Negative interest rates are scaring people

What the heck is a 'negative' interest rate?
What the heck is a 'negative' interest rate?

Europe's economy is limping along.

The European Central Bank has taken extraordinary steps to resuscitate the economy, but it's gone too far, say two power players.

In June of 2014, Europe's Central Bank slashed interest rates into negative territory, a move that was called unconventional and experimental. The central bank pushed rates even deeper into the negative zone this year. That strategy is backfiring, warns Paul Achleitner, chairman of Deutsche Bank.

"People look at that and see negative interest rates as a warning signal that the future is even less safe than it is today," said Achleitner at an American Council on Germany event in New York Wednesday evening.

Renowned American investor Jeffrey Gundlach called negative interest rates in Europe and Japan "the great plague of the 21st Century" in a webcast this week.

Related: Janet Yellen: Negative rates possible in U.S.

Why negative rates?

The whole point of negative rates is to penalize banks and savers who hold onto cash. They get 0% interest or have to pay a penalty fee in some cases. The idea is to spur Germans, French, Italians, Spaniards, etc. to go out and spend their money.

But Achleitner says that's not happening.

"If you give the U.S. consumer $100 more, he or she is likely to spend it. You give the German consumer $100 more, they are going to save it," he explains.

This fearful mentality explains the historic turn of events in Germany's bond market this week. For the first time ever, the yield on the 10-year German bond turned negative, meaning people are worried enough that they are willing to lose a little money on a safe government bond.

"Markets are rejecting their medicine of negative interest rates," says Gundlach, the CEO of DoubleLine Capital, a top bond investment company.

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European banks aren't lending enough

Banks in Europe are doing the same thing as consumers: they're hoarding cash.

"Negative interest rates make it impossible for banks to make money," says Gundlach. Deutsche Bank's (DB) stock is down 40% this year as investors worry about the health of its finances. Fears of a Brexit are only adding to the woes for Europe's banks.

Achleitner says European banks haven't recovered from the financial crisis like American banks. Europe's banks still don't have enough cash in their coffers to stave off the next crisis and meet the new requirements from the European Central Bank.

So when the European Central Bank started following the U.S. Federal Reserve's playbook and doing quantitative easing to try to get more money into the economy, Europe's banks held onto the cash. They didn't turn around and lend it out.

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"We may just have to come to the conclusion that maybe we cannot manage growth from the top," warns Achleitner. He says the private sector and venture capital has to do more.

Mario Draghi, the head of the European Central Bank, disagrees. He says the data show that banks have been lending more.

"Overall, the monetary policy measures in place since June 2014 have clearly improved borrowing conditions for firms and households," Draghi said in April.

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