February 6, 2020 • 22 mins
The monetary experiments with zero interest rate policy (ZIRP) and negative interest rate policy (NIRP) continue to be overlooked as the "new normal." What are the intended—and unitended—outcomes of these unprecedented policies? In this episode, Everett summarizes the economic risks associated with persistently low and negative rates. He also examines the argument that paying negative interest is not an unusual idea or practice.
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Episode Transcript
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Speaker 1 (00:03):
This is Breaking The Dollar the podcast that
dismantles some of the biggestmisconceptions about money.
Presented by Gainesville Coins.
Speaker 2 (00:23):
I am Everett Millman and this is Breaking The Dollar.
This week's episode is going totouch on a topic that I'm sure at
some point in past episodes Ihave in passing discussed and
that is NIRP and ZIRP, and thosestand for negative interest rate
policy a nd zero interest ratepolicy.
(00:45):
Now both of these things have been going on in the financial
world for a little while now, soI thought it would be good to
tackle them in a little bit moredepth. So we should start with
some basic definitions. What arewe talking about here? And when
it comes to interest rates untilvery recently, until after the
(01:06):
financial crisis, the idea ofhaving a zero interest rate
really wasn't even considered. Insome sense, it defeats the
purpose of interest ratesthemselves. Right now, I'm not
talking about how down the linein the economy you may have seen
offers for something where youpay 0% interest usually for a
(01:30):
limited amount of time.
Speaker 2 (01:32):
Yes, these types of promotions have existed, but
that's what made it a specialpromotion. That 0% interest rate
is sort of unheard of.
(01:41):
But in terms of policy, like on a national level where a
government or policymakers aresetting a national interest rate,
0% rates have never been a thing.The reason for this is relatively
obvious. If you are loaning outmoney, you want something in
return for letting someone holdthat money and use it. So the
(02:04):
idea of a 0% interest rate, youreally can translate that to free
money. It is essentiallyeliminating the cost of borrowing
money; free credit. So I guess Ishould step back and explain,
well where does this unusualpolicy come from? Why have
(02:24):
governments considered zerointerest rates? And the whole
motivation was to reinvigoratethe economy after the global
financial crisis. The quickestway to get money moving around
the economy again and gettingbanks to lend again was to
essentially make it as easy aspossible for people to get access
(02:46):
to that funding.
Speaker 2 (02:47):
If you were to tell someone you owe me nothing for
borrowing this money, that'sabout as good of a deal as it
gets. And although I will touchupon some of the problems
associated with these types ofinterest rate policies in this
regard, an objective observerwould have to say that the policy
sort of worked.
(03:07):
And when you think about it, why wouldn't it? Why wouldn't
someone or a business want a 0%interest loan? It's great. But as
you m ight h ave already guessed,the rabbit hole goes down
further. So in the United States,the Federal Reserve after the
financial collapse did instituteessentially a zero interest rate.
(03:28):
But in Japan, in Europe, theyhave experimented with negative
interest rates. To this day,there are still several major
countries like Japan and Germany,which by the way are the third
and fourth largest economies inthe world, that have resorted to
negative interest rates.
Speaker 2 (03:48):
So in this case the policy is even weirder still.
Instead of saying that credit ischeap or free, now with negative
interest rates, you are actuallycharging people to hold their
money in the bank or you arepaying them to borrow money.
(04:06):
So it is completely flipped on its head the way that charging
interest normally works. So whywould they do this? Why are
central banks around the worldsome of the biggest ones
resorting to negative rates? Itis such an unusual policy and the
main reason goes hand in handwith my explanation for zero
(04:28):
interest rates. It is intended tospur economic activity, make it
easy to kind of grease the wheelsof business and industry, but at
the same time it discouragespeople from saving their money or
keeping their money in a bankaccount on the sidelines.
Negative interest rates literallymean that you are losing money,
(04:51):
albeit a small amount and fairlyslowly, but nonetheless you are
losing money just to keep it inthe bank.
Speaker 2 (04:59):
The intended consequence of this is to put
that money into place so tospeak, to get it moving around to
get people to invest their moneyand do productive things with it
rather than saving it. Aside fromthat, there are some other
reasons that negative interestrates have not only been
(05:19):
attempted and implemented, but asI said, they are still here.
