That said, what's the current economic model for independent online brokerages?
Sell order flow? Rate arbitrage off uninvested assets?
Dutch source, do use a translator https://www.tijd.be/markten-live/nieuws/algemeen/nieuwe-eige...
"Is it easier for a pan European company to keep big US competition like Robin Hood and Ameritrade out?
Niehage: 'The companies you name are very badly positioned for Europe. Their economic model is based on two pillars. Firstly, they want to offer everything for free. But if you offer all services for free, you have to earn money with the capital in the investors' accounts. That is possible in the US, where you can still get 2% of interest. In Europe, with zero interest rates, that's very different.'
And the second pillar of their economic model?
Niehage: 'That's the high frequency traders. As far as I know, Robin Hood sells its customer orders to this kind of parties. They are prepared to pay good money for that. According to the European MiFID II-regulation, that is illegal. Those two examples show that the US and EU markets are totally different. That's why American brokers have difficulties breaking into the EU market.' "
Is this front running (and hence illegal), or do they mean to say customer trades, or something else?
Also I don't define front running that way, FINRA does.
https://www.finra.org/rules-guidance/rulebooks/finra-rules/5...
Retail order flow is worth buying because it's what's called "non-toxic". That means the retail traders generally don't know which way the market is going, ie they are either wrong or too small to make the market move against the market maker.
Contrast that to trading against a hedge fund which might have a better clue and is potentially large enough to push the market in some stock.
Liquidity is unlike hamburgers in that there is a risk profile associated with it if you sell it to anyone who wants it. Adverse selection happens as detailed elsewhere; you lose money on their custom, potentially a lot of money relative to the margin on your product.
Certain buyers of liquidity are, like essentially all buyers of hamburgers, functionally riskless. You can profitably sell your product to them at a positive margin all day long, at virtually any quantity they could demand.
Payment for order flow is setting up a liquidity stand in a place where you structurally only get the non-risky customers. That liquidity stand is, like a hamburger shop, a cash machine, and justifies CapEx and OpEx to run. Part of the OpEx is paying your landlord for prominent placement of your liquidity stand in front of willing customers who are buying that sweet, sweet liquidity you're selling.
The price of liquidity changes moment-to-moment based on market conditions but is effectively standardized by law nationwide (NBBO). You are not overcharging your customers for liquidity; they pay the same price literally anyone in the country buying it in that instant does and you can, at your option, discount it further to reward them for buying it from you.
You are making superior margins on their custom because you don't inevitably lose lots of money by being in the liquidity business. The liquidity stand down the street is doing the same thing; your vicious competition against each other has caused the prices for your product to crater, to the enduring joy of the people who line up daily to buy your liquidity.
What happens when we have another market crash and everyone is broke because they put money they would have saved into investments instead and now they have no safety net?
https://www.ecb.europa.eu/pub/pdf/scpwps/ecb.wp2283~2ccc0749...
One problem that becomes a bit hard is that in the retail sector if interest rates go below zero people are willing to simply withdraw the money, which would hurt banks' ability to lend. (Eg. the central bank would have to add funding via some mechanism, such as lowering the fractional ratio, or QE . [Or paying interest on reserves. But that would go against the negative interest on excess reserves.])
The paper concludes that the negative interest rates resulted in more loans.
How did holding money become so worthless in the first place?
Can this really be natural, or is there massive central bank shenaningans behind it? Clearly savers lose, but who benefits?
If that economy expands without corresponding increase in the money supply, then prices go down (because there are more stuff, but the same amount of money, so the same amount of money now represent more stuff). But this represents a deflation, which would auto-magically counteract the expansion, because it would incentivize people to wait and spend just at the last minute. (Time value of money and all would revert, wages would fall, fixed amount mortgages would start to spiral out, and all the regular deflation doomsday scenarios.) So the central banks make sure that even in an expanding economy the money supply "stays ahead" of the expansion of the economy. Targeting 2%. (And usually falling short, so inflation is somewhere between 1-2%.)
So holding money did not became worthless, quite the opposite, holding cash is now better than holding it in a bank. But the central bank has only a few policy tools available, and one of them is the interest rate manipulation.
The central banks want to encourage people to make some investments, to take on some risk, or at least spend. Sure, one way is to simply fund the government, as that usually seems the least risky. And it's not like there's nothing to spend on - the Green New Deal and co, but governments are quite reluctant to do so.
That was all I was talking about. Why isn't that happening anymore?
