Deflation Causes Negative Interest Rates?

Negative Interest Rates Confuse
[courtesy Google Images]

Negative

“Economic madness continues nonstop. In the race for safe havens, Nestle’ bond yield has fallen below zero.

 “Nestle’s short-term euro-denominated bond yield has fallen into negative territory, possibly marking the first time in history that a corporate bond maturing in more than a year has had a negative yield.

“Yes indeed folks, you can now pay Nestles for the privilege of lending it money.”

Get that?  If you lend euros to Nestle’, they’ll only accept your loan if you pay them for the privilege of lending them your currency.

Nestle’s new policy isn’t exactly a first.  Several European banks have already imposed negative interest rates on bank depositors.  But Nestle may be first major corporation to issued bonds with negative interest rates.

Of course, on the face of it, paying negative interest rates sounds nutty.  But are negative interest rates really evidence, as Mish Shedlock said, of the “Privilege of Lending Gone Mad”?

I don’t think so.

I suspect that negative interest rates anticipate deflation.  Just as inflation allows borrowers to repay their debts with cheaper dollars, deflation requires borrowers to repay their debts with more expensive dollars.

Thus, if you lend currency to Nestle during a period of inflation, Nestle will repay its loan with currency that has a diminished purchasing power. For example, in an era of inflation, I could lend $1 million to Nestle’, and when Nestle’ repaid the $1 million, it might only have the purchasing power of $900,000.  By means of inflation, I (the lender) would lose $100,000 in purchasing power, and Nestle’ (the borrower) would be gain by $100,000 in purchasing power.

On the other hand, if I loaned $1 million to Nestle’ during an era of deflation, Nestle’ would be forced to repay that loan with currency that was “more expensive” (had a higher purchasing power) than the currency originally borrowed.  I.e., when Nestle’ repaid the loan in three years, the $1 million they borrowed might have $1.1 million in purchasing power.  Result?  Due to deflation, I (the lender) would gain an unearned $100,000 in purchasing power and Nestle’ (the borrower) would lose $100,000 in purchasing power.

Nestle’ didn’t get to be one of the world’s greatest corporations by playing the fool.  If Nestle’ sees that we’re entering an era of deflation, Nestle’ will not accept loans that will cause them to lose purchasing power.

Therefore, to offset the possible losses incurred by the borrower (Nestle’) due to deflation, Nestle’ is imposing a negative interest rate.  Nestle’ is charging interest on the money it borrows because Nestle’ anticipates deflation, economic depression, and being forced to repay whatever currency it borrows with “more expensive” euros, dollars, etc.  Nestle’ is charging a negative interest rate to offset the losses in purchasing power they might otherwise suffer due to deflation.

Negative interest rates sound nutty, alright—but they make perfect sense in our brave new world of fiat currencies, economic depression and monetary deflation.

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