(05:23):
They are still a reality in many countries in the world. The
two other major intendedconsequences of negative rates is
to try and increase inflation,which is associated with economic
growth in general and also makesit easier to pay off debt over
time. So that is one piece of it.The second expected benefit is to
(05:45):
simply anchor all interest ratesof all kinds at a lower level. So
that might be a bit unclear. Theinterest rates set by central
banks, essentially the governmentinterest rate is really just the
baseline scenario for rates.
Speaker 2 (06:02):
There are all sorts of other interest rates charged
throughout the economy, whetherit's a business loan, a personal
loan, an auto loan, or a homemortgage. And so if banks can get
these very low or negative rates,then that means they can then
charge lower rates to theircustomers.
(06:22):
I have to admit that as another example where these sort of
experimental policies have atleast done what they were
intended to do, they have indeedlowered borrowing costs and made
credit for the most part moreaccessible across the economy. On
the other hand of course, zeroand negative interest rate policy
(06:45):
hurts savers and this effect istwo fold. On the one hand you are
literally charging peopleinterest to just save their money
or keep it in the bank. So that'sone way that it discourages or
hurts people from saving money.And as I pointed out, it is
supposed to drive inflation muchhigher.
Speaker 2 (07:05):
In turn, higher inflation means that your cash
and your money that is justsitting there in savings is
losing value. It is losing itspurchasing power relative to the
prices of other things.
(07:17):
So thus far you can see both the benefits and the potential
drawbacks to these policies. ButI'd like to focus for just a
minute on why they really arestill so weird. So I've heard
some very smart people in thefinancial press make some pretty
convincing arguments that weshouldn't think of negative
(07:38):
interest rates as anythingparticularly strange because
there are so many other financialarrangements that are essentially
imposing a negative rate on thepeople who use them. So for
instance, one example is thecapital gains tax. Anything you
do that generates a profit justby trading or investing your
(08:01):
money is going to cost you apercentage of that gain.
Speaker 2 (08:12):
Another example would be that you often pay a
commission to brokers orsalespeople anytime you buy
something or you buy a financialproduct.
(08:22):
Another telling example of this as it relates to my industry with
precious metals is that there isessentially a slightly negative
interest rate baked into owningphysical gold and that is what
they call the opportunity cost ofnot using that money elsewhere.
So because you could get apositive return from something
(08:44):
like a bond or even a corporatebond or other securities, the
fact that you're choosing not toown those financial products and
instead are just holding, meansyou are missing out on earning an
interest rate or gaining a rateof return on your money. Now,
this whole idea of opportunitycosts with gold is absolutely
(09:06):
true. However, if the gold priceis going up and you are gaining
purchasing power just based offof that price appreciation,
you're really not going to noticethat you're missing out on a 1%
or 2% yield somewhere else.
Speaker 2 (09:21):
Nonetheless, these are all case studies of how the
concept of negative interest doescrop up in certain sectors of our
lives. I think that there aremany, many more examples that
disprove that idea or that pushagainst the notion that it is not
abnormal for people to be payingnegative interest.
(09:45):
You know, you see a lot of attorneys who try civil cases,
who handle civil lawsuits. Theywill say that unless their client
wins, you don't owe us anything.In other words, they're saying
they will only get paid by takinga percentage of what their
clients make. I am sure you'veheard this in a radio commercial
(10:06):
or on TV somewhere. I'm notsingling out attorneys for this
practice, but can you imagine ifit was the other way around if in
exchange for that attorneyservices somehow they had to pay
you to be a client?
Speaker 2 (10:23):
I don't think that anybody sees that as a
sustainable business model.Granted, you can say that's
comparing apples to oranges andfair enough, but it is still
worth emphasizing that theimplementation of negative
interest rates goes againstthousands of years of financial
history. There is no doubt thereis no denying that this is a
(10:45):
totally experimental path forinterest rate policy. As such,
it's important to keep in mindthat this experiment has not
fully played out yet.
