The consequences of these negative interest rate policies are as yet unknown, but they have the potential to be profound. Remarkably, investors can now use instruments that guarantee a negative nominal return. Furthermore, issuers such as highly rated sovereigns and large corporates are today getting paid to issue debt.

Above, we have the immediate effects of NIRP. As a result of these market dynamics, a more significant debate has now started to surface about the meaning of cash and about what differentiates its physical form from that of a cash deposit at a bank.

First, let’s look at the meaning of money in the form of a banknote. According to one definition, “a banknote constitutes a central bank's promissory note to pay a stated sum to the bearer on demand”. According to another, money is considered to be an “unencumbered means of exchange and a store of value”. Put simply, a bank note in your wallet is yours to spend or keep as you wish.

However, money held in a cash account at a bank is very different. It is not money, as defined above, but rather a loan to a bank for use at its discretion. A depositor in such a bank account or money market fund can count their cash-like asset as an investment, but not as money. In other words, a bank cash deposit is not risk free. It is not unencumbered money.

And so, via the law of unintended consequences, the keepers of the fractional-reserve-banking model have created a systemic Achilles heel in the form of NIRP. Through a series of negative inducements brought about by extreme central bank policy actions, many large and sophisticated investors are now asking why they are assuming counterparty risk and a guaranteed negative return by holding cash at a bank, when there is an option to hold unencumbered notes for less cost.

In the following table (Table 2), courtesy of Bridgewater Associates, LP, we get a sense of what the incentives are for holders of large cash deposits to exchange these for physical cash. The table is comprised of a series of cost estimates for storing the largest denominations of notes based on the storage costs of gold in those countries. As acknowledged by Bridgewater, Table 2 is not perfect, but it does provide some insight into why we are hearing debates about the role of cash in society. It is also an indication of why gold, another form of money and a store of value, has just had one of its best quarterly performances—a trend that we believe is in its early stages.

David Fuller's view

I am delighted to post this report from Peter Van Dessel of Abbington Investment Group, LLC.  He is someone I have known for a number of years and hold in high regard.  I think subscribers will also enjoy these thoughtfully prepared reports, for their originality and the quality of analysis.  They will be posted on a quarterly basis.