Free money isn't fun for everyone

It almost sounds too good to be true. The Dutch government can borrow money for no less than 30 years, without paying interest on it. This gives the government every opportunity to give the economy a significant corona boost. Meanwhile, the pension sector, among others, is paying the price of low interest rates.

Are you going to put your money into a company that will run through billions and billions of euros within a quarter? The price movements of many oil stocks suggest that few investors are interested in this. The stock market capitalization of companies such as BP and Shell, which recorded losses of more than €15 billion in the second quarter, have fallen by more than half since the turn of the year.

However, the situation is different with governments. The budget deficit in the Netherlands amounted to €24 billion in the second quarter, Statistics Netherlands reported on Wednesday. Still, investors lined up this week to buy Dutch government bonds.

Borrow money? money!
Our government raised €5,96 billion this week by placing a loan with a maturity of 2052 and an interest of only 0,028%. Since then, interest rates have fallen even further. And for bonds with a shorter maturity, the Netherlands even receives money. An important reason for the extremely low interest rates is the policy of the European Central Bank.

The ECB already reduced the compensation for banks that temporarily store their money – the so-called short-term interest rate – to below zero in 2014. In addition, the bank massively buys government bonds from European countries. This drives up the prices of those loans, pushing interest rates down.

Pain in the pension sector
As a result of this policy, the ECB has become one of the buyers of Dutch government bonds. In addition, it is mainly pension funds and insurers that purchase these loans. These parties want to put their money away safely to meet future obligations. However, due to the low interest rates, the price of security has become very high.

The low interest rate was about 10% 4 years ago. At such a rate, an amount of €300 grows to almost €30 within 1.000 years. A pension fund that now wants to be sure that it can pay out €2050 in 1.000 years must set aside €0 at an interest rate of 1.000%. That huge difference shows why low interest rates hurt the pension sector so much.

Low interest rates and the euro
Of course there are also advantages. For example, the government can get money very cheaply to give the economy a big boost. Usually, low interest rates also lead to a cheaper currency, which is good for the export sector. In the case of the euro, however, this is hardly noticeable.

Since the turn of the year, the euro has appreciated by 4% against the dollar. The gain on the British pound is even 7%. However, the strength of the euro is to a large extent also the weakness of the other currencies. The dollar is under pressure from the unpredictable presidential elections, while the uncertainty about Brexit is playing tricks on the British pound. Both matters will become clear before the turn of the year. Then it becomes clear where the euro really stands.

Joost Derks

Joost Derks is a currency specialist at iBanFirst. He has over twenty years of experience in the currency world. This column reflects his personal opinion and is not intended as professional (investment) advice.

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