(10:56):
So one of the puzzling things about having negative interest
rates in Japan and parts ofEurope for about the past decade
has been that neither of theseregions have seen an appreciable
rise in inflation. So in thatsense, bizarrely the negative
rates aren't having theirintended consequence. Another
(11:18):
oddity that is actually happeningon the ground is that despite the
rates being negative, many, manypeople are still holding these
government bonds and thesesecurities that offer a negative
yield.
Speaker 2 (11:31):
That just speaks to the level of uncertainty that has
driven a lot of investors to safehavens.
(11:38):
So even if you are losing a little bit of money by buying
that bond or keeping your moneyin the bank, the idea is that at
least it is still safe. And as aresult we have seen investors
really pile into negativeyielding debt. In late 2019 the
amount of debt that had anegative yield, in other words, a
(12:01):
negative interest rate, got ashigh as$17 trillion. I'm pretty
sure that made up a s izeablechunk of all the debt issued in
the world. It was something likea third of the world's debt. Now
recently, that has pulled back alittle bit, but nonetheless,
there is obviously an appetitefor investing in securities that
(12:23):
offer a negative yield. So longas those investors think it is a
safe bet.
Speaker 2 (12:28):
It's also somewhat unfortunate that because this has
gone on for so long in many waysis considered the new normal. It
has led a lot of observers tothink that slashing interest
rates and just cutting them evenlower is the solution to
everything. We live in a worldwhere all manner of negative
(12:51):
financial events will promptpeople to offer lowering interest
rates even if they're alreadynegative as the solution.
(13:00):
Now, as we already discussed, lowering interest rates and
keeping them low is seen as a wayof stimulating the economy, of
getting the economy going whenit's in a downturn or recession.
So that begs the question, ifinterest rates have already been
at zero or below for so long,what would policymakers do in
(13:21):
order to combat the nextdownturn? It's important to see,
even if it's a bit morecomplicated than you or even I
can understand that keeping thattype of emergency policy in
place, even when the economy isgrowing can cause some
unpredictable distortions.
Speaker 2 (13:41):
The best example I can give for that, relates to debt.
If a company doesn't have to payinterest on its debt and
borrowing costs are extremely lowas they are in this type of
situation, than zero interestrates actually increase the
number of companies that are ableto survive being unprofitable.
You often hear them referred toas zombies because they are
(14:05):
literally walking dead.
(14:07):
Zombie companies are able to survive in that type of interest
rate environment only becauseborrowing another line of credit
is so cheap. Again, if this isdone as a temporary emergency
measure, then that's fine. Thatmakes perfect sense to me. Yes,
you should try and rescue thosebusinesses if you can do it in a
reasonable manner, but it is notgood for the overall economy for
(14:31):
unprofitable businesses to stayopen when under normal
circumstances they would havebeen insolvent.
Speaker 2 (14:39):
That is a natural part of free markets. Sometimes there
are losers and by losing themoney that would have been
flowing into those companies, canthen go to other areas of the
economy.
(14:52):
This is really what I mean by distortions and it is probably
the biggest problem from negativeinterest rates and zero interest
rate policy is that they lead tomisallocation of capital. That is
just a fancy industry term forsaying money is going to the
wrong places. It is chasing thewrong things. It's being invested
(15:14):
in assets that are not productiveor not profitable. Even though it
seems like the government canbasically print money at an
unlimited pace, there is still afinite amount of money out there
to flow around the economy, soany funding, any capital that is
going to an unproductive sourcecould have been going elsewhere.
(15:36):
Everybody else loses. Every otherparticipant in the economy loses
if capital is miss allocated likethat. Now rather than leave
things on a sour note like that,I think there are two interesting
side effects that we should bepaying attention to as a result
of these interest rate policies.One is that people are flying to
(16:01):
gold, US Treasuries and the USDollar. These are traditionally
seen as the safest assets. You'renot going to earn a whole lot of
money by investing in them, butat the same time they have
historically proven to offer thesafest store of value you can get
and in all three cases that hasbeen true for more than a year.
