This article, by Justin Baiocchi, was originally published in The Northern Daily Leader on 6 June 2015.
Imagine you went to the bank to borrow some money. An everyday event and certainly nothing out of the ordinary. Now imagine that when it came time to work out paying the interest on the loan, the bank said it would pay you interest instead? Sounds crazy doesn’t it? Whoever heard of a bank paying you interest on a loan, instead of charging you interest? Welcome to the strange world that passes for modern finance. This story might sound like fiction but it is in fact a true story. Eva Christiansen, a therapist living in Denmark recently took out a loan with Denmark’s biggest bank at an interest rate of -0.0172%. So each month the bank would pay Eva around 7 Danish Krone (just under $1.50) in interest, rather than her having to make any interest payments. A far cry from interest rates of 17% that existed in Australia in the late 1980’s, but also an example of the very unusual and dangerous situation that exists within global financial markets.
In an effort to stimulate economic growth, central banks around the world have pushed interest rates as low as they can go, even below zero, hoping that low rates will assist in jump-starting business investment and consumer spending. The world is full of unintended consequences however, and ultra-low interest rates are starting to distort financial markets. For if the bank is willing to pay you interest on money you borrow, why not go ahead and borrow as much as it will lend you? Then put the money into any type of an asset and wait for the value to increase. It doesn’t cost you anything to wait, you make money while you wait. In fact, the longer you wait the better. The problem is that if everybody is doing the same thing, as is logical, then prices for the assets start to rise as they are bid up by buyers. That’s fine for the people who got in early, but increases the risks for those people who are late to the party. For when interest rates rise, as they one day must, the loans will need to be repaid, funded through the sale of the assets (be they shares, property, collectibles or fine art). Inevitably there will be more sellers than buyers and prices will fall, perhaps severely.
This is the way that all financial cycles play out and this one will be no different. The only difference this time may be that never before has money been so freely and cheaply available. And if the supply of easy money causes a boom of incredible proportions, what might the bust be like once that supply vanishes? Unfortunately one day we will find out.