When I think back on all the crap I learned in grad school, it’s a wonder I can think at all, to paraphrase Paul Simon. And that also goes for what was drummed into me as an undergraduate, way back when we used Kodachrome film to take photographs with Nikon cameras, instead of iPhones (and Eastman Kodak was among the elite 30 Dow industrials).
 
Among those shibboleths was that low interest rates always stimulate the economy. Reduced borrowing costs make it easier for folks to buy houses and companies to invest and expand. Lower yields on savings cut the incentives for consumers to stash their cash in the banks like Scrooge and instead make them more inclined to go out and spend and have a good time. And all that spending should tend to push up prices and, in due time, set up the next cycle of rising rates.
 
And if interest rates ever hit zero, money would be free, which should mean the economy should be like an open bar—a real party. Then think about what would happen if rates went where they never had gone before—below zero percent and into negative territory. Lenders would be paying borrowers, rather than the other way around.
 
This isn’t some alternate universe, but rather what’s actually happening in Europe. As The Wall Street Journal reported last week, some borrowers in Spain had the rates on their mortgages fall below zero, which meant the bank owed them money. That comes as approximately one-third of all European government bonds carry negative yields.
 
Those are mainly short-to-intermediate maturities whose yields have followed the European Central Bank’s minus 0.20% deposit rate into negative territory. But, by week’s end, the benchmark 10-year German bund yield seemed inexorably headed below zero, as it set another record closing low of 0.073%, according to Tradeweb. At that return, investors would double their money in a mere 1,000 years.
 
But the boom that the textbooks predict is nowhere in evidence. That’s not a surprise to Jason Hsu, vice chairman and co-founder of Research Affiliates and also a card-carrying Ph.D. and adjunct professor at UCLA. As a frequent visitor to Japan over more than a decade, he’s had a chance to observe firsthand the effect of near-zero interest rates.
 
In the complete opposite of what classical economics teaches, low returns actually have induced Japanese consumers to spend less, he says. As the aging population saves more to get to a threshold of assets needed for retirement, firms seeing no spending are loath to spend, invest, or hire. “This is a bad spiral that never was predicted,” Jason explains (appropriately enough, over a sushi lunch).
 
This had always been assumed to reflect both the demographics and cultural traits of Japan. But that world view will have to be revised, as there’s evidence of the same thing happening in Europe, he adds, with Germans reacting to zero interest rates by saving more. This behavioral dimension helps explain the tepid payoff from the unprecedented “financial repression” that has taken interest rates to zero and below.
 
The restraints on spending from forcing savers to save more in a low-rate environment has been a theme sounded by a number of critics, including David Einhorn, the head of Greenlight Capital, a hedge fund. At a recent Grant’s Interest Rate Observer conference, he quoted Raghuram Rajan, the head of India’s central bank, who, in a lecture at the Bank for International Settlements in 2013, spoke of the plight of someone nearing retirement and facing losses on savings (from two bear markets this century) and low prospective returns. That “can imply low real interest rates are contractionary—savers put more aside as interest rates fall in order to meet the savings they think they will need when they retire.” Indeed, according to a widely cited estimate by Swiss Re, U.S. savers have foregone some $470 billion in interest earnings since 2008.
 
That conundrum was quantified in a report by David P. Goldman, head of Americas research at Reorient Capital in Hong Kong. A saver who accumulates assets for retirement through stocks would want to “annuitize” or convert that wealth into a stream of income for retirement. “But the amount of income investors can expect to receive from an equity portfolio converted into bonds actually has fallen over the past 18 years,” he writes.
 
At the peak of the stock market in 2000, Goldman calculates that one unit of the Standard & Poor’s 500 annually earned the real equivalent of $1,900 (adjusted for inflation, in 1982 dollars) when invested in Baa (medium-grade) corporate bonds. At the market’s recovery in 2007, one unit of the S&P would earn $1,300; now, it’s only $1,100.
 
