Could Negative Interest Rates Create a Financial Crisis?

The COVID pandemic has come close to affecting every corner and niche of the world. It has been difficult to escape its brutal tentacles, and we might not have seen the worst of it. According to Carmen Reinhart, chief economist at the World Bank, the pandemic is evolving into an economic crisis, and a severe financial crisis may be looming ahead. 

“This did not start as a financial crisis, but it is morphing into a major economic crisis, with very serious financial consequences. There’s a long road ahead.” She added, “The “longer the uncertainty, the longer the pandemic works its way through the global economy, the bigger the balance sheet damage.”

Reinhard has proven her expertise in financial crises. She is the co-author of the 2009 book, “This Time Is Different: Eight Centuries of Financial Folly.” Her comments came after several wealthy countries agreed on another debt-relief measure for poor, debt-ridden countries. They have agreed to extend the existing debt through 2021. 

China is the largest lender within the group, is owed more than half – up to 60 percent -of the money that it lent to poorer and developing countries. It is only partially involved in the debt-relief program.

In addition to global debt, the pandemic is likely to affect interest rates. There are signs that the Bank of England will implement negative interest rates soon. The Central Bank has not committed itself, but it hasn’t ruled out the possibility. The question is, how will banks cope as interest rates fall below zero? The British regulatory body, the Prudential Regulation Authority, has asked this question.

What exactly are negative interest rates? The concept is simple. When interest rates are positive, and a bank lends you money, you receive the loan in addition to the interest you need to pay the bank back. With negative interest rates, however, you pay back less than the original loan amount. The bank pays the borrower for the privilege of using its funds. This is not a winning financial situation. It encourages desperate banks to lend out more money. It is textbook banking: the lower the interest rates; the more borrowing is encouraged. Can a debt bubble be far behind? 

Negative interest rates are nothing new. Japan, European members of the EU, and Switzerland all have negative rates. However, these are countries with historic low inflation rates. 

The 2008 financial crisis has shown that low interest, on a short-term basis, can prevent a total economic collapse. This can benefit the wealthy. But it does not help the average consumer. Those already suffering financially won’t realize the benefits of low credit card interest rates. More than likely, due to loss of employment, their credit score will plunge, and borrowing money – which is supposed to flood the economy with money – will not be possible for them. The best thing for them is to keep their money in a low-interest savings account instead of accumulating additional debt. 

With global finances likely to remain in a state of turmoil, investing in physical gold is an obvious solution against encroaching negative interest rates. It’s a safe investment in a world inundated with negative interest. At this time, the price of gold has risen to about $1880 an ounce. 

Gold is also a trusted hedge against inflation.

One easily overlooked fact is how negative interest rates can bring us closer to a cashless society, a situation some countries are already attempting to implement. Historically, people have taken their money out of banks during times of low-interest rates and simply held on to it elsewhere (such as beneath the traditional mattress). If cashless living turns into the new normal, the consumer will be forced to leave his or her money in a bank against their will. This leaves the bank in total control of the consumer’s assets, while the consumer has none.

The financial crisis will grow. This is why many investors are turning to gold to keep their finances as stable as possible.