The Alternative Bank Schweiz wrote to customers telling them they would face a -0.125 per cent rate on their money from 2016 – and a -0.75 per cent rate on deposits above 100,000 Swiss francs.

The move echoes the Swiss central bank’s -0.75 per cent negative deposit rate imposed on financial institutions placing money with it.

Sweden’s central bank also introduced negative rates, which currently stand at -0.35 per cent, while the European Central Bank introduced them in part with its -0.2 per cent overnight deposit rate.

The Bank of England’s chief economist Andy Haldane delivered a speech in September discussing how Britain could have to consider negative interest rates as an extreme measure in a future crisis.

The big Swiss banks passed on some of the pain from the Swiss central bank’s -0.75 per cent rate to their institutional clients, but Alternative Bank Schweiz is believed to be the first retail bank to hit savers with a charge.

The bank describes itself as an ethical organisation focused on backing firms investing in social and environmental projects.

With its balance sheet totalling nearly 1.6 billion Swiss francs last year, most of its activities are concentrated in cooperative housing projects, providing affordable housing and sustainable energy solutions, as well as organic farming.

Imagine a bank that pays negative interest. Depositors are actually charged to keep their money in an account. Crazy as it sounds, several of Europe’s central banks have cut key interest rates below zero and kept them there for more than a year. For some, it’s a bid to reinvigorate an economy with other options exhausted. Others want to push foreigners to move their money somewhere else. Either way, it’s an unorthodox choice that has distorted financial markets and triggered warnings that the strategy could backfire. If negative interest rates work, however, they may mark the start of a new era for the world’s central banks.

The Situation

With the fallout limited so far, policy makers are more willing to accept sub-zero rates. Having once said that the European Central Bank had hit the “lower bound,” President Mario Draghi signaled in October and November that the deposit rate could be cut even further into negative territory. The ECB became the first major central bank to venture below zero in June 2014, and it now charges banks 0.2 percent to hold their cash overnight. Sweden also has negative rates, Denmark used them to protect its currency’s peg to the euro and Switzerland moved its deposit rate below zero for the first time since the 1970s.

That means investors holding to maturity won’t get all their money back. Banks have been reluctant to pass on negative rates for fear of losing customers, though Julius Baer began to charge large depositors.

Economic Distortions

That's actually a balanced synopsis by Bloomberg as far as it went.

But unlike Europe, the US has large money market funds that would be destroyed by negative rates. Banks may be able to hold out for a while by raising other fees, but money market funds would immediately be in trouble.

Customers would withdraw money, put it into banks charging the lowest fees, stuff cash under the mattress, or open safe deposit boxes.

If rates get negative enough, there would be a run on the banks, but arun on money market funds would likely happen first.

Someone Has to Hold the Cash

The central bank thesis is to get people to spend the money. But note the absurdity. Someone must hold every dollar printed at all times.

If you buy a candy bar and eat it, or a coat and wear it, the store that sold those items to you has has the money. Mathematically, someone at all times must hold all the money.

What About Velocity?

Reader "Vince" has been bugging me to write about the velocity of money. Velocity purportedly measures the speed at which money circulates in the economy.

I have commented before on the absurdity of the velocity thesis, but this seems like a good time for a rehash.

Velocity = Value of transactions / supply of money 
The value of transactions = price * transactions = GDP.

Thus, velocity is nothing more than GDP divided by money supply. Here is the equations, two ways.

V = PT / M
V = GDP / M

Right now, velocity is falling simply because money supply is increasing faster than GDP.

But what constitutes money supply?

M1, M2, MZM, base money, and true money supply all yield different measures of velocity.

M2 Velocity

So is velocity 1.7, 5.9, 1.5, 1.3 or something else?

If we rearrange the equation, GDP / Velocity = M.

Supposedly we know GDP but what do we plug into the equation for velocity to derive M? Can one independently measure velocity?

The answer to that question is a resounding no.