(16:25):
Gold prices are up, the dollarhas remained very strong and the
yield on treasuries has beencontinuing to fall, which means
that there's strong demand forgovernment bonds in the United
States. So that's one side of itis that yes, lots of investors
and institutions are seekingsafety from this rather strange
(16:45):
set of policies. The second pointrelates to a famous quote from
certainly the world's most famousinvestors, the Oracle of Omaha,
talking about Warren buffet and Idon't think that buffet
originated this saying, but he isthe most famous person to have
reiterated it so it gets creditedto him. Anyway, Warren Buffet
(17:07):
said that recessions are like thelow tide at the beach. It's the
only time you find out who hasbeen swimming naked and that's
not only a humorous littlesaying. It's also an excellent
illustration of what I mean byzombie companies because right
now thankfully you don't hear alot about companies going
(17:30):
bankrupt, becoming insolvent,going under. We really haven't
seen a big wave of that becauseslowly but surely the U S economy
has been growing and of course wehave all these stimulus policies
in place, but of course there issuch thing as a business cycle.
Markets move in and so eventuallythere will be another recession.
(17:53):
At some point there will be adownturn. It will be at that
point that those zombie companieswill be caught naked. Swimming
financial history shows that youcannot survive as a business
purely by taking on more debtover and over.
Speaker 2 (18:09):
Eventually that low tide comes in and everyone sees
you're naked and they don't wantto invest their money with you
anymore.
(18:17):
So connecting that example to the topic at hand about zero
interest rates and negativeinterest rates, NIRP and ZIRP are
filling up the bathtub so tospeak. They are adding more and
more liquidity to make it easierfor a company that is swimming
naked, to hide that fact. It ismy sincere hope that policymakers
(18:38):
will find a way to somehownormalize interest rates and move
away from this policy before weget to that point. But the trend
certainly seems to be in thewrong direction. Alrighty, we
will now move on to our mailbagto check out this week's question
from the listeners. This week'squestion comes from Portland,
(19:01):
Maine from anonymous, and theyask, are diamonds a similar
investment to gold? I can see whyyou might think that. Some of the
obvious similarities are thatthey are considered precious,
that they are used often forornamentation and jewelry and
that's because they look pretty,they're shiny to some extent. You
(19:25):
could also say that both diamondsand gold are mined, t hat they
are dug out of the ground, butincreasingly that is not true.
One of the main differences I'llpoint out is that science has
basically figured out the formulato create diamonds synthetically.
Moreover, the average personcan't even tell a synthetic
(19:45):
diamond from the real thing. Thesame is absolutely not true of
gold. You cannot just manufacturegold in a lab. Alchemists spent
hundreds if not thousands ofyears trying to do that and they
were never successful. Evenmodern science cannot make
synthetic gold. So that is onedifference. The other main
(20:07):
difference between diamonds andgold comes down to something
called fungibility. So if an itemis fungible, it means that two
equal parts of the piece areperfectly interchangeable. They
can be exchanged for one another.This is one of the qualities of
money that if you have fourquarters, it's the same as a
dollar and vice versa. Pure goldis fungible because every little
(20:32):
gram or even down to molecule ofgold in that bar is identical to
the rest of them. This isunfortunately not true of
diamonds. It really matters howthat diamond is cut, what it
looks like, what it is. There areall these factors you have to
take into account and you cannotjust break a diamond into equal
(20:53):
pieces and say they're allequally valuable or have the same
exchange value. Those two reasonsare why diamonds are not
generally considered a mainstreamalternative investment, in the
same way that gold is considered.That doesn't mean that people
don't buy diamonds as a luxuryitem. Certainly people do buy
jewelry with diamonds, but it isnot like gold where you can
(21:17):
reliably know that your ounce ofgold is the same as anyone else's
ounce of gold. So long storyshort, that's what makes diamonds
unsuitable as a financialinstrument. That is it for this
week's episode. Really appreciateeverybody listening. Thank you so
much for tuning in. Be sure tocheck out next week's episode
(21:37):
where we'll be discussing how theCorona virus in China is
impacting markets. Today'sepisode was presented by our
sponsors, Gainesville coins. Youcan find out more at
GainesvilleCoins.com. If youenjoyed today's show, we
encourage you to go to iTunes andsubscribe, leave a review, and
leave a rating. The views andopinions expressed on this show
(21:58):
are for informational purposesonly and should not be used or
construed as professionalinvestment advice.
