This is Breaking The Dollar the podcast that dismantles some of the biggest misconceptions about money. Presented by Gainesville Coins.

I am Everett Millman and this is Breaking The Dollar. This week's episode is going to touch on a topic that I'm sure at some point in past episodes I have in passing discussed and that is NIRP and ZIRP, and those stand for negative interest rate policy and zero interest rate policy.

Now both of these things have been going on in the financial world for a little while now, so I thought it would be good to tackle them in a little bit more depth. So we should start with some basic definitions.

What are we talking about here? And when it comes to interest rates until very recently, until after the financial crisis, the idea of having a zero interest rate really wasn't even considered. In some sense, it defeats the purpose of interest rates themselves.

Right now, I'm not talking about how down the line in the economy you may have seen offers for something where you pay 0% interest usually for a limited amount of time.

Yes, these types of promotions have existed, but that's what made it a special promotion. That 0% interest rate is sort of unheard of.

But in terms of policy, like on a national level where a government or policymakers are setting a national interest rate, 0% rates have never been a thing.

The reason for this is relatively obvious. If you are loaning out money, you want something in return for letting someone hold that money and use it.

So the idea of a 0% interest rate, you really can translate that to free money. It is essentially eliminating the cost of borrowing money; free credit.

So I guess I should step back and explain, well where does this unusual policy come from? Why have governments considered zero interest rates?

And the whole motivation was to reinvigorate the economy after the global financial crisis.

The quickest way to get money moving around the economy again and getting banks to lend again was to essentially make it as easy as possible for people to get access to that funding.

If you were to tell someone you owe me nothing for borrowing this money, that's about as good of a deal as it gets. And although I will touch upon some of the problems associated with these types of interest rate policies in this regard, an objective observer would have to say that the policy sort of worked.

And when you think about it, why wouldn't it? Why wouldn't someone or a business want a 0% interest loan? It's great. But as you might have already guessed, the rabbit hole goes down further.

So in the United States, the Federal Reserve after the financial collapse did institute essentially a zero interest rate. But in Japan, in Europe, they have experimented with negative interest rates.

To this day, there are still several major countries like Japan and Germany, which by the way are the third and fourth largest economies in the world, that have resorted to negative interest rates.

So in this case the policy is even weirder still. Instead of saying that credit is cheap or free, now with negative interest rates, you are actually charging people to hold their money in the bank or you are paying them to borrow money.

So it is completely flipped on its head the way that charging interest normally works.

So why would they do this? Why are central banks around the world some of the biggest ones resorting to negative rates?

It is such an unusual policy and the main reason goes hand in hand with my explanation for zero interest rates. It is intended to spur economic activity, make it easy to kind of grease the wheels of business and industry, but at the same time it discourages people from saving their money or keeping their money in a bank account on the sidelines.

Negative interest rates literally mean that you are losing money, albeit a small amount and fairly slowly, but nonetheless you are losing money just to keep it in the bank.

The intended consequence of this is to put that money into place so to speak, to get it moving around to get people to invest their money and do productive things with it rather than saving it. Aside from that, there are some other reasons that negative interest rates have not only been attempted and implemented, but as I said, they are still here.

They are still a reality in many countries in the world.

The two other major intended consequences of negative rates is to try and increase inflation, which is associated with economic growth in general and also makes it easier to pay off debt over time. So that is one piece of it.

The second expected benefit is to simply anchor all interest rates of all kinds at a lower level. So that might be a bit unclear.

The interest rates set by central banks, essentially the government interest rate is really just the baseline scenario for rates.

There are all sorts of other interest rates charged throughout the economy, whether it's a business loan, a personal loan, an auto loan, or a home mortgage. And so if banks can get these very low or negative rates, then that means they can then charge lower rates to their customers.

I have to admit that as another example where these sort of experimental policies have at least done what they were intended to do, they have indeed lowered borrowing costs and made credit for the most part more accessible across the economy.

On the other hand of course, zero and negative interest rate policy hurts savers and this effect is two fold.

On the one hand you are literally charging people interest to just save their money or keep it in the bank. So that's one way that it discourages or hurts people from saving money. And as I pointed out, it is supposed to drive inflation much higher.

In turn, higher inflation means that your cash and your money that is just sitting there in savings is losing value. It is losing its purchasing power relative to the prices of other things.

So thus far you can see both the benefits and the potential drawbacks to these policies. But I'd like to focus for just a minute on why they really are still so weird.

So I've heard some very smart people in the financial press make some pretty convincing arguments that we shouldn't think of negative interest rates as anything particularly strange because there are so many other financial arrangements that are essentially imposing a negative rate on the people who use them.

