Zero is an interesting number. It might also be a very nice number, as in “you owe zero.” In other circumstances, it could be a problem, as in “your bank balance is zero.”
Recently interest rates in Europe have reached zero for most consumer deposits. This means that you can expect to receive no interest on your bank deposit. It is very hard to save for retirement or anything else when you do not get any help from interest compounding over the years.
The situation in the government bond market is even worse. If you buy a German or Swiss government bond, you will receive negative interest. This means that you will receive less money than what you deposited when you bond matures. Imagine depositing $1,000 and in seven years receiving $997 back when you your bond matures.
This phenomenon extends to business deposits as well. European banks charge their business customers a fee to hold their money. In a case like this, you might wonder why anyone would deposit money. Why not just keep the cash on hand? The answer is that cash on hand presents a security problem. It is also difficult to put that much money in a safety deposit box, since currency is bulky. In addition, the European authorities make hoarding cash difficult.
The European Union once issued notes in denominations up to $1,000. Now the largest denomination note is $200. In addition, the European Union is removing the larger notes from circulation and will at some point set an expiration date for the larger bills.
You may also wonder why the Europeans would reduce rates to such low levels. The answer is that Europe never fully recovered from the financial crisis. Unemployment is still relatively high and growth has been very slow.
The normal economic tools to increase growth and reduce unemployment are lower interest rates, lower taxes, reduced regulation or increased government spending. Because of European Union rules, increased deficit spending, lower taxes and reduced regulation are all off the table. With only one option, the European Union has pushed interest rates to historic lows. Unfortunately for them and for us, this one-dimensional recovery plan has not worked as intended. Instead, despite extraordinarily low interest rates Europeans are reducing their spending causing their economies to slide into recession.
While we are sympathetic to the Europeans, this situation is not just unfortunate for them. The low European rates mean that our rates must also be low. The reason for this is that if Europeans can hedge their currency risk and buy United States Treasuries at better rates than Euro government bonds, they will invest here. This effectively puts a cap on United States government rates at about 2.5 above the equivalent European rate.
Borrowers are of course very happy to see these low rates but savers are not. The likely next step for Europe is even lower rates, so we can expect to see consumer rates decline again in December.
Stay tuned and keep an eye on Europe. It is a global economic system now and what happens in the rest of the world affects us as well.