Below Zero: Why The U.S. Might Join The Negative-Rate Club Debt By The Street
The U.S. is becoming something of a rare breed in the developed world: It still has interest rates above zero.
While both Federal Reserve Chair Janet Yellen and her predecessor, Ben Bernanke, have downplayed the likelihood of negative rates in the U.S., especially in the near future, there's still a chance the world's largest economy might follow in the footsteps of Japan, Sweden, Switzerland and Europe's single-currency area, known as the eurozone.
With interest rates between 0.25% and 0.5%, there's not much room to bolster the economy through a traditional rate cut, which RSM chief economist Joe Brusuelas says would need to be at least four percentage points over time to have a meaningful impact. Based on the slow pace of hikes after the Fed cut rates to nearly zero during the financial crisis, it could be years before they rise above 4%.
By going negative, however, the Fed could keep using monetary policy to boost the economy in a downturn. It would assess a percentage charge on reserves held overnight for financial institution, giving them a choice between paying to keep money in reserve or lending more cash to customers, on which they earn a return. In theory, the move would prompt lenders to extend more credit, which gives consumers and businesses more spending power, leading to economic growth.
And there's a perennial risk of so-called Black Swans, highly unlikely -- and often, unforeseen -- events that have a big economic impact and might force the Fed to try just that.
One such event could be an unraveling of the European Union, possibly sparked by U.K. residents voting to leave in a referendum scheduled for this summer.
"There could be ripples throughout the EU, and there is a risk that other countries might want more control of their own economies as well," says Peter Tchir, managing director for macro income strategy at Brean Capital in New York.
Should Britain choose to depart, that might lead to a host of other member states bailing as well; Greece considered doing so last year. "With all the economic benefits that happened due to the European Union, the process of it all separating could be very disruptive," he says.
If that happens, expect the Fed to jump in with efforts to stabilize the markets, likely with negative interest rates, says Tchir.
Another cause might be the adoption of a protectionist stance toward international trade, which would mean increased tariffs or quotas on foreign goods, neither of which would be good for consumers or economic growth, as prices of goods would rise.
It's notable that protectionism, by one means or another, was part of the reason the world economy slowed to a crawl in the Great Depression of the 1930s.
It might sound like an event with only a remote possibility. After all, the United States just agreed to the trade-deal known as the Trans-Pacific Partnership. It's something that has generally been favored by the business community and seems likely to help automakers bother foreign and domestic, such as General Motors (NYSE:GM) , Ford (NYSE:F) , Toyota (NYSE:TM) and Honda (NYSE:HMC) .
But there has been a growing level of protectionist rhetoric on the presidential campaign trail this year, particularly from maverick Republican front-runner Donald Trump, as well as Democrat contender Bernie Sanders, and voters have responded somewhat enthusiastically.
If the next president decides to capitalize on that enthusiasim, trade, and hence the economy, could suffer. When it does, expect to get even less interest on your savings account.
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