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Why The Current Low Or Even Negative Interest Rates Make Perfect Sense

|Includes: iShares 20+ Year Treasury Bond ETF (TLT)

There are at least 5 use cases that drive the current demand for negative yielding assets and don't make the investment a lock in loss.

Nobody has a crystal ball and that's why the willingness to lend money at zero or negative *nominal* rates actually makes sense. If prolonged deflation (Japan style scenario in the U.S. and around the world) has a 10% probability of happening (just my guesstimate, you can use your own value), then it makes sense to allocate 10% of your assets to investments that will benefit from deflation to stay diversified and hedged at least a little. In deflation, even the low or negative *nominal* interest rates will make you money because the nominal inflation rate will be even lower (even more negative). So you will have positive *real* interest returns even while buying Treasuries at negative nominal interest rate levels.

Second, there is huge demand for *future* spending and as a result severe lack of financial capacity for *current* spending. People are willing to get zero interest or even pay for the ability to transform current wealth into future spending (most retirees need exactly this). You can withdraw small sums into cash, earning zero nominal interest rate. But pension funds can't just withdraw all the money into cash, so negative nominal interest rates are possible. The low rates exacerbate the need to transform even more of current savings into future spending because retirees want to live off of yield (or dividend). With lower yields, they need to put aside higher nest egg to generate the same income. So the aim of lowering interest rates by central banks is exacerbating the problem.

Third, the world, incl. the U.S. has some of the highest Gini coefficient rates compared to historical levels. This means inequality is very high. Inequality means more money is free, available for investing or playing around because you only need so much every month to spend on sensible things. Most people simply don't buy 100 cars even if they could afford it so the money goes to stock market, bonds, real estate and other investment assets. Rising average age and people living longer exacerbates the inequality problem (compounding by time)

Fourth, as the debt bubble keeps growing, more and more future demand is consumed today, pulled from the future. This means there will be even lower demand in the future and that will keep inflation lower or negative and keeps inflation expectations low.

There are many other reasons why low rates make sense at the moment. I didn't even begin describing the huge displacement of people by technology in the workforce (IT, software, apps, robots, drones, etc.) (exacerbated by low interest rates and cheap money). This means nominal (and real) wages are stagnant at best (real wages today are probably lower than 30 years ago in the U.S. and future expectations are not better). Real wages growth is one of the main factors that determines future inflation rates and interest rates.

In summary, there are plenty of reasons why interest rates are low at the moment and why in nominal terms, they can easily be negative. It's the real interest rate that matters (nominal interest rate minus the nominal inflation rate).

Disclosure: The author is long TLT.