The Age of Negative Interest Rates
Preserving the real, inflation-adjusted value of a corporate treasury has been a challenge for some time now. The problem has worsened over the last years though, as today even the nominal value isn’t guaranteed anymore. With negative interest rates, companies are now paying to deposit their money with banks. For example, government-owned bank PostFinance located in Switzerland charges -0.75% for deposits over 100’000 CHF. Alternatives to bank deposits are hard to find. Investing parts of the corporate treasury into the money markets doesn’t mitigate the problem. Yields are so low that they hardly compensate for inflation, if at all.
Investing in stocks or bonds exposes a company to stock market risks, which is often undesired, especially for treasury assets. The last option is the repurchasing of a company’s own stock. But with the stock markets at all-time highs and companies valued at above-average multiples, stock buybacks don’t seem like the best way to put hard-earned money to use.
Is Inflation the Real Problem?
For many companies, interest rates of -0.50% per annum might be annoying, but not an existential threat. But what about inflation rates? In the US, the inflation rate has strongly risen over the last several months to around 5%, a trend that experts are closely monitoring due to the ongoing quantitative easing by the FED. In Switzerland, the estimated consumer price index (CPI) is 0.4% for 2021 and 0.5% for 2022. The estimates for the EU are only slightly higher with 1.5% for 2021/22. Thus, CPI inflation in Europe doesn’t seem to pose a problem at present.
More important though is the asset price inflation of stocks, commodities, real estate, and art – in other words, ‘the everything bubble’. Hard assets have strongly increased in price, especially since the Covid-19 outbreak in March of 2020. Even though the real economy is going through turbulent times, the prices of assets fell only shortly and bounced back really fast, catapulting in many cases to new highs. The economic impact of Covid-19 is real, but assets prices don’t seem to be affected. On the contrary, they are on the upswing.
Figure 1: S&P 500 (SPX) versus the Fed Balance Sheet (FARBAST INDEX)
Raoul Pal, one of the world’s leading macro investors, explains in a recent video how he has gradually found a new way to comprehend what currently is going on in the markets. When he looked at a chart of the S&P 500 stock market index, which returned ≈33% in the last year alone, side by side with the Fed Balance sheet, a moment of clarity hit him. Comparing the S&P 500 not to its dollar valuation but to the Fed Balance sheet reveals the true picture of the stock market. When using the right denominator, equities look undervalued like they should during challenging economic times.
Elevated asset prices calculated in dollars are ultimately the result of the Fed’s strongly increased money supply over recent years. When looking at them with the right denominator, which needs to be the Fed’s balance sheet, prices are flat. This is true for gold, real estate as well as equities. The S&P 500 for example has nominally grown on average 15% per year over the last decade. But so did the Fed’s balance sheet. Thus, the conclusion is that the S&P 500 real returns have been much lower than the officially inflation-adjusted return of 12%.
The True Inflation Rate
Looking at these facts, estimates are that the real inflation rate for the US-Dollar is closer to 15% per year. As most other currencies follow the Fed’s US-Dollar, above all the ECB, overall fiat currency debasement is visible when comparing them to hard assets. This means that your savings – and as a company your treasury – need to generate a 13%-15% annual return just to stay flat in real, cost of capital terms. It’s not asset prices going up but fiat currencies going down in price.
As a corporate treasurer, this poses the question which assets can protect your savings from an annual devaluation of 15%? As indicated, traditional, low-risk low-return assets such as bonds or money market instruments won’t do the job. As seen above, even the S&P 500 barely manages to keep up with the real inflation rate. One option are FAANG stocks (Facebook, Amazon, Apple, Netflix, Google) which have generated a nominal annualized return of 38% over the last 10 years.