Did you notice the news story that shook the foundations of our global economy last week? Although it didn’t receive much attention in the popular press, one doesn’t need to possess a PhD in Accounting or Finance to appreciate the potential threat that now confronts us.
You see, for the first time in the history of European finance, private corporations issued bonds with negative interest rates. Specifically, the corporations Sanofi and Henkel announced that they will charge investors to borrow money from them.
Although European government entities have issued securities with negative interest rates, never before have private corporations done so. Presumably, investors are now so nervous about the future of the European Union that they are willing to accept such terms from Sanofi and Henkel.
Why did this event shake the foundations of our economy? Because our global financial system is predicated on the assumption that it is worthwhile to invest for the future. Under normal circumstances, when a borrower pays interest to a lender, the interest payment represents an acknowledgment that the borrower is investing the principal in a project that is generating future value.
So what happens when interest rates turn negative? In essence, investors are incentivized to spend all of their money immediately, or to store their money in their proverbial mattresses, rather than investing in the private sector. And the calculation known as Net Present Value (NPV), which relies on positive interest rates to discount future payments to their current values, fails to function.
Furthermore, if we no can longer estimate the present value of future cash flows, many tangible and intangible assets will no longer possess calculable values. Commercial landlords, for instance, will no longer be able to estimate the values of their properties on the basis of their future rent receipts. And banks will no longer be able to estimate the values of their loans on the basis of their future repayments.
In other words, we’d experience a valuation nightmare. So why did the Sanofi and Henkel announcements garner so little public concern? Perhaps it’s because the financial press is assuming that their negative interest rates will prove to be isolated incidents.
If other private corporations start to issue debt at negative interest rates, though, there’s no question that we’ll start to hear about it. After all, if the practice of investing for the future is no longer perceived to be a generator of value, it’s difficult to envision how our economy will ever grow.