In a recent column for Mises Wire, Doug French raised very important issue of negative interest rates. Quoting Fleckenstein Capital He wrote,

Yesterday a Parisian BBB-rated company (i.e., quasi junk) issued $500 million in three-year notes yielding negative 0.026%. We have been peppered with so many absurdities, nothing seems absurd anymore…

French continues with his own observations: 

[The French utility company] Veolia Environnement S.A. floated €500 million of debt, rated just 2 notches above junk, with a three year maturity priced to yield negative 0.026%. As Grant’s Almost Daily writes, “Even better: Investor demand for the Veolia issue was such that the offering was oversubscribed by more than 4:1. Said another way, three out of four investors who wished to lose money on a yield-to-maturity basis were left disappointed.”

Clearly, this supposedly contradicts the view of important thinkers such as Mises and Rothbard that individuals always assign a greater importance to present goods versus future goods (i.e.. that interest rates must be always positive). This is also known as a positive time preference.

Before attempting to reconcile the apparent contradiction of the facts of reality and the positive time preference theory of interest let us have a look at the essence of this theory.

The Essence of Time Preference

As a rule, people assign a higher valuation to present goods versus future goods. This means that present goods are valued at a premium to future goods. Here is why.

An individual who has just enough resources to keep him alive is unlikely to lend or invest his paltry means. To this individual the cost of lending or investing is likely to be very high — it might even cost him his life if he were to consider lending part of his means. Therefore, under this condition he is unlikely to lend, or invest even if offered a very high interest rate.

Once his wealth starts to expand, the cost of lending, or investing, starts to diminish. Allocating some of his wealth towards lending or investment is going to undermine to a lesser extent our individual’s life and wellbeing at present.

From this we can infer, all other things being equal, that anything that leads to an expansion in the real wealth of individuals gives rise to a decline in the interest i.e. the lowering of the premium of present goods versus future goods.

Conversely, factors that undermine real wealth expansion lead to a higher interest. We can also, conclude that given the positive time preference the interest rate cannot be a negative figure.

We can thus conclude that the essence of the phenomenon of interest is the cost that a lender or an investor endures.