The people running the show have zero understanding of how banking works. And no, I’m not being arrogant - negative rates destroy capital, which is not what you want in a bank.
If you look at the largest European banks, they are all very weak (due to many factors, not just this one). However, negative rates is making them weaker.
Further, the aging demographics of Europe are going to continue to drive lower and lower growth.
In sum, I believe that all of this will cause smart money to leave Europe. At least in part as a hedge if nothing else.
There is also little empirical evidence that such low rates help (or no evidence, because negative rates were never tried before). Japan's had low rates for a while and they didn't seem to help, but the argument could be made that without those low rates the situation would be even worse (you could find economists who'd argue both sides). Personally I think it's better to err on the side of favouring whatever the "market rate" of interest would be (the rate if the central bank was taking no action to alter the supply of money or loans), and I'm very doubtful that would be negative.
https://www.ft.com/content/478fe908-5168-11ea-8841-482eed003...
Sweden raised rates recently, but only back to zero.
Swedish banks - for some reason - simply waited for the NIRP to pass and moaned.
[from the link]: Johan Torgeby, chief executive of one of Sweden’s largest banks SEB, says lenders involved in fixed income “struggled for years” and calls the end of sub-zero rates “good news”. He adds: “We have never really understood what effect negative yields have on [boosting] consumption.”
https://www.theguardian.com/money/2019/aug/13/danish-bank-la...
It certainly helps expanding the money supply. That should help increase savings, that then can be loaned out. (And simply increasing savings doesn't automatically lead to more investment: https://en.wikipedia.org/wiki/Saving_identity - I know wikipedia is not a proper source, sorry, anyway: "This identity only holds true because investment here is defined as including inventory accumulation, both deliberate and unintended. As such, this does not imply that an increase in saving must lead directly to an increase in investment. Indeed, businesses may respond to increased inventories by decreasing both output and intended investment.")
https://www.ecb.europa.eu/pub/pdf/scpwps/ecb.wp2283~2ccc0749...
"Given this finding and its robustness when tested using a variety of standard robustness checks, we conclude that NIRP has acted as an empowerment to the ECB’s asset purchase programme (APP). Banks most reliant on retail deposits have the strongest incentive to convert their EL (excess liquidity), created by the APP, into loans - and our results document that they did so."
> Personally I think it's better to err on the side of favouring whatever the "market rate" of interest would be (the rate if the central bank was taking no action to alter the supply of money or loans), and I'm very doubtful that would be negative.
Isn't the problem that the market rate would lead us to deflation?
Yep, but in the longer term (decades), all other things being equal a country that is saving 2% will have less investment taking place than that same country saving 5%.
> Banks most reliant on retail deposits have the strongest incentive to convert their EL (excess liquidity), created by the APP, into loans - and our results document that they did so.
One problem is we don't have clear insight into how risky these loans are. If a bank is incentivised to give out loans just to avoid having to pay the central bank interest, it may end up taking on riskier loans than it otherwise would have (if it didn't think they were too risky, it would already have made them). And even if this is not the case, and it's only giving loans because now even a low return of e.g. 0.5% looks good, there's a limit on how cheaply it can offer loans because it still has to cover all its own costs.
>Isn't the problem that the market rate would lead us to deflation?
Empirically it's not clear that would definitely lead to worse outcomes. Europe and the US managed to sustain high rates of growth during deflationary times throughout the 19th century, and while there were crashes during that period they weren't as severe as the Great Depression. In the short run it would definitely be painful, as savings rates increased, but there's a hard cap on this. E.g. everybody needs to eat, they're not going to starve themselves for a week just because food will be marginally cheaper next week. Like how people kept buying computers during the 2000s even though the price of compute was halving every year.
There's an interesting argument for why deflation is bad that I read in a labour economics textbook once, termed wage stickiness. Essentially, if there's deflation we might see labour prices falling every year (but falling less than other prices, so purchasing power still increases). Wage floors (minimum wages, inflexible contracts) however prevent this from happening, prevent the market from clearing. This is one reason unemployment was so bad during the great depression: wage floors introduced by the government to stabilise things ended up preventing wages from adjusting to the new price levels, causing unemployment as the value of good produced wasn't enough to pay those wages. Imagine if the price of every good fell by 90% today: suddenly a $10 minimum wage would be the equivalent of a $100 minimum wage in real terms, causing massive unemployment.