So for instance, one example is the capital gains tax. Anything you do that generates a profit just by trading or investing your money is going to cost you a percentage of that gain.

Another example would be that you often pay a commission to brokers or salespeople anytime you buy something or you buy a financial product.

Another telling example of this as it relates to my industry with precious metals is that there is essentially a slightly negative interest rate baked into owning physical gold and that is what they call the opportunity cost of not using that money elsewhere.

So because you could get a positive return from something like a bond or even a corporate bond or other securities, the fact that you're choosing not to own those financial products and instead are just holding, means you are missing out on earning an interest rate or gaining a rate of return on your money.

Now, this whole idea of opportunity costs with gold is absolutely true. However, if the gold price is going up and you are gaining purchasing power just based off of that price appreciation, you're really not going to notice that you're missing out on a 1% or 2% yield somewhere else.

Nonetheless, these are all case studies of how the concept of negative interest does crop up in certain sectors of our lives. I think that there are many, many more examples that disprove that idea or that push against the notion that it is not abnormal for people to be paying negative interest.

You know, you see a lot of attorneys who try civil cases, who handle civil lawsuits. They will say that unless their client wins, you don't owe us anything. In other words, they're saying they will only get paid by taking a percentage of what their clients make. I am sure you've heard this in a radio commercial or on TV somewhere. I'm not singling out attorneys for this practice, but can you imagine if it was the other way around if in exchange for that attorney services somehow they had to pay you to be a client?

I don't think that anybody sees that as a sustainable business model. Granted, you can say that's comparing apples to oranges and fair enough, but it is still worth emphasizing that the implementation of negative interest rates goes against thousands of years of financial history. There is no doubt there is no denying that this is a totally experimental path for interest rate policy. As such, it's important to keep in mind that this experiment has not fully played out yet.

So one of the puzzling things about having negative interest rates in Japan and parts of Europe for about the past decade has been that neither of these regions have seen an appreciable rise in inflation. So in that sense, bizarrely the negative rates aren't having their intended consequence.

Another oddity that is actually happening on the ground is that despite the rates being negative, many, many people are still holding these government bonds and these securities that offer a negative yield.

That just speaks to the level of uncertainty that has driven a lot of investors to safe havens.

So even if you are losing a little bit of money by buying that bond or keeping your money in the bank, the idea is that at least it is still safe. And as a result we have seen investors really pile into negative yielding debt. In late 2019 the amount of debt that had a negative yield, in other words, a negative interest rate, got as high as $17 trillion. I'm pretty sure that made up a sizeable chunk of all the debt issued in the world. It was something like a third of the world's debt.

Now recently, that has pulled back a little bit, but nonetheless, there is obviously an appetite for investing in securities that offer a negative yield. So long as those investors think it is a safe bet.

It's also somewhat unfortunate that because this has gone on for so long in many ways is considered the new normal. It has led a lot of observers to think that slashing interest rates and just cutting them even lower is the solution to everything. We live in a world where all manner of negative financial events will prompt people to offer lowering interest rates even if they're already negative as the solution.

Now, as we already discussed, lowering interest rates and keeping them low is seen as a way of stimulating the economy, of getting the economy going when it's in a downturn or recession. So that begs the question, if interest rates have already been at zero or below for so long, what would policymakers do in order to combat the next downturn?

It's important to see, even if it's a bit more complicated than you or even I can understand that keeping that type of emergency policy in place, even when the economy is growing can cause some unpredictable distortions.

The best example I can give for that, relates to debt. If a company doesn't have to pay interest on its debt and borrowing costs are extremely low as they are in this type of situation, than zero interest rates actually increase the number of companies that are able to survive being unprofitable. You often hear them referred to as zombies because they are literally walking dead.

Zombie companies are able to survive in that type of interest rate environment only because borrowing another line of credit is so cheap. Again, if this is done as a temporary emergency measure, then that's fine. That makes perfect sense to me. Yes, you should try and rescue those businesses if you can do it in a reasonable manner, but it is not good for the overall economy for unprofitable businesses to stay open when under normal circumstances they would have been insolvent.

That is a natural part of free markets. Sometimes there are losers and by losing the money that would have been flowing into those companies, can then go to other areas of the economy.

This is really what I mean by distortions and it is probably the biggest problem from negative interest rates and zero interest rate policy is that they lead to misallocation of capital.

That is just a fancy industry term for saying money is going to the wrong places. It is chasing the wrong things. It's being invested in assets that are not productive or not profitable.

