Will Liabilities Become “Assets”

In September 2019, US President Donald Trump, in his original manner via Twitter, suggested that the US Federal Reserve move interest rates to a negative zone from zero and below to refinancing the US government ‘s current $23 trillion debt and extend its maturity. The idea of zeroing out rates to stimulate growth is tempting, especially when the amount of accumulated debt is huge and virtually all markets are dependent on changes in the US Federal Reserve monetary policy. But emergency measures that temporarily worked after the 2008 crisis could prove disastrous to the global financial system if applied for populist reasons on a permanent basis.

“I don ‘t understand anything,” Alice said. “It ‘s all so confusing!

“It ‘s just that you ‘re not used to living in reverse,” the Queen explained good-natured. “At first everyone has a little dizzy head…

Lewis Carroll, “Alice in the Mirror,” 1871

Negative rates are a relatively new phenomenon in the monetary policy of central banks. Since 2008, many central banks have reduced interest rates to zero and near-zero in order to help their economies overcome the effects of the global economic crisis. It didn ‘t help everyone. In developed countries, economic growth remained extremely low for many years, when the European Central Bank, the Bank of Japan, and national banks in Denmark, Sweden, and Switzerland launched negative rates policies.

According to this policy, credit institutions are obliged to pay interest for the storage of funds on accounts at the central bank, including excess reserves. Monetary authorities believed that in this way banks could be forced to increase lending to the economy and population, as well as to weaken the exchange rate, which gives a competitive advantage to exports.

But this policy had an unexpected side effect: first, the yields on government bonds of a number of developed countries became negative, then corporate bond yields went into the negative zone, then loans at negative rates, including mortgage rates, and, finally, negative deposit rates appeared.

Bonds of more than a hundred European companies with a total volume exceeding €1 trillion are traded already with a negative yield. And companies (not only in Europe) have an incentive to increase debts, which now become a quasi-asset, as well as to buy back their shares from the stock market, replacing expensive equity capital, on which dividends need to be paid, with additional interest income of debt capital.

The financial world, based on loan interest, has turned around. If interest is paid on the obligations to the debtor rather than to the creditor, if the holders need to pay someone for the possession of assets, and the liabilities are now paid extra, the debts become a new source of income.

It turns out that in this “gap” financial world, someone who has gained more debt becomes more creditworthy than someone who has savings that make a loss.

Now companies with good credit ratings can be borrowed not because they need financing to develop their business, but simply because it becomes a new principle of “reasonable” financial behavior even when the volume of world debt has already reached astronomical values of $247 trillion.

However, only companies with high credit ratings have the opportunity to borrow at negative rates, but here is how to assess the credit quality of borrowers now?! And will the credit valuation of those companies that have a lot of free funds and have to pay banks for the opportunity to keep funds in their settlement accounts be affected?

Despite the fact that bankers and a number of politicians in the industrialized countries of Europe believe that negative rates are catastrophic and condemn the eurozone to death, Christine Lagarde, replacing Mario Draghi as head of the ECB, immediately supported the negative interest rates imposed by her predecessor.

Asked about the impact of negative rates on savers, Ms Lagarde said they should think about how much worse the situation would be if the ECB did not cut rates so much, and also said people should be happier that they have jobs than the higher savings rate.

Monetary authorities can be understood. The threat of recession and a new economic downturn is tangible, and only incredibly soft monetary policy still somehow supports the entire economic and financial structure afloat. In its semi-annual report on the state of global financial markets, the IMF 40% that almost half of corporate debt in eight leading countries — the United States, China, Japan, Germany, the United Kingdom, France, Italy, and Spain — would have been impossible to service if the recession had been even half that of a decade ago.

Does all this mean that the debt bubble has been given the opportunity to expand indefinitely? Is there a limit to the policy of negative rates and the boundary of this gap?

In mathematics, there is the concept of “the disclosure of uncertainties” — that is, the calculation of the limits of functions given by formulas that lose meaning as a result of the formal substitution of the limit values of the argument in them. The $17 trillion amount of debt with negative returns we saw in 2019 is apparently not yet the limit value of the argument. But the meaning of the idea of lending itself is already being lost. Capital owners and creditors, including banks, cannot extend lending indefinitely and suffer losses forever. There will be a time when refinancing at negative rates will be refused. The crazy experiment will end, and then the financial world will shake.