This is Breaking The Dollar the podcast that
dismantles some of the biggestmisconceptions about money.
Presented by Gainesville Coins.
Speaker 2 (00:23):
I am Everett Millman and this is Breaking The Dollar.
This week's episode is going totouch on a topic that I'm sure at
some point in past episodes Ihave in passing discussed and
that is NIRP and ZIRP, and thosestand for negative interest rate
policy a nd zero interest ratepolicy.
(00:45):
Now both of these things have been going on in the financial
world for a little while now, soI thought it would be good to
tackle them in a little bit moredepth. So we should start with
some basic definitions. What arewe talking about here? And when
it comes to interest rates untilvery recently, until after the
(01:06):
financial crisis, the idea ofhaving a zero interest rate
really wasn't even considered. Insome sense, it defeats the
purpose of interest ratesthemselves. Right now, I'm not
talking about how down the linein the economy you may have seen
offers for something where youpay 0% interest usually for a
(01:30):
limited amount of time.
Speaker 2 (01:32):
Yes, these types of promotions have existed, but
that's what made it a specialpromotion. That 0% interest rate
is sort of unheard of.
(01:41):
But in terms of policy, like on a national level where a
government or policymakers aresetting a national interest rate,
0% rates have never been a thing.The reason for this is relatively
obvious. If you are loaning outmoney, you want something in
return for letting someone holdthat money and use it. So the
(02:04):
idea of a 0% interest rate, youreally can translate that to free
money. It is essentiallyeliminating the cost of borrowing
money; free credit. So I guess Ishould step back and explain,
well where does this unusualpolicy come from? Why have
(02:24):
governments considered zerointerest rates? And the whole
motivation was to reinvigoratethe economy after the global
financial crisis. The quickestway to get money moving around
the economy again and gettingbanks to lend again was to
essentially make it as easy aspossible for people to get access
(02:46):
to that funding.
Speaker 2 (02:47):
If you were to tell someone you owe me nothing for
borrowing this money, that'sabout as good of a deal as it
gets. And although I will touchupon some of the problems
associated with these types ofinterest rate policies in this
regard, an objective observerwould have to say that the policy
sort of worked.
(03:07):
And when you think about it, why wouldn't it? Why wouldn't
someone or a business want a 0%interest loan? It's great. But as
you m ight h ave already guessed,the rabbit hole goes down
further. So in the United States,the Federal Reserve after the
financial collapse did instituteessentially a zero interest rate.
(03:28):
But in Japan, in Europe, theyhave experimented with negative
interest rates. To this day,there are still several major
countries like Japan and Germany,which by the way are the third
and fourth largest economies inthe world, that have resorted to
negative interest rates.
Speaker 2 (03:48):
So in this case the policy is even weirder still.
Instead of saying that credit ischeap or free, now with negative
interest rates, you are actuallycharging people to hold their
money in the bank or you arepaying them to borrow money.
(04:06):
So it is completely flipped on its head the way that charging
interest normally works. So whywould they do this? Why are
central banks around the worldsome of the biggest ones
resorting to negative rates? Itis such an unusual policy and the
main reason goes hand in handwith my explanation for zero
(04:28):
interest rates. It is intended tospur economic activity, make it
easy to kind of grease the wheelsof business and industry, but at
the same time it discouragespeople from saving their money or
keeping their money in a bankaccount on the sidelines.
Negative interest rates literallymean that you are losing money,
(04:51):
albeit a small amount and fairlyslowly, but nonetheless you are
losing money just to keep it inthe bank.
Speaker 2 (04:59):
The intended consequence of this is to put
that money into place so tospeak, to get it moving around to
get people to invest their moneyand do productive things with it
rather than saving it. Aside fromthat, there are some other
reasons that negative interestrates have not only been
(05:19):
attempted and implemented, but asI said, they are still here.
