Keith Underwood 3 Comments

When all else has failed, use taxes to influence investment decisions. That, to me at least, seems like the approach that 16 countries that have issued some $8 trillion of debt that are trading at negative interest rates. In effect, tax savings with negative rates to encourage investment in risky assets. Well, that’s the theory behind the negative rates but I’ve never met a tax that achieved the expected outcome. Rather, taxes typically encourage avoidance and reduce the chances of succeeding. Negative interest rates will not reverse global demographic trends (aging) and technological advances (transparency of price). In fact, they will potentially aid in reducing growth in those countries and inflict a cycle of lower growth and persistently low inflation.

A quick look at the wall of shame (negative rates) for major industrialized countries places Japan at the top of the heap with $5.6 trillion of debt in negative territory. Their March ‘How we doin’ report card’ has core consumer prices in Tokyo registering their biggest annual drop in almost three years. In addition, growth in the 4th quarter was minus 0.4% and GDP fell 1.1% over the previous quarter. Private consumption is collapsing while growth is slowing so it’s hardly surprising that Japan’s population over 65 years of age (26% of the total) is stuffing their proverbial mattresses full of yen. Risk is not a word in the elder generations vocabulary.  Just look at the Nikkei recently.


Taking a quick look at two other compatriots to Japan, Germany and France, which together have issued nearly $1.7 trillion of negative debt. To boil this down to a quick read, the export led economy of Germany is expected to grow at 1.7% according to government projections and France, a tepid 1.3% growth is projected in 2016. While both Germany and France have positive growth, most major economies have downgraded their 2016 and 2017 growth rates since November. Do you think the ECB wants the Euro to weaken further to support growth? Ja!  Negative interest rates would suggest a weaker currency is part of his plan to sustain growth in Germany, which happens to be Europe’s largest exporter. Imagine that.


Returning to our demographic analysis, Europe has roughly 20% of its population above the magic age of 65. While this is significantly less than Japan, the European welfare state is a significant drain on overall growth (think 20%-25% VAT rates) and with an expected overall reduction in productive (tax paying) workers, growth will continue to be suppressed by simple mathematics of revenue versus social expenditure in the deficit restricted Eurozone. Slow bleed.


In the developed world, one measure of inflation used to be signaled by wage increases, when workers enjoyed the upper hand on their employers. While celebrities and professional sports people will always enjoy superstar remuneration (demand vs. supply), the average hourly worker has been reduced to an online resume submission by the likes of where hundreds of jobsites supply millions of potential workers for jobs. With the math far, far in favor of employers, and transparency of pay between firms (yes, they share compensation willingly between competing firms), wage inflation will be stagnant to non-existent until the supply and demand component changes significantly in the favor of the prospective candidate.


At times I can be viewed as an economic pessimist or ‘crises fan’ (vestiges of being a long volatility trader) but I do look through the lens of global macro economic trends that exist today. Quite simply, after nearly 10 years of continued economic policies of easing, bond buying, and pledges to increase growth (G20 slogan du jour), I just cannot view negative interest rates to be a sign of policy strength. Rather it is more of a sign of policy experimentation (government intervention to suppress rates to buoy equities and real estate assets) that we as investors have learned to accept and trade according to a central bank script. I know how the central banks want the end of the play to finish (mission accomplished!) but perhaps they should craft several endings rather than believing in the fairy tale ending that they are hoping.

Quick, discreet, and so worth the risk.


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