Negative rates? No, a revolution in attitudes!

How should we live in a world where interest rates are negative? It is a genuine paradigm shift that tells us to prepare for global deflation. While the U.S. will be spared, our Europe is sinking into economic stagnation, an ice age likely to be secular in nature. Switzerland and Denmark are leading the way and the SNB’s base rate of negative 0.75% (- 0.75%) will probably drop further into the red.

Since no other central bank in the financial history of the world had previously pushed rates to such negative levels, the Swiss experience will be an especially interesting one. Switzerland is the country with the largest denomination banknote in circulation in the world, 1,000 Swiss Francs (about 955 euros or ,055 at this time). As I have often said and written, most recently in “Switzerland declares war“, “only the disappearance of cash allows negative rates established by a central bank to have their optimal effect. In the presence of negative interest rates – that is to say, a tax on bank account balances – nothing prevents investors and speculators, and even the average citizen, to refer to banknotes as “fiat money” paying a 0% interest rate. In an environment where the number of 1,000-denominated Swiss Franc banknotes has doubled in 10 years and where it represents one third of the 60 billion Swiss cash in circulation, it is clear to me that this number will keep expanding in the presence of negative rates paid on bank accounts.”

Indeed, it seems that this banknote proportion has changed considerably since 17 January 2015 (date the above was written) as some rumors indicate that 1,000-denominated Swiss Franc notes now account for almost 50% of Swiss cash in circulation! This frenzied accumulation of CHF 1,000 notes threatens the efficiency of the Swiss National Bank’s monetary policy and it may undermine its strategy of negative rates. The Swiss authorities can certainly eliminate 1,000 Franc banknotes, forcing investors to use the 200 Franc banknote and multiplying fivefold the costs associated with cash conversions. In an extreme situation, the SNB could even abolish all denominations in excess of 50 Francs terribly complicating savers’ lives and forcing them to handle 20,000 50-Franc notes (representing 1 million Swiss Francs), instead of 1,000 1,000-Franc notes.

As stated earlier, the SNB could also tax customer deposits in the banking system by applying such a tax when funds are withdrawn at bank retail counters. However, such a tax is not likely to be effective with slightly negative interest rates, up to minus 1% (- 1%). It seems clear that depositors will not be reluctant to pay fees of 0.5 or 1% of cash withdrawn at the counter. It would be quite different if interest rates were to be minus 5% (- 5%). Such a possibility should not be dismissed. Significantly negative rates are expected to continue for many months or even a few years. This new situation will fundamentally change our eating and spending habits. Our priority in fighting these negative rates will be to avoid leaving large cash balances “sleeping” in our bank accounts. Or we might well see said balances “amputated” by a few precious percentages points.

There are several new personal habits that will likely be adopted such as: paying our taxes before they are due, buying extra gift cards, buying more stamps, pre-paying our electricity and telephone bills, or even paying our rent or home mortgage in advance. The ultimate goal is to avoid paying negative rates on our bank deposits. Instead, “pass the buck” to businesses or to the state. Our suppliers traditionally penalize us with late fees for delayed payment of a bill. But it may well be that we will soon see an inversion of this practice where the same supplier will increase our bill if prepaid! I was very serious when I spoke of a “paradigm shift” in the beginning of this article. The introduction of negative interest rates will strongly challenge our macroeconomic framework by puncturing the floor of our zero-bound world. It will gradually revolutionize our personal habits, our consumer economy and our laws.