(05:23):
They are still a reality in many countries in the world. The
two other major intendedconsequences of negative rates is
to try and increase inflation,which is associated with economic
growth in general and also makesit easier to pay off debt over
time. So that is one piece of it.The second expected benefit is to
(05:45):
simply anchor all interest ratesof all kinds at a lower level. So
that might be a bit unclear. Theinterest rates set by central
banks, essentially the governmentinterest rate is really just the
baseline scenario for rates.
Speaker 2 (06:02):
There are all sorts of other interest rates charged
throughout the economy, whetherit's a business loan, a personal
loan, an auto loan, or a homemortgage. And so if banks can get
these very low or negative rates,then that means they can then
charge lower rates to theircustomers.
(06:22):
I have to admit that as another example where these sort of
experimental policies have atleast done what they were
intended to do, they have indeedlowered borrowing costs and made
credit for the most part moreaccessible across the economy. On
the other hand of course, zeroand negative interest rate policy
(06:45):
hurts savers and this effect istwo fold. On the one hand you are
literally charging peopleinterest to just save their money
or keep it in the bank. So that'sone way that it discourages or
hurts people from saving money.And as I pointed out, it is
supposed to drive inflation muchhigher.
Speaker 2 (07:05):
In turn, higher inflation means that your cash
and your money that is justsitting there in savings is
losing value. It is losing itspurchasing power relative to the
prices of other things.
(07:17):
So thus far you can see both the benefits and the potential
drawbacks to these policies. ButI'd like to focus for just a
minute on why they really arestill so weird. So I've heard
some very smart people in thefinancial press make some pretty
convincing arguments that weshouldn't think of negative
(07:38):
interest rates as anythingparticularly strange because
there are so many other financialarrangements that are essentially
imposing a negative rate on thepeople who use them. So for
instance, one example is thecapital gains tax. Anything you
do that generates a profit justby trading or investing your
(08:01):
money is going to cost you apercentage of that gain.
Speaker 2 (08:12):
Another example would be that you often pay a
commission to brokers orsalespeople anytime you buy
something or you buy a financialproduct.
(08:22):
Another telling example of this as it relates to my industry with
precious metals is that there isessentially a slightly negative
interest rate baked into owningphysical gold and that is what
they call the opportunity cost ofnot using that money elsewhere.
So because you could get apositive return from something
(08:44):
like a bond or even a corporatebond or other securities, the
fact that you're choosing not toown those financial products and
instead are just holding, meansyou are missing out on earning an
interest rate or gaining a rateof return on your money. Now,
this whole idea of opportunitycosts with gold is absolutely
(09:06):
true. However, if the gold priceis going up and you are gaining
purchasing power just based offof that price appreciation,
you're really not going to noticethat you're missing out on a 1%
or 2% yield somewhere else.
Speaker 2 (09:21):
Nonetheless, these are all case studies of how the
concept of negative interest doescrop up in certain sectors of our
lives. I think that there aremany, many more examples that
disprove that idea or that pushagainst the notion that it is not
abnormal for people to be payingnegative interest.
(09:45):
You know, you see a lot of attorneys who try civil cases,
who handle civil lawsuits. Theywill say that unless their client
wins, you don't owe us anything.In other words, they're saying
they will only get paid by takinga percentage of what their
clients make. I am sure you'veheard this in a radio commercial
(10:06):
or on TV somewhere. I'm notsingling out attorneys for this
practice, but can you imagine ifit was the other way around if in
exchange for that attorneyservices somehow they had to pay
you to be a client?
Speaker 2 (10:23):
I don't think that anybody sees that as a
sustainable business model.Granted, you can say that's
comparing apples to oranges andfair enough, but it is still
worth emphasizing that theimplementation of negative
interest rates goes againstthousands of years of financial
history. There is no doubt thereis no denying that this is a
(10:45):
totally experimental path forinterest rate policy. As such,
it's important to keep in mindthat this experiment has not
fully played out yet.
(10:56):
So one of the puzzling things about having negative interest
rates in Japan and parts ofEurope for about the past decade
has been that neither of theseregions have seen an appreciable
rise in inflation. So in thatsense, bizarrely the negative
rates aren't having theirintended consequence. Another
(11:18):
oddity that is actually happeningon the ground is that despite the
rates being negative, many, manypeople are still holding these
government bonds and thesesecurities that offer a negative
yield.
