The idea is companies can borrow at near-zero interest rates (because safe government bonds are negative yielding), they are inclined to borrow a lot while simultaneously returning money to shareholders. Those shareholders, seeing such low bond yields, will invest that money into other equities.The flaw in this theory is that it doesn’t account for international capital flows.
Case in point: Japan & Europe. These regions have had negative interest rates, and yet they really don’t have any notable bubbles aside from maybe some expensive real estate (which is to be expected with 0% rates). If anything, these regions have had the cheapest equities based on traditional valuation methods.
Countries with negative rates typically go negative due to little to no growth. By introducing negative rates, this allows the companies that are not growing or not doing anything productive to stay alive simply by rolling debt continuously. It supports zombie firms in other words, which tends to prevent real economic growth.
note: speaking of zombie firms look up the ECB bailing out the European corporate bond market and look at corporate bond ratings in europe (which fucked the people who went short). Theres a shitload of trash bonds, ie broken window fallacy on monetary Roids.
Instead, investors in countries with low rates will simply borrow in the 0% interest rate, then move that money into a region with higher growth and yield. In other words, it just causes capital flight, deflation, and a bit of currency devaluation. The risk with these big carry trades is that when the region being invested in (take Japanese investors investing in USA) starts to perform poorly, you get big swings in capital flows, which cause the currency to rise dramatically, which then can cause some problematic unwinds.
So putting it simply, negative rates cause bubbles in other countries / regions to form unless there are intense capital controls put in place. China for example has the world’s strictest capital controls for a country of its size, hence the enormous buildup in bubbles within China directly. Without capital controls, a ton of that money would just flee the border. Europe and Japan on the other hand do not have intense capital controls, so financial assets owned by them tend to be heavily foreign.
It also creates a trap, a no/low growth, low inflation, high debt trap. It destroys money markets, venture capital, the banking sector and causes large amounts of capital flight. Sometimes it makes me wonder if central bankers forgot about the Solow Swan Growth model and that savings lead to growth.
I don’t see a solution to it especially for european nations, other than force rates above negative, let a recession run, purge out the malinvestment, which who knows a painful and how long that will run.
Even after that point you’d have to address government spending and debt issuance which crowds out the private sector; in the US check the IOER and feds funds rate and how it coincided with problems with dollar liquidity, which personally is my pet theory on what really pushed the federal reserve to lower rates as they were losing control of the value of money….yes I’m basically saying the fed cuts rates to provide enough liquidity to markets to then fund the federal governments deficits…..and it matches up look at which three large banks are buying all the bonds, look at which bank ceos meet with the president and the federal reserve.
Extension of the original post: In regards to the crowding out effect; to be more specific we had Fed Funds rate going over Interest on Excess Reserves (IOER) and it stayed there for some time even with technical adjustments that where made. Now why does this matter for deficits?
In Q4 2018, primary dealer holdings of treasuries rose at a $500 to $600 billion annual rate. In short, in Q4 2018 the US government was being financed in no small part by primary dealers. Now that information is easy enough to see BUT there was a recent study done…by i think a Norwegian financial analyst ( i cant remember the name) but in the paper it showed how much the US federal government relies on the big US banks to buy treasuries, and the amounts are increasing dramatically.
Also banks are not lending into the Fed Funds because the “excess reserves” are not really excess reserves at all. They have become required….effectively. It looks like they or their depositors have shifted cash into the treasury market either directly or indirectly (money market funds).
So fed funds over IOER is a sign that the US banking system (by extension the private sector) is running out of balance sheet capacity to finance the US government deficits. So the fed is forced to cut rates to provided needed liquidity.
edit: Fun fact
www.ft.com/content/da406fe8-ca8b-11e9-a1f4-3669401ba76f
German Government Bonds are Now Almost Entirely Held by Central Banks, Reserve Managers and Banks Meeting Regulatory Requirements and german banks are in the shitter as of right now. They are effectively covering the cost of the government budget (because they’re mandated to).
LONG GLD
EDIT: but really if we go with negative rates the $$$ will be found in foreign equities; IE find a country that isnt running negative rates, that also has a good open financial sector. Make money on the FOREX swap, then make more money on the equities bubble. That and property/land.
Disclaimer: Consult your financial professional before making any investment decision.