Since GDP = PT, GDP can rise if prices rise and GDP can go up if transactions go up. GDP can rise if transactions decline, provided prices rise enough. And GDP can rise if prices decline, provided transactions rise enough.

• Velocity can rise with rising prices
• Velocity can fall with rising prices
• Velocity can rise with increasing transactions
• Velocity can fall with increasing transactions

1. Velocity has no life of its own.
2. Velocity does not cause anything to happen.
3. Velocity cannot be measured by any independent means.

Mario Draghi has dropped his clearest hint yet that the European Central Bank is about to inject more monetary stimulus into the eurozone economy, brushing aside staunch opposition from Germany’s powerful Bundesbank.

The ECB president said yesterday that ECB policymakers would “do what we must to raise inflation as quickly as possible”. The remark echoed a promise Mr Draghi made during the region’s debt crisis in 2012 to do “whatever it takes” to save the single currency.

The ECB is widely expected to unleash a souped-up version of its €1.1tn quantitative easing package and consider cutting one of its benchmark rates deeper into negative territory.

“If we conclude that the balance of risks to our medium-term price stability objective is skewed to the downside, we will act by using all the instruments available within our mandate,” Mr Draghi said. “In particular, we consider the APP [asset-purchase programme] to be a powerful and flexible instrument, as it can be adjusted in terms of size, composition or duration to achieve a more expansionary policy stance.”

He added: “The level of the deposit facility rate can also empower the transmission of [QE], not least by increasing the velocity of circulation of bank reserves.”

• Negative interest rates are a sign of central bank desperation. 
• They are a sign central banks are clueless about how the economy really works. 
• And they are a sign of extreme hubris coupled with extreme stubbornness as Japan has proven over the course of three decades that unconventional measures do not work as economists expect.

Following up on last week’s piece highlighting the catastrophe of negative interest rates created by Central Bank Policy, I found myself thinking, as I’m sure you did too, a lot about the catastrophe in Paris.  Outside of the dark vs. light human battle (of which I believe light will win), I gave thought to the potential unwinding of the great European Union experiment and what it might mean for our collective financial health.  Coincidentally, a great geopolitical strategist piece crossed my desk this week.  I share it with you below.

Maybe I’m obsessing over what I feel is transitory faith placed in global central bankers (the Fed, ECB, JCB) but I can’t help recalling Bernanke’s “Goldilocks” quote on February 14, 2007 (New York Times) and the happy no-doc mortgage days in 2007/08. The economy was not too hot, not too cold but just right. Right?

“Fear and euphoria are dominant forces, and fear is many multiples the size of euphoria. Bubbles go up very slowly as euphoria builds. Then fear hits, and it comes down very sharply. When I started to look at that, I was sort of intellectually shocked. Contagion is the critical phenomenon which causes the thing to fall apart.”
– Alan Greenspan

I felt a bit like Chicken Little in my writings back then.  The “sky is falling” and all that sort of thing. Was the sky falling or was opportunity being created.  It depends on your portfolio positioning at that time.  It turned out to be a great opportunity if one was prepared. Wait and see what happens if Italy, Spain or Portugal pulls a Greek-like default move.  Contagion being the “critical phenomenon”.  I feel a little bit like Chicken Little again today.

In the book House of Cards, William Cohan exposed the corporate arrogance, power struggles and deadly combination of greed and inattention which led to the collapse of not only Bear Stearns and Lehman Brothers, but the very foundation of Wall Street.  Despite Fed Chairs Greenspan and Bernanke’s inability to (admittedly) see the risks, there was abundant evidence that I and others wrote frequently about prior to the crisis.  Though truthfully, in my wildest dreams, I didn’t imagine the entire financial system would come so near to collapse.

“Sort of intellectually shocked”?  Gotta love his honesty.

