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We hear more and more talk about moving into negative interest rates in
the US. In a recent article former Fed chairman Ben Bernanke asks the
question as to what tools the Fed has left to support the economy and
discusses in this article the use of negative rates. We have to first define
what we mean by negative interest rates. For nominal rates it’s simple. When
the interest rate charged goes negative we have negative nominal rates. To
get the real rate of interest from the nominal rate we have to subtract
inflation. That’s what we call the illusion of inflation.
 
Real interest rates have been negative fairly often, including for most of
the period since 2009. The problem then comes in choosing the appropriate
measure of inflation. Since the calculation of inflation is highly subjective
and easy to manipulate I came to adjust nominal prices to gold to get the
real interest rates. In the chart below you can see nominal U.S. 10-year
Treasury rates versus gold-adjusted rates since 1962.
Ben Bernanke says in his article that, “The fundamental economic
constraint on how negative interest rates can go is that, beyond a certain
point, people will just choose to hold currency, which pays zero interest.
(It’s not convenient or safe for most people to hold large amounts of
currency, but at a sufficiently negative interest rate, banks or other
institutions could profit from holding cash, for a fee, on behalf of
customers). Based on calculations of how much it would cost banks to store
large quantities of currency in their vaults, the Fed staff concluded in 2010
that the interest rate paid on bank reserves in the U.S. could not
practically be brought lower than about -0.35 percent.”
In Japan, the European Union and Switzerland, where negative interest
rates are already there, an increased demand was observed for safes and cash.
When negative rates took effect in mid-February in Japan, queries about home
safes surged, especially from customers aged 50 and over. Sales of safes are
now running some 40 to 50 percent above this time last year, according to a Reuters’ article. In the European Union Reuters reports
the same trend. The European Central Bank's negative interest rates are
sparking demand for safe deposit boxes, where bank customers can store cash
to avoid the prospect of paying the bank interest on their accounts, said
German bankers to Reuters. The same trend was observed recently in
Switzerland, not only with private investors but also with pension fund
managers.
At the same time, we learn that negative rates have boosted demand for
gold in Japan. According to Takahiro Ito, chief manager at Tanaka Kikinzoku
Kogyo K.K.’s store in Tokyo’s Ginza shopping district, “Many customers are
wagering that it’s better to turn their savings to gold as a safe asset
rather than deposit money at banks that offer low interest rates,” reports Bloomberg. Consumer gold demand in Japan rose to 32.8
metric tonnes in 2015 from 17.9 tonnes a year earlier, also reports Bloomberg
in the same article. Gold bar sales climbed by 35 percent to 8,192 kilograms
in the three months ended March 31 from a year earlier, Tanaka Kikinzoku Kogyo
K.K., the country’s biggest bullion retailer, said, according to Bloomberg.
A boom in safe-deposit-box companies was also observed in Switzerland in
the canton of Ticino, according to another Bloomberg article. The rise of safe-deposit boxes has
created a boon for jewelers along Lugano’s Via Nassa, home to Cartier,
Bulgari, and Bucherer boutiques, as people race to convert cash into assets
they can lock away. Bloomberg reports that, “Investors are buying more gold
as an alternative to holding Swiss franc cash deposits, according to Vontobel
Holding AG, a Swiss bank and wealth manager… “We keep noticing that gold is
coming back into favor with investors,” said Vontobel’s Chief Executive
Officer Zeno Staub.”
Gold in a negative interest environment is the best way to store large
amounts of cash. A gold coin of 1 once (31.1 grams) stores about $1,230 while
a one-kilogram bar of gold stores about $39,620 today and is just about the
size of your palm. With the threat of banning cash and with the
one-hundred-dollar bill being the largest denomination, both in the U.S. and
Canada, you can easily see the advantage of holding gold in a safe or under
the mattress. In the European Union there is also talk of banning large euro
denominations like the 500-euro bill.The largest denomination in the UK is
just 50 pounds.
But negative interest rates also increase the cost of doing business for
the banks, which find it hard to pass on those costs to borrowers, therefore
weakening the banking system. This has the effect of encouraging people to
buy gold and hold it outside the banking system despite the inconveniences.
It is for this reason some economists are associating negative interest rates
with a ban on physical currency. In order to impose effectively negative
rates, you must have control of people’s cash. The state can easily control
access to electronic money by limiting the amount of withdrawal from the
banking system just with a small adjustment in the software. The state can
stop printing fiat money but it can’t easily ban physical currency like gold
and silver. It is estimated that there is approximately 20% of the
above-ground gold in private hands and in the purest bullion form. A large
part of the jewelry stock can also be used, if necessary, as cash.
Today in this negative interest rate environment you should be more
concerned about the return of your money, than the return on your money.
Compared with negative interest rates it is obvious why people are
rediscovering the value of holding gold. Gold tends to perform well in declining
or negative real interest-rate environments. The more central banks move to
negative rates, the more gold is going to take off because there's no
carrying cost. High real rates are bad for gold while negative real rates are
good for gold.
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