The global economy is entering an era of negative interest rates. How would this affect the economy and should investors buy Bitcoin as an alternative?
In the last year, governments from all around the world decided to lower interest rates in order to help their economies grow and expand in periods with low consumption, low inflation rates, and a slowing economy.
Some of the most important central banks that decided to lower interest rates include the U.S. Federal Reserve (FED), the European Central Bank (ECB) and the Bank of Japan. The decision to lower interest rates will clearly have an impact on the economy and eventually in the growing cryptocurrency market.
The main questions investors have is how they could remain profitable in a world of negative interest rates. As we will explain in this article, there were just a few cases of negative interest rates that lasted for short periods of time, however, many are starting to analyze which could be the effects on the economy in the mid- and long-term.
How Could Negative Interest Rates Affect The Economy?
Interest rates are one of the main instruments to handle monetary policies and that central banks use to modify different attributes of the economy. By lowering interest rates, consumption increases and the credit in the economy starts growing. It becomes increasingly cheap for companies and individuals to take credit rather than investing funds in fixed income solutions.
This would increase economic activity and have a direct impact on the prices of the economy. Ultimately, unemployment falls and the economy recovers or it grows at a faster rate.
Negative rates have a similar effect on the economy. However, the incentives of firms, institutions, and individuals grow to take away their savings. Also, they will use these savings to spend or invest in the real economy. In general, the future prospects of the economy should be very negative if central banks have to use negative interest rates.
The problem of ever-growing global debts
It is no secret that countries like the USA, Japan and most countries in Europe have to face with ever-growing debt balance sheets. When interest rates turn negative, the speed of growing debt will be even higher. This is a very worrying scenario.
Countries such as Greece opted to take low-interest credit and help its economy grow, however, the country faced a credit crisis in which it showed it couldn’t deal with the payments for its debt. The same can happen with companies and other individuals.
Cheap credit and inflation of markets
Also, negative and low interest rates could have an adverse effect on the economy. Considering credit is cheap and individuals prefer to spend their funds rather than saving money, the economy could be generating a credit bubble.
Many individuals without the resources to do so would be able to have access to credit before they were not able to pay.
Moreover, stock markets could start becoming inflated considering many investors would move their fixed-income investments to stocks that promise higher returns. However, when everyone leaves the stock market, a crash may occur considering some prices may be overvalued.
Interest Rates And Investments
One of the main consequences of low interest rates and negative interest rates is related to pension funds. Generally, pension funds and their portfolios include a high portion of fixed income investment tools closely tied to interest rates. In periods in which interest rates are high, these pension funds grow generally faster than inflation.
However, during long periods of negative interest rates, all pension funds yields would be at stake. How would pension funds remain profitable? Would pension funds have to take and accept more risks on their portfolios?
Negative interest rates increase the need for alternative investments
Investors would also realize their investments are not growing as expected due to the low interest rates. This is why these investors are now looking for new investment alternatives to spend money elsewhere.
Investors may move their funds to foreign markets in order to receive a better interest rate for their funds. This would increase the flow of money that leaves the country, which could have a negative effect on currency rates.
Some investment alternatives could be stock or index funds, real estate and eventually cryptocurrencies. The stock market has been inflated during the last months despite the fears of an economic crisis in the future. Stocks have been fuelled by low-interest rates and investors moving their funds to have higher yields on their investments.
Alternative investments like cryptocurrencies could be a serious option
Real estate could also be a good investment for those affected by the negative interest rates. Moreover, the housing market remains a good alternative, but it has also been inflated in the last few years. This should also be a warning signal for investors that are trying to search for more attractive returns.
In addition to it, investors could also move to cryptocurrencies. We have prepared a special section in which we explain cryptocurrencies and interest rates in greater detail.
Low and Negative Interest Rates And Their Effect On Cryptocurrencies
Cryptocurrencies have been operating in the market since Bitcoin (BTC) was released at the end of 2008. New cryptocurrencies have been launched trying to offer solutions to different problems and issues in the space.
Bitcoin and cryptocurrencies have been operating in an environment with low-interest rates in the U.S. and other major economies. In the United States, interest rates started to grow at the end of 2015 and reached their peak in April 2019.
During that period of time, Bitcoin and other digital assets were able to expand and become established assets. Although they didn’t reach mainstream investors there seems not to be any meaningful relationship between Bitcoin and interest rates.
Is there a relationship between interest rates and Bitcoin?
Many analysts consider that when interest rates are low, funds could move towards Bitcoin to find better returns for their investments. However, moving funds to Bitcoin is something that increases investors’ risks. Especially if cryptocurrencies are experiencing a crypto bear market like the one in 2018. Cryptocurrencies are known to be very volatile assets and this could seriously damage their investments.
Other analysts would claim that when interest rates are low or negative, investors want to take care of their funds by placing them in cryptocurrencies. In general, these kinds of investors believe in Bitcoin as a store of value, which is something that remains to be seen considering the digital asset is very volatile.
Negative interest rates should have a similar impact on cryptocurrencies. However, there is no clear relationship because of two main reasons. The first one is the fact that negative interest rates have been used in just a few occasions by central banks and for short periods of time.
The second reason is related to the magnitude and size of the cryptocurrency market. Bitcoin and other cryptocurrencies are uncorrelated assets. That means that they do not yet respond to macro trends as many individuals or enthusiasts would like.
Bonus video: How negative interest rates work
Conclusion
Low and negative interest rates have an impact on economic activity through the expansion of cheap credit and consumption. Nonetheless, the side effects of low interest rates are related to how the economy decides to focus on consumption rather than on investment which needs capital accumulation over long periods of time.
Investors are searching for new investment possibilities with higher yields, including the stock market, real estate, and cryptocurrencies.
Cryptocurrencies remain unaffected by monetary policy changes considering the market is still not closely correlated to traditional finances and to macro trends. In the future, however, things could change and Bitcoin could become an asset influenced by changes in interest rates by central banks. In order for this to happen, new institutional and traditional investors should enter the space and make the market bigger.
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