A safe place for your money

Imagine just for a moment that you have €100,000 of spare cash and you would like to invest it. (If you do actually have this amout of money lying around, you might want to pay particular attention.) Imagine also that inflation is zero.

What should you do with your money? You could invest it in shares, otherwise known as stocks or equities. Or you could buy government bonds, or invest in precious metals such as gold or silver. Then again, you could invest in property.

But no, you decide these options are all just too complicated. You are going to take the money to your bank and leave it there for the next 12 months. Safe — you hope — and simple.

But when you arrive at the bank, you get a bit of shock. The interest rate your bank is offering for one year is not three per cent, nor two per cent, nor even one per cent. In fact, it's not even zero. The interest you are offered is minus one per cent.

Minus one per cent? How can that be? Surely interest rates on savings can't be negative. Well, in theory they certainly can be. What this means is that, if you give the bank your €100,000 now, they will guarantee to give you €99,000 in a year's time.

Unhappy with this offer, you check with all the other banks — both real and online — and discover they are offering the same rate of interest. Has the world gone mad, you wonder?

Not necessarily, is the answer. Imagine that inflation is five per cent and the best rate of interest is four per cent. Would you accept that? Quite possibly, even though the real rate of interest — the nominal (actual) rate minus the rate of inflation — would be minus one per cent.

So why wouldn't you accept an interest rate of minus one per cent if inflation is zero? In this case, the real interest rate would also be minus one per cent.

So much for the theory. What about reality? In a superb article in the Financial Times this week, Wolfgang Munchau demolishes the myth that interest rates can't fall below zero, giving the recent behaviour of the Swedish central bank as an example.

Munchau also discusses why negative interest rates need not cause everyone to withdraw their money from the banks. One reason is that keeping large sums of money at home also incurs costs, such as security systems or guards to protect your savings.

We are not yet in a world of negative interest rates. Nor is it likely. But it is not impossible, either in theory or practice.