Several of the world’s central banks have adopted negative interest rates. But why would investors go along? There are several possible reasons:

1. Security and safety: Government bonds or insured bank deposits are backed by the full faith and credit of a sovereign nation, which has the ability to issue currency to make repayments.

2. Returns are relative: In Europe, for example, purchasing bonds yielding more that the official rate at the central bank — even if it is negative — is the least worst alternative.

3. Speculation: Investors may be attracted by the opportunity for capital gains from price appreciation if they expect yields to become even more negative. Foreign investors also may be attracted by possible currency appreciation.

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4. Real returns: Investors may favor real return over nominal return. Bonds with nominal low- or negative return may preserve or increase purchasing power in situations where the expected deflation is greater than the negative yield, providing positive real yield.

5. Investment mandate: Fund managers may be forced to purchase negative yielding bonds, irrespective of the fact that it locks in a loss.

6. Banks’ and insurers’ mandate:Financial institutions may be forced to purchase negative yielding securities, given liquidity regulations that require these entities to hold high-quality securities.

7. Central banks’ mandate: Central banks with restricted investment choices are also buyers of negative-yielding securities.

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Coping strategies

Yet large and persistent negative interest rates would meet significant resistance, triggering alternative strategies to avoid losses.

To begin with, investors can withdraw cash and hold it. In the 1990s, low interest rates and concern about bank failures drove significant withdrawals of cash in Japan, creating something of a bull market for home safes.

Nowadays, Europe and Japan are seeing record purchases of safes, presumably designed to store cash and avoid the impact of negative rates.

Second, investors may avoid negative rates by resorting to a variety of near-cash instruments. For instance, businesses could take payment by bank checks that would not be deposited until the money was needed.

Third, investors could hold savings in foreign currencies, converting into a negative-yielding currency when needed. This strategy avoids negative yields but entails foreign-exchange risk, unless this can be effectively hedged.

Fourth, real assets such as land, property, commodities — especially precious metals and collectibles — would be favored. Businesses also could stockpile inventory.

Fifth, payments would be made quickly. This strategy could be extended to prepayments of taxes, suppliers, or employees, where parties could pay for future obligations in advance. While this avoids the impact from negative yields, it does carry credit- and performance risk.

Yet while these mechanisms cope with negative yields, they are socially and economically destructive. Funds become tied up in unproductive assets. Savings do not circulate to provide essential financing of social and industrial investment, reducing growth. Capital allocation is distorted by the sole desire to avoid negative rates.

Moreover, a shift out of banking deposits would adversely affect the funding of banks. The reduction and instability of funding, as liabilities shift to certified checks or prepayments, may reduce the ability of the financial system to extend credit, further hampering economic activity.

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Trashing cash

The most radical consequence of negative rates would be the abolition of cash itself.

To date, the case for banning cash has been couched in terms of deterring criminality or terrorism, eliminating tax avoidance, enhancing efficiency by faster funds-flows, reducing costs, or even improving hygiene by preventing contact with bacteria and virus-harboring notes.

In a future economic or financial crisis, current low rates would restrict the effectiveness of monetary policy. Enhancing the ability to use negative rates would provide central banks with additional flexibility and tools to deal with a slowdown. This would be an imaginative, rapid, and durable mechanism for levying negative rates to confiscate savings.

Abolishing cash would require a revolutionary change. Despite the increasing acceptance of electronic payment, cash is still extensively used throughout the world In effect, currency remains an important medium of exchange and means of payment for legitimate, legal transactions.

Cash use is especially high among both poor and older people. Accordingly, the elimination of currency would have implications for social and financial exclusion. The cost of converting these users to digital payments would be substantial.

Central banks also would lose financially, experiencing a decline in “seigniorage revenue” — the difference between the minimal cost of creating currency and the investment return on government bonds. The amounts lost are significant, reducing both the loss-absorption capacity of central banks and a source of revenue for public finances.

An exclusively digital or electronic payment system also increases security and operational risks significantly; counterfeiting, cyber-hacking, and disruptions due to technology failures would be considerable.

Of course, banishing cash would likely meet stiff resistance. People are likely to object to the loss of the anonymity and privacy that cash provides. Where the elimination of cash is linked to negative rates, it would be seen as a tax on savers and the state confiscation of savings. The intrusion of the state and authorities on such a mass scale would undoubtedly become an explosive political issue.

Satyajit Das is a former banker and author of The Age of Stagnation (Prometheus Books).