Politically, that's a hard problem to solve, so I can see why many people prefer inflation.
Sure, but that means they are rather different economies. If one economy can save 5% it will - by definition of the identity - invest 5%, so it'll grow much faster. If it can find the demand to service, which directly leads back to the problem of consumption (spending vs saving).
The interest rate should be orthogonal to actually saving or spending. It just happens that since we want stability of prices, coins, notes, money in our accounts, and steady growth, instead of constant 2.00% central bank interest rate we vary the rate. If the central bank could simply rewrite a lot of numbers all around it could keep the base rate constant. But people would go mad, and people would come up with a new model that just translates back everything and blurts out the actual money supply and base rate changes.
Yes, there's talk about zombie corps, because money is cheap. But so is money to invest in new companies to compete with these zombies. Plus, if they don't make real money, then investing them makes no sense, buying their bonds make no sense, and extending them credit makes no sense, no matter how small the interest rate is. (Sure, they can live on smaller margins, but that doesn't make them literal zombies.)
Even in a negative interest situation creditors still need to price in risks. (People still need to pay them back on time. There's still administration and other kinds of overhead as you said.) For example the Danish mortgages are low risk, that's why the bank was able to offer them at negative rates. The moment negative interest rates start to seep into retail people will start to buy shit like there's no tomorrow. Which will push inflation up, and then the central bank moves out of the negative regime. And if all else fails, the central bank can simply buy government bonds, basically financing and encouraging public spending, which should open up the legislature to lower taxes, procure more stuff, etc.
> One problem is we don't have clear insight into how risky these loans are. If a bank is incentivised to give out loans just to avoid having to pay the central bank interest, it may end up taking on riskier loans than it otherwise would have (if it didn't think they were too risky, it would already have made them).
Agreed, yet in the face of deflation even risky busywork is better than nothing. At that point it's up to people, investors, speculators, legislators, to take risks and invest (to increase efficiency so more of the output becomes economic surplus which can be then spent/invested) or consume (to increase demand so investment becomes profitable).
The financial sector can scream all it wants about being squeezed tight, but it's not like they are the paragons of efficiency and foresight. Sometimes they are too risky (2008) sometimes they are too cautious (last year - all the talk about an impending recession, too long business cycle, etc.). And ultimately it's up to the population to prod their legislature to spend. (Related, but might be too cutting-edge: https://johnhcochrane.blogspot.com/2020/02/new-paper-fiscal-... - tl;dr a model that reproduces a lot of the empirical data, and shows how risk free return [gov debt] pays for itself)
The latest Eurostat report ( https://ec.europa.eu/eurostat/documents/2995521/10159412/2-2... ) states EU inflation is around 1.4%. (0.2 %points of that is energy, which is pretty much just natural resource extraction, and should be ignored, as it's not something that results in economic growth in the EU - I'd argue.) So still a bit far from the 2% mark.
But at least the curve inches up.
> Like how people kept buying computers during the 2000s even though the price of compute was halving every year.
Interesting example. A lot of people bought the new computer because it enabled different things. And "decommissioned" the old one because it got obsolete. The desire for new coupled with the low price (thanks to mass production of standardized components) allowed people to substitute their old computer, even though they had to pay the "transaction price" (the price of the new computer, plus setup).
Similarly some folks argue that a Tesla car is so much better all around and it just happens to be an EV. (Though they are pretty pricey, so mass adoption is not happening, but stock prices indicate that a lot of folks think it or something like that will indeed happen.)
Companies/businesses were relatively slow to replace their computers. The large technology churn was (and is) fueled by newcomers, and people replacing their old rig.
That said, I have no problem with experimenting with deflation (especially because I despise these dumb hard-limit policies like minimum wage - https://danluu.com/discontinuities/ ), just as I have no problem with negative interest rates (because our central banks [and models, interchangeably] seem to understand that better).
What you're asking is sort of like this, "the big dam is breaking apart right now because of all the rain, and the rain isn't letting up. What do we do?"
Demographic challenges are really tough to overcome because they affect the demand of everything. As people have fewer kids, there is not as much need for schools, or teachers, or pencils, or wood to make those pencils...
As people get older, they tend to want smaller houses (kids are grown and out of the house). Smaller houses use less wood, less heating and air conditioning, etc.
One last thought for you: Japan, doesn't have millennials. That's right - there was never a second big population boom after their baby boomer generation.
Still with these items, I agree that a move to 0 commission trading will cause a shift.