Even though it seems like the government can basically print money at an unlimited pace, there is still a finite amount of money out there to flow around the economy, so any funding, any capital that is going to an unproductive source could have been going elsewhere. Everybody else loses. Every other participant in the economy loses if capital is miss allocated like that.

Now rather than leave things on a sour note like that, I think there are two interesting side effects that we should be paying attention to as a result of these interest rate policies.

One is that people are flying to gold, US Treasuries and the US Dollar.

These are traditionally seen as the safest assets. You're not going to earn a whole lot of money by investing in them, but at the same time they have historically proven to offer the safest store of value you can get and in all three cases that has been true for more than a year.

Gold prices are up, the dollar has remained very strong and the yield on treasuries has been continuing to fall, which means that there's strong demand for government bonds in the United States.

So that's one side of it is that yes, lots of investors and institutions are seeking safety from this rather strange set of policies.

The second point relates to a famous quote from certainly the world's most famous investors, the Oracle of Omaha, talking about Warren buffet and I don't think that buffet originated this saying, but he is the most famous person to have reiterated it so it gets credited to him. Anyway, Warren Buffet said that recessions are like the low tide at the beach. It's the only time you find out who has been swimming naked and that's not only a humorous little saying. It's also an excellent illustration of what I mean by zombie companies because right now thankfully you don't hear a lot about companies going bankrupt, becoming insolvent, going under. We really haven't seen a big wave of that because slowly but surely the U S economy has been growing and of course we have all these stimulus policies in place, but of course there is such thing as a business cycle.

Markets move in and so eventually there will be another recession. At some point there will be a downturn. It will be at that point that those zombie companies will be caught naked. Swimming financial history shows that you cannot survive as a business purely by taking on more debt over and over.

Eventually that low tide comes in and everyone sees you're naked and they don't want to invest their money with you anymore.

So connecting that example to the topic at hand about zero interest rates and negative interest rates, NIRP and ZIRP are filling up the bathtub so to speak. They are adding more and more liquidity to make it easier for a company that is swimming naked, to hide that fact. It is my sincere hope that policymakers will find a way to somehow normalize interest rates and move away from this policy before we get to that point. But the trend certainly seems to be in the wrong direction.

Alrighty, we will now move on to our mailbag to check out this week's question from the listeners. This week's question comes from Portland, Maine from anonymous, and they ask, are diamonds a similar investment to gold?

I can see why you might think that. Some of the obvious similarities are that they are considered precious, that they are used often for ornamentation and jewelry and that's because they look pretty, they're shiny to some extent. You could also say that both diamonds and gold are mined, that they are dug out of the ground, but increasingly that is not true.

One of the main differences I'll point out is that science has basically figured out the formula to create diamonds synthetically. Moreover, the average person can't even tell a synthetic diamond from the real thing. The same is absolutely not true of gold.

You cannot just manufacture gold in a lab. Alchemists spent hundreds if not thousands of years trying to do that and they were never successful. Even modern science cannot make synthetic gold. So that is one difference.

The other main difference between diamonds and gold comes down to something called fungibility. So if an item is fungible, it means that two equal parts of the piece are perfectly interchangeable. They can be exchanged for one another. This is one of the qualities of money that if you have four quarters, it's the same as a dollar and vice versa.

Pure gold is fungible because every little gram or even down to molecule of gold in that bar is identical to the rest of them. This is unfortunately not true of diamonds. It really matters how that diamond is cut, what it looks like, what it is. There are all these factors you have to take into account and you cannot just break a diamond into equal pieces and say they're all equally valuable or have the same exchange value.

Those two reasons are why diamonds are not generally considered a mainstream alternative investment, in the same way that gold is considered.

That doesn't mean that people don't buy diamonds as a luxury item. Certainly people do buy jewelry with diamonds, but it is not like gold where you can reliably know that your ounce of gold is the same as anyone else's ounce of gold. So long story short, that's what makes diamonds unsuitable as a financial instrument.

That is it for this week's episode. Really appreciate everybody listening. Thank you so much for tuning in. Be sure to check out next week's episode where we'll be discussing how the Corona virus in China is impacting markets.

Today's episode was presented by our sponsors, Gainesville coins. You can find out more at

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Everett Millman

Everett Millman

Managing Editor | Analyst, Commodities and Finance

Everett has been the head content writer and market analyst at Gainesville Coins since 2013. He has a background in History and is deeply interested in how gold and silver have historically fit into the financial system.

In addition to blogging, Everett's work has been featured in Reuters, CNN Business, Bloomberg Radio, TD Ameritrade Network, CoinWeek, and has been referenced by the Washington Post.