The Contrarian

“In the investment markets, what everyone knows is usually not worth knowing.”

Consequences Of NIRP

The Bank Pays You to Borrow

In normal times, you borrow cash from a bank and repay it slowly over time. When interest rates go below zero, the bank might have to pay you. It’s happening right now in Denmark, where banks are paying interest to thousands of borrowers, instead of the other way around.

The pressure is spreading, too. Homeowners in Spain and Portugal with variable-rate mortgages are demanding their banks pay them. Their loans are tied to a benchmark rate called Euribor, which is now below zero. The laws and contracts didn’t imagine any such scenario-but the math says banks should be paying borrowers.

Spanish and Portuguese banks are fighting for legal protection from this. Will they succeed? Maybe not. Banks themselves routinely argue that contracts are sacred when they want to foreclose on someone. Now the shoe is on the other foot and they don’t like it at all.

Banks Demand Free Money

Banks make money on their interest rate “spread.” That’s the difference between their cost of funds (interest paid to depositors, for instance) and the interest they collect from borrowers. The wider the spread, the greater the bank’s profitability.

This doesn’t work so well when interest rates are negative, so US banks are looking elsewhere for income.

My view: I have called NIRP the greatest mistake ever made in the history of central banking. It’s similar to what John Law tried when he immigrated to France, about 200 years ago, and suggested a central bank that could create money out of thin air to pay the country’s huge debt. Predictably, it resulted in hyperinflation and a collapse of the economy.

In the 2008 global crisis, the trigger was the Wall Street of packaging poor credit subprime mortgages into pools, buying a AAA rating from the rating agencies, and then selling participations around the world. When these pools collapsed, it took a number of banks around the world with it.

This time we have every major economic zone in the world at record debt to GDP ratios, printing money as never before. The more money (credit) they create, the worse conditions get. There is no painless way out. And when no additional debt can be added, the mountain of debt collapses.

But that will take time. The authorities make the rules. They can prolong, prolong, prolong.

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