By Kerim Derhalli. Originally published at ValueWalk.
Far before the global coronavirus pandemic began and shocked the world’s economy, President Trump called on the Federal Reserve to lower interest rates down to “zero or less” in order to shore up the economy and encourage Americans to borrow and spend money. Now that coronavirus has ravaged the U.S. economy and the central bank lowered rates near zero in a historic move, President Trump has once again called for negative interest rates to be instituted, even describing them as a “gift.” Federal Reserve Chairman Jerome Powell recently announced the Fed’s decision not to lower interest rates past zero – which I wholeheartedly agree with.
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The Adverse Effects Of Negative Interest Rates
This situation is comparable to the 2008 financial crisis: cheaper borrowing costs encouraged excessive corporate borrowing that applied to non-productive purposes like stock buybacks or paying dividends to shareholders, rather than fortifying the economy through investments or expanding payroll. This trend hollowed industrial capacity – for example, U.S. manufacturing losing 20 percent of its output during the Great Recession. Negative interest rates also deter households from saving more money and equally deter banks from lending as their margins collapse, having an adverse effect rather than stimulating economic activity.
Artificially low or negative interest rates are also highly divisive in two other ways: they inflate the wealth gap between rich and poor and they create a division between generations. Those with wealth disproportionately benefit from financial asset price inflation, while many around the world are struggling to survive, much less build a portfolio. Creating a pattern of borrowing and spending money now would leave future generations footing the bill, not to mention adversely affecting millennials who are already saddled in credit card and college debt. With unprecedented unemployment numbers that rival the Great Depression, Americans will increasingly find themselves in a financially dubious position and drastic measures such as lowering interest rates further will have a profound effect.
The Rejection Of Governmental And Financial Institutions
Eventually, negative interest rates might be inevitable as a bankrupt political and economic system resorts to desperate measures to preserve itself rather than trying to adapt. Negative interest rates will instead sow the seeds for more social and intergenerational divisions. We have already seen this fission in 2011 with the Occupy Wall Street and the Tea Party movements. While those movements are on opposite ends of the spectrum, they carry the same ideology of the rejection of governmental and financial institutions. We will be sure to see these types of movements crop up again, and it will only be made worse by negative interest rates. We will pay twice over what we save on interest rates now in the ensuing revolution.
Instead of changing interest rates, we should invest in a new social and economic model for our future. We should learn from the coronavirus crisis that there is a need for greater investment in our infrastructure so that we can have the capacity to handle similar crises in future. It is also a lesson for households to build up ‘rainy day’ money, and for individuals to become financially independent by starting to invest early. These tasks can seem daunting, especially for younger generations that are increasingly distrustful of financial advisors.
An alternative to get started would be to invest in an employer-sponsored retirement plan if you work for an organization that offers one. This is also why we created the Invstr app, so beginners can learn more about how to make smart financial decisions. Negative interest rates would achieve exactly the opposite result of building up the economic capacity to handle similar crises in future and be highly counter-productive to the health of the country.
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