Fixed Income  

Low rates mean if cash is king, it comes at a cost

Low rates mean if cash is king, it comes at a cost

Most interest rates around the world are at, or close to, all-time lows. The extreme case is Switzerland, where the national bank has set a negative base rate of -0.75 per cent, meaning that it charges to take cash deposits.

The reasoning behind central banks setting low or negative interest rates is complex, but the two broad aims are, firstly, to encourage people to spend rather than save; and secondly to encourage foreign investors to stop buying, hence strengthening, the domestic currency. The latter is Switzerland’s main reason at the moment.

With all of the monetary policy battles being fought at present, central bankers could well find themselves nodding understandingly to Yogi Berra’s famous quote – “In theory there is no difference between theory and practice. In practice there is.”

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It will be some years - or decades - though before we can really analyse the outcome of these central banking experiments.

More interesting at present is the curious situation this negative interest rate world creates. Government bond yields have been dragged lower and lower - in Germany at the moment, a two-year government bond has a yield to maturity of -0.2 per cent. If you were to invest €1 million in such a bond, with the intention of holding it to maturity, in two years’ time you would be the proud owner of €996,000. Just to reiterate, people are investing money in instruments that, in the best case scenario, guarantee a loss – and that’s before taking any inflation into account.

Aberrations such as this create opportunities to think outside the box – or in this case, inside it. M&G Investments’ Bond Vigilantes blog points out that for the conservative investor, there is alternative option to buying a bond – you keep the cash in its purest form, paying only for storage.

Holding €1 million in cash creates some physical problems though. The eurozone does issue a €500 note which seems ideal for the job of bulk cash hoarding - in fact, it is so perfect that for some time it was known by European crime agencies as a Bin Laden, because everybody knew it existed, but only criminals ever saw it.

Keeping things above board, let’s settle for the more familiar €100 note, which is 8.2cm by 14.7cm, and 0.0113cm thick. Stacking ten thousand of these notes would form a tower 1.13m tall – too big a wad for even the deepest pocket. So, where to store it then?

The classic option is to hide it under the mattress. Spreading that tower of cash out across a double bed would raise the height by 0.5cm, although the impact on comfort sleeping might be uncertain. There would be no expenses – and the cash is easily accessible. The downside is that the cash is also easily accessible to any thief who has done his due diligence on “uninventive hiding places”.

A more modern approach would be to rent a safety deposit box at a secure institution, and place your pile of cash there. Obviously, in normal circumstances, this would be a ludicrous idea – you’d earn no interest and pay for the privilege...which is exactly the situation in short-term quality government bonds, discussed above.