(AmericanProsperity.com) – For the first time in US history, interest rates on government debt have gone negative thanks to the impact of COVID-19. A week and a half ago, the Federal Reserve cut interest rates to zero. On March 25, one-month and three-month Treasury bill interest rates went below zero.
That begs an important question: what if negative interest rates in the future don’t just affect government debt?
What if it affects the money in your bank right now or your ability to spend in the future?
What “Negative Yield” Means
Currently, there are negative yields because there’s an extremely high demand for government debt held in the form of bonds. As the stock market has taken large hits, investors have moved their money into safer government bonds. The higher the demand for bonds, the lower the yield.
Buying a bond at a negative interest rate is a huge gamble. If held to maturity, it’s a guaranteed loss. However, if the bond is sold before maturity and while rates are rising, investors can make money.
In this case, the negative interest rates are not directly correlated to the Federal Reserve’s zero interest rate policy. However, it’s possible that, in the future, the United States could join European countries and introduce a negative interest rate that could affect everyone.
How Could Negative Interest Rates Directly Affect You?
Under normal circumstances, when you borrow money, you pay an interest rate. When you save money, you earn an interest rate.
When rates go negative, the exact opposite happens.
In that case, you’ll have to pay the bank to hold your money, but if you buy something on credit, you could make money.
Banks will not only begin to charge consumers for having money in their account, they’ll also be charged by the federal reserve for holding onto money. This may sound unintuitive, but it’s the logical opposite of how our system has worked for a long time.
This happens because, when rates go negative, it incentivizes strong levels of borrowing and spending. In turn, that ought to turn an economy around quickly. This could especially be the case in America where over 70% of economic growth is based on consumer spending.
It’s in everyone’s interest to not sit on money because it will cost you in the long run. By stimulating the flow of credit and increasing spending, everyone ought to win as the economy heats up. The Federal Reserve should increase interest rates back to a positive value when things get better.
What Are the Consequences of Negative Interest Rates?
For one, the biggest concern is that negative rates could cause a run on banks. People may not want their money in the bank due to the fees and will instead put their cash under the mattress. This would change the interest rate to zero percent, but bank runs can cause more economic harm than good.
The banks could also cause problems by instituting a “reversal rate.” If rates go too low, it could discourage banks from depositing money with the Federal Reserve. Instead, they’d convert their reserves to hard cash, which would strain the financial system.
In turn, negative rates could cause the very problem the Federal Reserve was trying to solve. Once it starts, prolonged negative rates could become a domino effect that has long-term damaging consequences. Just ask most of the European countries who have tried it and are stuck with them.
What Does the Future Hold?
Today we’re talking about negative interest rates for bonds. If the coronavirus pandemic continues for too long, the Federal Reserve may need to stimulate the economy more significantly than it already has, to get America back on track. The Fed may use negative interest rates in this scenario. As it stands now, we’ll all have to learn to adapt to whatever comes next, take advantage of the opportunities, and avoid new pitfalls.
This is certainly an interesting time to be alive!
~Here’s to Your Prosperity!
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