It is a good time to understand negative interest rates because they’re likely to be with us for a while. Since the US assault on inflation in the early Eighties, bond yields have been falling. This hasn’t been a plan, but is a consequence of our economic system. Inflation was tamed, and tamed so well that we are close to deflation, something far worse. As Baby Boomers are aging, they are spending less and are more likely to invest in supposedly stable bonds instead of supposedly risky stocks. As they are living longer, pensions have to fund longer lives which means pension managers are buying more bonds, driving down their yields as sellers don’t have to charge as much because of the increased demand from buyers. As pensioners are spending less, there’s less economic growth. Lower economic growth decreases the incentive for businesses to invest in R&D, especially when credit squeezes curtail potentially disruptive competitors. Central banks tried to spur growth by infusing funds into the markets, but even with that influence growth has been low. Without that influence would growth be negative? Or, has their influence maintained the bond yield trend? There are two main worries: 1) If bond yields continue to go negative, we may encounter deflation with no tools left to counter it, and 2) if bond yields reverse and increase, the reaction of the investment community may be abrupt enough to cause an economic upset across many businesses and industries. The economists haven’t been here before. It may be that no one knows what will happen.
(Click on the graph for the link.)