We are now approaching 11 years since the world's central banks embarked on an unprecedented experiment in low interest rates and quantitative easing. What began as a temporary emergency measure to save the global financial system has since turned into the new normal of monetary policy.
With the Federal Reserve gearing up to cut rates again, and with the European Central Bank planning on bringing negative rates even lower, no one is really sure how this is supposed to play out. In a February 2016 interview with CNBC, Warren Buffett (Trades, Portfolio) echoed similar concerns and explained how negative rates affect Berkshire Hathaway (BRK.A, BRK.B)
When asked to clarify his comments about Berkshire Hathaway being an "interest rate-sensitive" company, Buffett said that low rates have been harming its European business by making holding euro-denominated deposits a net loss:
"Interest rates are like gravity in valuation. If interest rates are nothing, values can be almost infinite. If interest rates are extremely high, that's a huge gravitational pull on value - and we had that in the early 1980s. So we have gone into this period where Berkshire Hathaway is sitting with billions of dollars of euros in an insurance company that we have in Europe, and they will bear a negative rate.
We would be better off if we had a big mattress in Europe that we just stuck all of this stuff in it - if only I could just find the person whom I trusted to sleep on the mattress! That's what we would do. If we have a billion euro at -35 basis points, that would be 3.5 million euro a year that it's costing us just to have that. That means you don't want to collect your receivables! It distorts everything".
We thought when we started it that it would end fairly soon. Europe, in particular, needed further jolts in the arm and they've extended it. We can't get too far away from it [due to the problem of the U.S. raising rates while Europe is at negative rates] - what that does to the dollar and what that does to trade and what that does to business."
I have written at length on the issue of corporate debt and the growing number of companies who struggle to service their obligations. The proliferation of these so-called "zombie firms," I believe, is directly tied to the easy availability of cheap debt that has been unleashed by low rates. This is a problem that will only get worse the lower rates go, but clearly the ECB feels it cannot raise rates either, partly due to chronically low inflation. In short, no one knows how to get out of this mess:
"In economics, the most important thing to remember - it's important in other areas of life too - after anything that happens, if someone tells you 'this is gonna happen,' you have to ask 'and then what?'...And in terms of sustained low interest rates, I don't know the answer."
Neither do we, Buffett, neither do we.
Disclosure: The author owns no stocks mentioned.
Read more here:
- Franchise Value: I Know It When I See It
- 4 Catalysts for Economic Contraction
- If This Is the Greatest Economy in US History, Then Why Is the Fed Cutting Rates?
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