Speaker 2 (11:31):
That just speaks to the level of uncertainty that has
driven a lot of investors to safehavens.
(11:38):
So even if you are losing a little bit of money by buying
that bond or keeping your moneyin the bank, the idea is that at
least it is still safe. And as aresult we have seen investors
really pile into negativeyielding debt. In late 2019 the
amount of debt that had anegative yield, in other words, a
(12:01):
negative interest rate, got ashigh as$17 trillion. I'm pretty
sure that made up a s izeablechunk of all the debt issued in
the world. It was something likea third of the world's debt. Now
recently, that has pulled back alittle bit, but nonetheless,
there is obviously an appetitefor investing in securities that
(12:23):
offer a negative yield. So longas those investors think it is a
safe bet.
Speaker 2 (12:28):
It's also somewhat unfortunate that because this has
gone on for so long in many waysis considered the new normal. It
has led a lot of observers tothink that slashing interest
rates and just cutting them evenlower is the solution to
everything. We live in a worldwhere all manner of negative
(12:51):
financial events will promptpeople to offer lowering interest
rates even if they're alreadynegative as the solution.
(13:00):
Now, as we already discussed, lowering interest rates and
keeping them low is seen as a wayof stimulating the economy, of
getting the economy going whenit's in a downturn or recession.
So that begs the question, ifinterest rates have already been
at zero or below for so long,what would policymakers do in
(13:21):
order to combat the nextdownturn? It's important to see,
even if it's a bit morecomplicated than you or even I
can understand that keeping thattype of emergency policy in
place, even when the economy isgrowing can cause some
unpredictable distortions.
Speaker 2 (13:41):
The best example I can give for that, relates to debt.
If a company doesn't have to payinterest on its debt and
borrowing costs are extremely lowas they are in this type of
situation, than zero interestrates actually increase the
number of companies that are ableto survive being unprofitable.
You often hear them referred toas zombies because they are
(14:05):
literally walking dead.
(14:07):
Zombie companies are able to survive in that type of interest
rate environment only becauseborrowing another line of credit
is so cheap. Again, if this isdone as a temporary emergency
measure, then that's fine. Thatmakes perfect sense to me. Yes,
you should try and rescue thosebusinesses if you can do it in a
reasonable manner, but it is notgood for the overall economy for
(14:31):
unprofitable businesses to stayopen when under normal
circumstances they would havebeen insolvent.
Speaker 2 (14:39):
That is a natural part of free markets. Sometimes there
are losers and by losing themoney that would have been
flowing into those companies, canthen go to other areas of the
economy.
(14:52):
This is really what I mean by distortions and it is probably
the biggest problem from negativeinterest rates and zero interest
rate policy is that they lead tomisallocation of capital. That is
just a fancy industry term forsaying money is going to the
wrong places. It is chasing thewrong things. It's being invested
(15:14):
in assets that are not productiveor not profitable. Even though it
seems like the government canbasically print money at an
unlimited pace, there is still afinite amount of money out there
to flow around the economy, soany funding, any capital that is
going to an unproductive sourcecould have been going elsewhere.
(15:36):
Everybody else loses. Every otherparticipant in the economy loses
if capital is miss allocated likethat. Now rather than leave
things on a sour note like that,I think there are two interesting
side effects that we should bepaying attention to as a result
of these interest rate policies.One is that people are flying to
(16:01):
gold, US Treasuries and the USDollar. These are traditionally
seen as the safest assets. You'renot going to earn a whole lot of
money by investing in them, butat the same time they have
historically proven to offer thesafest store of value you can get
and in all three cases that hasbeen true for more than a year.