One of the pieces I penned in late 2008 was titled “So Bad It’s Good”. It just didn’t feel good, emotionally, at the time.  But with fear in heart and conviction in process, I took action and while I was a bit early, it turned out to be an exceptionally good trade.  Then, yields on high yield bonds were close to 20%. That’s what I believe may present again in the not too distant future.  Until then, it’s a process of participation, protection and patience.

At a recent conference, I was asked what I see as the biggest risks ahead.  I answered that it is not subprime but everything that existed in 2008 from the perspective of debt levels, debt to GDP, margin balances and derivative exposure (and the related counter-party risks) is worse today than in 2008.  Further, the Fed now finds itself painted into a corner with an inflated balanced sheet (QE asset purchases) and a zero interest rate policy.

So, I spoke of three big risks on the near horizon that may impact the equity and high yield markets and added that I feel like I did when I wrote about crazy high valuations in 1998 (“It’s not different this time” though I was two years too early) and in 2007 and 2008 (writing about subprime and leveraged derivative products).

All three risks have one common denominator – too much debt.  Here are my big three:

The Big Three

• Invest in a few liquid alternative mutual funds. Look for proven managers and find complementary pairs meaning strategies that may deliver return but do so in a way that don’t correlate with each other.  Match their historical return streams together and see if the correlation is close to zero.
• Consider current high valuation levels in U.S. equities. If you agree they are high (with forward probable 10-year returns low much like 2000 and 2008), then reduce exposure and hedge.  Find equity mutual funds that do it within a strategy or do it yourself.
• Get in front of the coming high yield opportunity. Find mutual funds that trend trade and others that are tactical or more flexible in nature.  Default waves create outstanding opportunity.  Be positioned and, importantly, mentally prepared to take advantage of the opportunity (it won’t feel good when the opportunity is best)

• CMG NDR Large Cap Momentum Index: Sell Signal on June 30, 2015 at S&P 500 Index 2063
• Long-term Trend (13/34-Week EMA) on the S&P 500 Index: Sell Signal – Bearish for Stocks
• Volume Demand is greater than Volume Supply: Sell signal for Stocks
• NDR Big Mo Signal: Buy Signal for Stocks

• NDR Crowd Sentiment Poll: Neutral Optimism (short-term Neutral for Equities)
• Daily Trading Sentiment Composite: Excessive Optimism (short-term Bearish for Equities)

• The Zweig Bond Model: Buy Signal
• High Yield Model: Sell Signal

• Don’t Fight the Tape or the Fed: Indicator Reading = -2 (Bearish for Equities)
• Global Recession Watch – High Global Recession Risk
• U.S. Recession Watch – Low U.S. Recession Risk

"The GDPNow model forecast for real GDP growth (seasonally adjusted annual rate) in the fourth quarter of 2015 is 1.8 percent on November 25, down from 2.3 percent on November 18. The forecast for the fourth-quarter rate of real consumer spending declined from 3.1 percent to 2.2 percent after this morning's personal income and outlays release from the U.S. Bureau of Economic Analysis."

The latest Blue-Chip forecast for early November was 2.7%, a highly unlikely number at this stage unless season spending picks up big time.

Reports show stores are not discounting merchandise as much as consumers like, and consumers generally expect to spend less, so odds of a hefty jump in Christmas sales is questionable.

We may know more next week when reports on Black and Blue Friday become available.

4th Quarter GDP Trends

Consumer Exhaustion 

The initial 4th quarter GDPNow forecast started at 2.5% on October 30. It rose as high as 2.9% following the auto sales and jobs reports. It's pretty much been downhill since then.

Wholesale trade, retail trade, existing home sales, all knocked off points.

Today's Personal Incomes and Outlays Report knocked off a half percentage point even though wage growth was substantial.

Many signs point to consumer exhaustion.

• Back-to-school spending was weak,
• housing starts have been weak,
• existing home sales are weak,
• manufacturing has been weak,
• recent spending reports have been weak, and
• Christmas sales appear "tepid" at this point.