In Europe, they’re thinking about getting rid of the €500 note, and former U.S. Treasury Secretary Larry Summers said recently it’s time Americans ditched the “Benjamin”, the country’s $100 bill.
Those supporting the idea argue that it’s mostly drug dealers and criminals who use these large-denomination bills. It’s probably true, given that the average Frenchman or Italian doesn’t keep the equivalent of a $750 Canadian bill on hand for-walking around money. Nor do many Americans use hundreds. So sure, bad guys use them.
But the other reason why the notion has gained traction has nothing to do with crime, and everything to do with the weakened state of the global economy. Eight years after interest rates were pushed to zero to rescue the international banking system, growth has failed to pick up, and it may be slowing again.
Having pushed interest rates to near zero — our central bank rate is 0.50 per cent — a new experiment is underway by the central banks. It involves pushing interest rates below zero.
The European Central Bank, along with the Swedes, Danes, Swiss and Japanese, have pressed ahead with negative interest rates. This effectively charges banks for their deposits, and is intended to discourage saving and encourage spending. Consumers get a very little interest — the appearance of a return — but, after inflation, they lose.
So instead of putting money in the bank, Europeans are hoarding cash; large denomination bills make that easier to do. You get more of them into a safety deposit box or a wall safe. Small bills, on the other hand, are easier to spend, both psychologically and practically. There are many more places to break a $10 than break a $100.
Not many people may have noticed, but real rates of return below zero have already arrived in Canada. Ontario’s inflation rate was 2 per cent in January, while the average yield on a one-year Guaranteed Investment Certificate quoted on the Fiscal Agents web site is 1.24 per cent.
In after-inflation terms, $1,000 invested in that GIC will be worth $992.40 a year from now.
These policies are on the radar of central banks in Canada and the U.S., though the consensus is that, barring a disaster, they won’t be used. However, the Federal Reserve is stress-testing American banks for a world of interest rates below zero. Our central banker Stephen Poloz said in December he’d consider the option if it was needed.
The implications of the trend are profound. Here are a few:
Pension returns drop: Pension funds have traditionally been structured on a model based on 60 per cent invested in stocks and 40 per cent bonds. So suppose the fund needs a 7 per cent return to pay its retirees. If 40 per cent of that comes from bonds that yield less than zero, the total has to come from stocks or other bond-like things. Is it likely markets will return above 7 per cent a year, on average, going forward?
Savings are destroyed: Older people who did all the right things by saving are being punished for their good behaviour. They’re getting nothing on their savings, and losing money after inflation. Debtors are being rewarded.
People move to riskier investments: If they can’t come out ahead with a GIC, many people are reluctantly heading into stocks. Risk has its reward, but that flow of money creates bubbles that will repeatedly burst.
It gets harder to save: Everyone will have to save more and longer to get an adequate return for retirement. And as more money heads into markets (without economic growth to support it), you get asset inflation. Dividends rise less quickly and yields fall.
Our biggest public and private pension plans are adapting to this trend by moving into areas once considered off-limits.
A sign of the times last week was news that a consortium led by the Ontario Teachers’ Pension Plan (OTPP) and the Ontario Municipal Employees Retirement System (OMERS) bought a regional airport outside London, U.K.
That’s just a taste of what’s going on. I’ll explore it in more detail next week.