(16:25):
Gold prices are up, the dollarhas remained very strong and the
yield on treasuries has beencontinuing to fall, which means
that there's strong demand forgovernment bonds in the United
States. So that's one side of itis that yes, lots of investors
and institutions are seekingsafety from this rather strange
(16:45):
set of policies. The second pointrelates to a famous quote from
certainly the world's most famousinvestors, the Oracle of Omaha,
talking about Warren buffet and Idon't think that buffet
originated this saying, but he isthe most famous person to have
reiterated it so it gets creditedto him. Anyway, Warren Buffet
(17:07):
said that recessions are like thelow tide at the beach. It's the
only time you find out who hasbeen swimming naked and that's
not only a humorous littlesaying. It's also an excellent
illustration of what I mean byzombie companies because right
now thankfully you don't hear alot about companies going
(17:30):
bankrupt, becoming insolvent,going under. We really haven't
seen a big wave of that becauseslowly but surely the U S economy
has been growing and of course wehave all these stimulus policies
in place, but of course there issuch thing as a business cycle.
Markets move in and so eventuallythere will be another recession.
(17:53):
At some point there will be adownturn. It will be at that
point that those zombie companieswill be caught naked. Swimming
financial history shows that youcannot survive as a business
purely by taking on more debtover and over.
Speaker 2 (18:09):
Eventually that low tide comes in and everyone sees
you're naked and they don't wantto invest their money with you
anymore.
(18:17):
So connecting that example to the topic at hand about zero
interest rates and negativeinterest rates, NIRP and ZIRP are
filling up the bathtub so tospeak. They are adding more and
more liquidity to make it easierfor a company that is swimming
naked, to hide that fact. It ismy sincere hope that policymakers
(18:38):
will find a way to somehownormalize interest rates and move
away from this policy before weget to that point. But the trend
certainly seems to be in thewrong direction. Alrighty, we
will now move on to our mailbagto check out this week's question
from the listeners. This week'squestion comes from Portland,
(19:01):
Maine from anonymous, and theyask, are diamonds a similar
investment to gold? I can see whyyou might think that. Some of the
obvious similarities are thatthey are considered precious,
that they are used often forornamentation and jewelry and
that's because they look pretty,they're shiny to some extent. You
(19:25):
could also say that both diamondsand gold are mined, t hat they
are dug out of the ground, butincreasingly that is not true.
One of the main differences I'llpoint out is that science has
basically figured out the formulato create diamonds synthetically.
Moreover, the average personcan't even tell a synthetic
(19:45):
diamond from the real thing. Thesame is absolutely not true of
gold. You cannot just manufacturegold in a lab. Alchemists spent
hundreds if not thousands ofyears trying to do that and they
were never successful. Evenmodern science cannot make
synthetic gold. So that is onedifference. The other main
(20:07):
difference between diamonds andgold comes down to something
called fungibility. So if an itemis fungible, it means that two
equal parts of the piece areperfectly interchangeable. They
can be exchanged for one another.This is one of the qualities of
money that if you have fourquarters, it's the same as a
dollar and vice versa. Pure goldis fungible because every little
(20:32):
gram or even down to molecule ofgold in that bar is identical to
the rest of them. This isunfortunately not true of
diamonds. It really matters howthat diamond is cut, what it
looks like, what it is. There areall these factors you have to
take into account and you cannotjust break a diamond into equal
(20:53):
pieces and say they're allequally valuable or have the same
exchange value. Those two reasonsare why diamonds are not
generally considered a mainstreamalternative investment, in the
same way that gold is considered.That doesn't mean that people
don't buy diamonds as a luxuryitem. Certainly people do buy
jewelry with diamonds, but it isnot like gold where you can
(21:17):
reliably know that your ounce ofgold is the same as anyone else's
ounce of gold. So long storyshort, that's what makes diamonds
unsuitable as a financialinstrument. That is it for this
week's episode. Really appreciateeverybody listening. Thank you so
much for tuning in. Be sure tocheck out next week's episode
(21:37):
where we'll be discussing how theCorona virus in China is
impacting markets. Today'sepisode was presented by our
sponsors, Gainesville coins. Youcan find out more at
GainesvilleCoins.com. If youenjoyed today's show, we
encourage you to go to iTunes andsubscribe, leave a review, and
leave a rating. The views andopinions expressed on this show
(21:58):
are for informational purposesonly and should not be used or
construed as professionalinvestment advice.
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