Traveling The Narrow Road

On January 29, 2016 the Bank of Japan announced it would join the European Central Bank (ECB) and three national banks in the negative interest club. Members in this exclusive club pay their own nation’s banks negative interest to keep excess reserves at the central bank in hopes that losing money will overcome the risk aversion banks have during uncertain economic times. Coercing the member banks to buy assets in this manner increases asset prices and decreases borrowing costs. By loosening credit the central banks believe they will spur economic growth and win the fight against their dreaded enemy – deflation.¹

Negative interest rates are not just for banks; they find their way to the average person. The interest paid on short-term sovereign bonds has gone negative in Austria, Denmark, Germany, the Netherlands and Switzerland.² This can happen very quickly as evidenced by Japan’s 10-year bonds dropping into negative interest rates today, February 9, just eleven days after the Bank of Japan announced the policy rate change.

Before going further, let’s just make this point and get it out-of-the-way – to be paid to borrow and charged to save is absurd. There, I said it. Let’s continue.

So, why would anyone buy government bonds that have a negative interest rate? One reason is for safety, fearing other types of investment might lose even more in a financial crisis. Another reason to buy bonds is to sell them at a profit anticipating that interest rates will go even lower.

What Enemy Are the Deflation Fighters Really Fighting?

We are told, erroneously in my opinion, by most economists and by those in power that deflation is the worst of all scenarios. They claim it leads to an economic death spiral like we experienced in the Great Depression. The argument goes like this: Once people realize prices are falling they delay spending until prices fall even further. This decreased spending lowers business sales and profits which, in turn, increases unemployment which decreases spending and so on.³

I believe the real reason indebted governments consider deflation disastrous is because deflation forces them to pay back debt in currency that is worth more than when they borrowed it. Financial repression, on the other hand, seeks to devalue the currency to pay off debt more easily.

Negative Interest Rates Have Some Disturbing Repercussions

I think many people, at a gut level, will suspect there is something sinister about negative interest rates. Hopefully this uneasiness will lead to more awareness of the widespread use of financial repression by governments around the world.

Maybe negative interest rates (combined with a zero or positive inflation rate) will end up serving a good purpose in a way that near zero interest rates never could. It is obvious that something is amiss when your bank savings statement shows an interest deduction. It is less obvious when the rate of inflation is higher than the low but positive interest rate you receive from the bank. In the latter case, your account has more money in it but you can purchase less with it. Maybe negative interest rates will expose central banks’ financial repression policies for what they truly are – wealth transfers.

Lest we think negative interest rates couldn’t happen in the U.S., consider the Federal Reserve’s 2016 Supervisory Scenarios for Annual Stress Tests. Though they are quick to say that their Severely Adverse Scenario “does not represent a forecast of the Federal Reserve” it does, nonetheless, include the use of negative interest rates in the event of a catastrophic financial crisis.⁴

Employing negative interest rates is economic theory run amok. Yet, in some weird and perverse way, it is logical. If the government fears deflation so much that they want to ensure people will not hoard money waiting for prices to drop, then they must take away the money they save faster than deflation lowers prices so that consumers don’t delay spending. It is truly diabolical genius.

Wait. It gets worse.

Banks subjected to negative interest rates are faced with lower profits if they fail to pass the rates through to customers and risk losing depositors if they do. But this may not be a conundrum for long as there is talk of banning cash. Seriously, there is.

But that troubling topic will have to wait until my next post.

References:

1. Global Economic Prospects, June 2015, Global Economic Prospects, Box 1.1
2. Frank Hollenbeck does a nice job of refuting this argument in his article entitled “What’s So Scary About Deflation”
3. Federal Reserve 2016 Supervisory Scenarios for Annual Stress Tests