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Investors Earn 6% When Others Are Losing Money

Companies / Investing 2015 Mar 16, 2015 - 11:58 AM GMT

By: Money_Morning


Peter Krauth writes: We're living in crazy economic times.

The race to debase and stimulate has taken us into uncharted financial waters.

Zero interest rate policies (ZIRP) are being replaced with negative interest rate policies (NIRP).

It's an upside-down banking environment that presents some serious challenges.

But investors who are willing to get just a little creative can profit nicely, even as others lose money that just sits there.

And, even better, the shares are trading at an 8% discount now…

"Financial Repression" Is the New Reality

Until a few years ago, few of us had ever heard the term "financial repression." Today, we're all living it.

Things are now so backwards that some are being paid to borrow money, while others are paying to leave their funds on deposit.

In Denmark, entrepreneur Eva Christiansen applied for a small business loan. When her bank called with news that her financing was approved, they informed her the interest rate was -0.0172%. That's a negative interest rate. Incredibly, it means Christiansen will be paid to borrow money.

To be sure, that was a pleasant surprise. But the obverse of this coin is decidedly less bright.

Also in Denmark, student Ida Mottelson, vying for her master's degree in health sciences, was contacted by her bank. In her case, she was told she would have to pay a 0.5% fee to leave her funds on deposit. She's now looking for another bank to do business with.

This backwards treatment goes beyond personal banking, too.

Just recently JPMorgan Chase & Co. (NYSE: JPM) decided it would soon start charging large institutional clients on certain deposits.

Hedge funds, foreign banks, and private-equity firms will be most affected. JPMorgan is reacting to new federal rules which discourage banks from holding deposits considered at risk of fleeing when financial stresses or crises present themselves.

Must Investors Take a Loss for Safety?

Europe appears to be the epicenter of this NIRP phenomenon.

Already Switzerland, Sweden, and Denmark foist negative interest rates on some bank deposits.

Australia's Commonwealth Bank estimates close to 25% of worldwide central bank reserves now carry a negative yield, meaning they're losing money on those funds.

Germany just issued $4 billion worth of five-year bonds paying a negative interest rate. Some investors have gotten so desperate for safety; they're willing to accept less than their full capital back after five whole years. Others are buying those bonds, betting rates will go lower still, and pushing bond prices up in the process.

In places like the Netherlands, France, Belgium, Finland, and even Italy sovereign bonds are being issued with negative yields.

As crazy as it sounds – and it is pretty crazy – it's a result of central bankers desperate to stimulate spending in an effort to boost inflation. Plain and simple.

And it's having some serious unintended consequences.

The Swiss National Bank's introduction of negative interest rates could bring dire consequences to Swiss pensions, according to UBS.

Lukas Gähwiler, head of UBS Switzerland, said "It is at least as serious for the economy as ending the floor to the euro, and could even be more serious." His bank's analysis concluded negative rates could weigh on the real economy, cause interest rate risks, compel banks to consolidate, and lead to severe consequences for pension funds, both government and private.

To wit, pension funds restricted from risky investments are in danger of becoming progressively underfunded. The only remedy may be resorting to hikes in contributions. Old age pensions are going to see funding gaps widen even further.

Believe it or not, these shenanigans could go on for a while yet.

I say that because, according to James McAndrews of the Federal Reserve Bank of New York, economists estimate the limit is when interest rates hit -0.5%. Beyond that level they figure depositors may begin to withdraw their funds and sit on physical cash instead.

Yet a 2012 study by the European Central Bank estimates the cost of private cash transactions is 2.3%, pointing to a possible tolerance for even lower rates.

But at some point, rather than pay to park their money, people and businesses will prefer to withdraw their cash and sit on it. If we do indeed get there, that could mean a great business opportunity for secure cash storage services.

Sidestep NIRP with This Investment

But storing physical cash comes at a cost, as proper facilities, security, and monitoring are a must. And done right, they're not cheap.

Meanwhile, individual investors need to look at creative ways to manage their cash positions, so they're not faced with a net loss on liquid funds.

One option I like is the idea of placing part of one's cash allocation in a higher yielding investment. Municipal bonds, or munis, look like a good option for this. Most munis are exempt from federal income taxes, and some of them are exempt from state and local taxes (these are known as triple-tax-free). And they're safer than you might think, with defaults only a tiny fraction of what's typical of investment grade corporate bonds.

What they aren't is risk free. But buying when undervalued with a tolerance for at least some volatility is the proper approach.

The Nuveen AMT-Free Municipal Income Fund (NYSE: NEA) is a closed-end fund holding an array of municipal bonds, and currently yields an attractive tax-free 5.95% dividend. Given that this payout is tax-free, it's the equivalent of earning 8.5% for an investor in a 30% tax bracket. What's even better is buyers get a bit of a safety cushion, since the fund's currently trading at an 8.1% discount to its net asset value (NAV).

So don't let negative interest rates rattle you.

Avoid financial repression, and use inventive solutions to manage your cash. It's your best option to fight back.

Source :

Money Morning/The Money Map Report

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