The Swiss franc fell to a sharp low after the head of the Swiss National Bank said on November 26 that he was prepared to drive interest rates even further into negative territory. Switzerland already has a -0.75% "overnight" rate for banks that draw from it. One Swiss bank plans to charge customers negative interest if they keep cash in their accounts.
The European Central Bank now looks like it will also go further negative in its attempts to cheapen the euro against the dollar, according to Reuters. The ECB currently has a -0.2% deposit rate for banks. Denmark and Sweden also have negative policy rates for their banks, Business Insider reported.
The problem for the Swiss is that if the ECB cuts further, the Swiss franc will then look relatively expensive by comparison, again.
So now Switzerland is locked into a race that no one wants to win: It must match each negative ECB move with an even more negative one of its own.
The intention behind negative interest rates is twofold: First, it makes your country's currency cheap by comparison. Who wants to hold a currency that only loses value? Cheap currency fuels exports and drives inflationary economic growth.
Second, it punishes people who keep cash in the bank. Rather than let yourself be charged interest for storing it in an account, the thinking is you would rather take it out and spend it, thus generating economic activity.
Scary Scenarios
But negative rates also create a surreal world in which you are charged for lending money and you make money by borrowing it. That is driving economists to speculate about all sorts of scary scenarios, on the assumption that the devaluation trend gets deeper and extends itself to consumer banking rates or countries outside Europe… like the US.
One obvious side effect of negative rates is that people would withdraw money from their banks and hold cash. That practical problem means that it is very difficult for banks to push a "real" interest rate on consumers past about -0.5%. Once the negative penalty starts to bite, people just hold bank notes which don't cost fees.
So how could banks force people to spend hard cash? Ken Rogoff of Harvard University has suggested banning cash altogether. Ken calculates that there is $4,000 of currency in circulation for every person in America. Much of it is used to hide transactions from tax authorities or the police. Abolishing it would curb such activities, as well as helping central bankers.
Alternatively, Gregory Mankiw, also of Harvard, has made a tongue in cheek suggestion that the Fed hold a lottery in which it periodically declares that notes with serial numbers ending in a given number from 0-9 suddenly be declared worthless. In that scenario, they expect return of holding any notes would be -10%.
