannot only go bust, they regularly do. Cash exceeding the European deposit guarantee of €100,000 is, in fact, an uncovered credit to your bank. If BOV goes bust, you would not get a penny more than the guarantee. This is why banks are so hesitant to pass on negative interest rates. We, in fact, insure their liquidity.
Therefore, for us savers and small investors, meagre or even negative yields can make sense, as a premium to be paid for safety. Sadly, one of the unintended consequences of quantitative easing, as the money creating impetus of the central banks is called, was that it did not boost lending or investment as much as it produced panic-fuelled increases in savings.
Seasoned investors hedging one currency against the other can achieve a positive return even with high-grade, negative-yielding government bonds. We retail investors, not capable of arranging forward contracts, interest rates or currency swaps, should refrain from reaching for higher yield, as tempting as it may be.
I have invested into two high-yielding bonds over the past few years. One was Banca Monte dei Paschi di Siena, which went bust together with my bond. The other was Burford Capital, a litigation finance business which suffered a reputational assault by an activist investor a few weeks ago. I did not want to see the outcome of the dispute and sold my bond at a loss of 25 per cent.
Germany’s 10-year bond, yielding -0.69 per cent at the time of writing, looks very compelling by comparison, doesn’t it? In times of mounting losses the least loss-making investment will reign supreme.
Andreas Weitzer is an independent journalist based in Malta. He reports on the economy, politics and finance. The purpose of his column is to broaden readers’ general financial knowledge and it should not be interpreted as presenting investment advice or advice on the buying and selling of financial products.
andreas.weitzer@timesofmalta.com