Friday, November 20, 2009

U.S. Interest Rates Go Negative Again

The 'Helicopter Economics Investing Guide' is meant to help educate people on how to make profitable investing choices in the current economic environment. We have coined this term to describe the current monetary and fiscal policies of the U.S. government, which involve unprecedented money printing. This is the official blog of the New York Investing meetup.

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At one point on November 19th, the yield on a new 3-month T-bill fell to 0.005%. A rational person would think you couldn't go lower than that, but a rational person would be wrong. The yield on 3-month bills maturing in January 2010 briefly turned negative. This was not the first time in recent history. It happened last year on December 9th, 2008 at the bottom of the Credit Crisis - or at least what has perceived to be the bottom so far. A 3-month T-bill auction on that date had a high bid equivalent of 0.000%. Apparently not everyone got in at that great rate.

Interest rates below zero are theoretically impossible. After all why not just keep the cash instead of settling for less money after a period of time? They do happen in the real world however and are an indication of extreme risk aversion on the part of banks. They are a marker of severe financial crisis. Before the current Credit Crisis, T-bill yields were only negative in the U.S. in 1940, after years of financial stress from the Great Depression. The auction low for T-bills was 0.01% in January of that year. Rates apparently went negative because of punitive property taxes imposed by a number of U.S. states. T-bills were not taxable and investors kept more of their money by taking a slight loss on T-bills than if they had paid the tax. No such special circumstances exist today to justify negative interest rates. The explanation for current negative rates is that banks are loading up on short term government instruments to improve the appearance of their year-end balance sheets.

Negative interest rates also took place in Japan during their current 19-year (and counting) financial debacle. Short-term interbank lending had a negative return one weekend in January 2003. As was the case in the U.S. during 1940, years of severe financial stress preceded this event. In Japan's case there were a series of rolling recessions - the modern version of depression thanks to government's now common practice of continual economic stimulus programs. There have been other cases of negative interest rates, however these seem to have been utilized (usually officially by the government) as a type of currency control. Switzerland imposed negative interest rates during 1970s after years of appreciation of the franc for instance, but only for foreign depositors.

The appearance of negative interest rates after a long period of financial stress raises the question of when economic problems actually began in the United States. It is reasonable to assume that they started long before the awareness of the Credit Crisis in 2007. Interest rate anomalies may have in fact already existed in 2003. While it is not generally known, between August to November some U.S. government repurchase agreements had negative rates. There is more than enough evidence to indicate that recessionary period actually began in the U.S. in 2000. Manipulated inflation rates and GDP calculations hid the details from the public. The U.S. government, businesses, and consumers lived off ever-increasing borrowing which made up for declining income. The Credit Crisis was merely the unraveling of this scheme, not when the financial problems started. The return of negative rate indicates a deeply entrenched problem within the U.S. financial system - and it doesn't look like it has been fixed yet.

Disclosure: No position in T-bills.

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Daryl Montgomery
Organizer,New York Investing meetup

This posting is editorial opinion. Like all other postings for this blog, there is no intention to endorse the purchase or sale of any security.