It’s no secret that Germans love saving. Germany has one of the highest saving rates in the OECD countries.
They are not big on investing though.
So when the European Central Bank (ECB) made the unprecedented move of lowering interest rates to negative….well, it angered German savers.
The idea of negative interest rates is to get people spending, instead of saving. The move was an attempt to boost the economy by lowering rates and get inflation going.
A negative interest rate works kind of like a tax on your money. Instead of the bank paying you interest to use your money, the saver pays for having a deposit.
In other words, keeping your savings in the bank means that you lose money.
Yup, negative rates are the upside-down world.
German savers had been keeping their money in the bank for years, even at low interest rates. So, when interest rates dropped to negative, German savers said enough is enough.
They started withdrawing their money from the banks…to keep their cash in safes at home.
In fact, according to The Wall Street Journal, the biggest safe manufacturer saw a 25% jump in sales in the first half of 2016, compared to the previous year.
You see, cash is cash. It has an interest rate of zero…which is better than negative.
So, as you can see with the ECB, cash restricts how much central banks can lower interest rates. If interest rates go below zero, people will start stashing cash at home to avoid losing money.
Keep this in mind for a moment.
Not only Australia is keeping interest rates low
The Reserve Bank of Australia (RBA) left interest rates untouched this week once again…no surprise there.
They have been at a record low of 1.50% for almost three years now.
In fact, the RBA is not the only one keeping rates low. As you can see below, many of the OECD countries — like Japan, Canada and the Eurozone — are keeping rates low.
The only exceptions are Turkey, Mexico and Iceland.
And, while the US Federal Reserve has been increasing rates, it is already looking at taking a break.
Central banks around the world are having a hard time lifting rates because…well, we think it’s because there is too much debt around. Higher interest rates will make all that debt more expensive.
Australia avoided the 2008 financial crisis…but check out how much the RBA lowered rates back then to boost the economy:
Source: Trading Economics
If a severe financial crisis hit, with interest rates at 1.50%, it wouldn’t leave the RBA — or most of the OECD central bankers — with much room to lower.
They may have to go down to 0, or even below, to negative, to boost the economy.
But, as we saw with German savers, that doesn’t really work right? Because people have an alternative: cash.
Well…enter the International Monetary Fund (IMF). The IMF has been studying a way to solve this ‘problem.’
And in a recent blogpost they outlined their solution for central banks, so that they can make negative interest rates a ‘feasible option’.
How would it work?
Well, one option would be to get rid of cash. But that has proven too hard to do so far.
Another would be to make cash less appealing to use.
How do you do that?
Well, as the IMF proposes, you could divide the money supply in two: Cash and e-money.
In practice, there are now two currencies.
E-money is only used electronically, and pays, let’s say, a negative 5% interest.
You can still use cash, but it has an exchange rate against e-money.
Every time you want to deposit cash into your bank account, you have to exchange it to e-money. The conversion is 1 to 0.95…that is, for every $100 in cash you deposit you get 95 e-money…so you lose 5% of it.
Stores also have two different prices. One is for payments in e-money, the other is for payments in cash.
And…you guessed it, paying in cash would be more expensive.
So, effectively, there is no benefit to people holding cash.
As they noted:
‘While a dual currency system challenges our preconceptions about money, countries could implement the idea with relatively small changes to central bank operating frameworks. In comparison to alternative proposals, it would have the advantage of completely freeing monetary policy from the zero lower bound.’
It’s been interesting economic times since the 2008 financial crisis.
We have seen low interest rates for a long time, and even negative interest rates. We could see even more unconventional policies applied when the next crisis hits…like the scenario the IMF depicts.
That is, you could be paying the bank to hold and use your money.
Editor, Markets & Money
PS: Check out our new Markets & Money video update. In it, Kris explains how house price falls could have a knock-on effect on these industries. You can watch it here.