04/08/2016 - Economist Satyajit Das On The Implications Of Negative Interest Rates & Banning Cash
Economist Satyajit Das sees negative interest rates as a radical move by central bankers .. Why would investors go along? There are several possible reasons:
1. Security & safety: Government bonds or insured bank deposits are backed by the full faith & credit of a sovereign nation, which has the ability to issue currency to make repayments.
2. Returns are relative: In Europe, for example, purchasing bonds yielding more that the official rate at the central bank — even if it is negative — is the least worst alternative.
3. Speculation: Investors may be attracted by the opportunity for capital gains from price appreciation if they expect yields to become even more negative. Foreign investors also may be attracted by possible currency appreciation.
4. Real returns: Investors may favor real return over nominal return. Bonds with nominal low- or negative return may preserve or increase purchasing power in situations where the expected deflation is greater than the negative yield, providing positive real yield.
5. Investment mandate: Fund managers may be forced to purchase negative yielding bonds, irrespective of the fact that it locks in a loss.
6. Banks’ and insurers’ mandate:Financial institutions may be forced to purchase negative yielding securities, given liquidity regulations that require these entities to hold high-quality securities.
7. Central banks’ mandate: Central banks with restricted investment choices are also buyers of negative-yielding securities.
“The most radical consequence of negative rates would be the abolition of cash itself. In a future economic or financial crisis, current low rates would restrict the effectiveness of monetary policy. Enhancing the ability to use negative rates would provide central banks with additional flexibility and tools to deal with a slowdown. This would be an imaginative, rapid, and durable mechanism for levying negative rates to confiscate savings. Abolishing cash would require a revolutionary change. Despite the increasing acceptance of electronic payment, cash is still extensively used throughout the world In effect, currency remains an important medium of exchange and means of payment for legitimate, legal transactions. Cash use is especially high among both poor and older people. Accordingly, the elimination of currency would have implications for social and financial exclusion. The cost of converting these users to digital payments would be substantial .. Banishing cash would likely meet stiff resistance. People are likely to object to the loss of the anonymity and privacy that cash provides. Where the elimination of cash is linked to negative rates, it would be seen as a tax on savers and the state confiscation of savings. The intrusion of the state and authorities on such a mass scale would undoubtedly become an explosive political issue.”