The same goes for home prices. A house bought for $500,000 in 2000 and sold today and reinvested in Baa bonds would yield $16,000 annually in 1982 dollars, versus $22,000 when it was bought 15 years ago. Bottom line: “Assets have soared, but the prospective interest on these assets has shrunk.”
 
Which means that even the affluent top 20% of Americans (who accounted for 61% of domestic consumption in 2012, up from 53%, according to data cited by Goldman) who actually have assets are more cautious about spending than a naïve view of the wealth effect might suggest, he concludes.
 
To be fair, what we learned about interest rates and the economy were predicated on “normal” levels.

A decline in mortgage rates from, say, 7% to 5% could reliably be counted on to set off a rebound.

That would lower the monthly payment on a $300,000, 30-year loan by nearly 25%, to around $1,600 from $2,000.
 
First-time home buyers then might qualify to get into a house; the sellers could trade up to nicer digs; those who stayed put could refinance and cut their payment or take down more money to pay off other debt or spend on a car, boat, or college tuition.
 
It may be that, as interest rates—which represent the time value of money—approach zero, their impact is distorted, just as time is distorted as the speed of light is approached, according to Einstein.
 
Financial repression that has depressed rates to levels that are unprecedented in history is having unpredictable effects, which shouldn’t be entirely unexpected. Even if we didn’t learn about them in school.

THE DOWNWARD PRESSURE ON interest rates got more intense Friday, with the global selloff in stocks. The declines grew intense after Chinese authorities announced measures to cool the sizzling market there (after it had closed for the weekend, naturally). Those included allowing fund managers to lend shares for short selling and to restrict some margin trading, which has exploded as punters try to get in on the rally.
 
In response, the iShares China Large-Cap exchange-traded fund (ticker: FXI), the favored speculative vehicle for China on this side of the Pacific, plunged 4.2% Friday, on more than twice the average volume.
 
Until then, the market had been rallying, on the assumption that bad news on the Chinese economy would mean more monetary stimulus, beyond the interest-rate and bank reserve-requirement-ratio cuts so far. Unlike in the West, Chinese officials are trying to tamp down speculative excesses while bolstering the slowing real economy.
 
By sheerest coincidence, BCA Research charts an upsurge in new Chinese brokerage accounts, just as Macau gambling revenue has cratered.
 
That made the 1.5% drop in the Dow and the Nasdaq Composite and the 1.1% decline in the S&P 500 seem mild. Europe yet again has the additional worry about Greece seeming to lurch toward default and exit from the euro. That helped send the Stoxx Europe 600 down 1.7% Friday.
 
But until Friday’s dip, U.S. markets had seemed more focused on earnings and the never-ending speculation about the Federal Reserve’s initial lift-off in interest rates. A June move seems increasingly unlikely, with the best odds on a December hike, with September a toss-up. Still, a large contingent of investors and analysts don’t expect an increase until 2016, rumored to be a presidential election year.
 
With Hillary Clinton announcing her candidacy for the Democratic nomination and Ted Cruz, Rand Paul, and Marco Rubio formally in the GOP race, and Jeb Bush et al. waiting to make their moves, you wouldn’t know the election was still more than a year and a half away.
 
Wouldn’t the Fed rather get started with rate hikes in 2015, rather than drawing attention to itself during the campaign? After all, the central bank is feeling the heat in D.C. these days, especially from Republicans not happy with ultralow rates. If the Fed is slow to hike, could it be open to criticism that Janet is trying to help Hillary? Greg Valliere of Potomac Research Group pooh-poohs the notion, contending that the central bank will stay above the political fray.
 
Meanwhile, there’s still not much sign of consumers spending their windfall from cheaper gasoline. Retail sales rose 0.9% in March, less than expected after three straight monthly declines. After culling food, gasoline, building materials, and autos, so-called core sales were up just 0.3%. Industrial production was off 0.6%, in part because of lower utility output as the deep freeze eased.
 
Nothing here to spur the Fed to move any time soon, so markets will stay attuned to headlines from Asia and Europe, as well as the parade of earnings well under way.