Those obsessing over next week’s possible Federal Reserve action should look further east. Europe’s central bank action is far more interesting.
Here in the United States, the question is whether the Fed will raise interest rates. It won’t be much if they do. In Europe, rates are pointed down and even dropping below zero.
Economists used to think negative interest rates were impossible. Now we know that was wrong. They are possible, and Europe is showing us how low they can go.
The Swiss National Bank is blazing the downhill trail.
In January 2015, the SNB cut its peg to the euro and dropped the primary bank deposit rate to -0.75%. Other Swiss interest rates followed the dip below zero. Swiss government bonds are yielding below zero all the way out to 10-year maturity.
Wrapping your mind around negative interest rates is not easy. You don’t put $100 in the bank and expect to get $99 back. You also don’t take out a mortgage loan and then expect the bank to pay you. Both those things are happening in Switzerland right now.
It’s going to get stranger.
An interest rate is simply the “price of money.” If that price can go negative, then it’s possible other prices can drop below zero, too.
In fact, negative prices are more than possible. They are already happening.
U.K. banking giant Barclays (BCS) agreed last week
to sell its 89 Italian branches to Mediobanca, a Milan-based investment bank. The deal is unusual in several ways. One is that Barclays is paying Mediobanca 237 million euros to take over the branches.
Read that again. Yes, the seller (Barclay’s) is paying the buyer (Mediobanca) cash money to take over these bank branches.
That’s not how commerce usually works. You don’t walk into a convenience store, grab a six-pack and have the cashier hand you $5 on the way out. Not on this planet. Yet Barclay’s is doing roughly the same thing.
Why?
You might think it would be cheaper for Barclay’s to just close the branches, fire the workers and walk away. Not so. They still have liabilities. Did they at least get rid of those?
Some of them, yes. Mediobanca will get residential mortgage loans worth 2.9 billion euros. Yet Barclay’s will keep another 14 billion euros in Italian mortgages.
Not counting those mortgages, which it is reportedly trying to unload, Barclay’s will book a 200-million-pound loss on the transaction.
This sort of thing isn’t unprecedented. Last year our own blue-chip International Business Machines (IBM) paid privately-held Globalfoundries $2 billion to
take over IBM’s microchip manufacturing plants. IBM apparently thought it was the best deal they could get.
This isn’t normal. It is the opposite of what we would see in an economy biased toward inflation – like we’ve had since World War II.
Inflation incentivizes you to own assets because their value is generally rising. Deflation works the other way around. You want to get rid of assets because their value is generally falling.
This Barclay’s deal might just be a fluke. Strange things happen sometimes.
It might also be a preview of things to come. If deflation takes hold, we’ll see a lot more weirdness – and it won’t be fun.
Patrick Watson is an Austin-based financial writer. Follow him on Twitter
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