02.17.2016 9

Why negative interest rates spell doom for capitalism


By Robert Romano

Interest rates in Switzerland, Denmark, Sweden, the European Central Bank and now the Bank Japan have now plunged into negative territory, starting a new phase in the era of central banking that is very much uncharted.

Time will tell if it leaves the global economy lost at sea.

So far, banks are primarily being charged for keeping excess reserves on account at these central banks, a policy designed to jumpstart lending by making it more expensive for banks to sit on reserves. In some cases, like Sweden, the deposit rates have gone negative, too.

Whether it will all work out or not remains to be seen — initiating inflation and economic growth.  Maybe it will, but so far it’s not really looking good.

So what if it doesn’t work? The longer term implication is that central banks will then feel compelled to move their discount rates and other rates negative, too. Once that Pandora’s Box is open, it will mean that when financial institutions borrow money from the central bank, they will earn interest instead of owing it.

You read that right. When, not if, central banks go completely negative, they will wind up paying banks to borrow money from them.

That’s quantitative easing by another name.

Say, the interest rate is -1 percent. For every $1 trillion that is lent, the central bank in theory would owe an additional $10 billion in interest to the borrowing banks.

Fast forward 10 or 20 years into the future. Can you imagine a world where commercial banks pay their customers to borrow money?

Sure, scoff now. But mark my words. Central banks are so desperate to kick start the economy and credit creation, they will do almost anything. So, if they have to bribe you to borrow money to start acquiring more things, then that’s exactly what they’ll do.

A few problems immediately emerge.

If it ends up costing money for banks to lend money, how will they make any profits?

The answer might be that the profits will be the difference between the interest earned from that bank borrowing the money from the central bank less the interest owed to the borrowing customer.

So, say the bank borrowed from the central bank at -5 percent and then issued a loan with that money at -1 percent. The customer still earns 1 percentage point of negative interest, and the bank still gets to pocket the remaining 4 percentage points of negative interest from the central bank.

But what about savers? Would they be charged just to put money into the bank? If so, why would they keep it there?

Since banks depend on deposits to make up their capital requirements, they would have a powerful disincentive against charging customers to keep deposits, lest it provoke a run on the banks.

But why invest in bonds?

This is where the real rub comes. Already the Japan 10-year treasury is testing 0 percent levels.

Can you imagine a retirement fund that earns less than zero percent? That would mean less than zero percent return on investment. An investor has to pay to hold the bond, only to have principal returned when it comes due. Why bother?

The only way that might make sense would be in an outright deflationary environment. So, say, inflation is at -10 percent, and you’re in a bond that charges -1 percent to hold the bond. In theory, the investor would come out 9 percent ahead because the value of holding cash is still technically appreciating via increased purchasing power.

But even then, it would still make more sense to simply just hold cash to begin with.

So to incentivize bond-buying still and deposits, central banks would simply ban keeping cash. Already the discussion is of discontinuing higher-denomination bills like €500 or $100 bills. To fight crime, they say. Yeah, sure it is. This forecasts eventually our society will be cashless.

In the future, perhaps the only way to get paid will be via a bank account. Then it would be a simple equation. Keep money in an account for too long, pay more. Put it into a bond or spend it all immediately, pay less or nothing.

Then, buying bonds could become the digital equivalent of stockpiling physical gold or silver to prepare for a financial Armageddon. You can see the slogans now: “Buy bonds now and only lose 2 percent this year!”

Okay, so we’ve worked through how financial institutions might survive the scourge of negative interest rates and remain profitable, and how central banks would forestall any more bank runs by simply banning them. And how even investors could in theory still come out “ahead” by putting money into bonds that cost less than keeping it idle.

Which brings us to the issue of deflation. By going negative, are not central banks basically forecasting that deflation — that is, outright asset price depreciation whether in stock prices or home values — is at hand? Perhaps banks can get by in such an environment since they apparently plan on getting paid to borrow money. But what about everyone else?

For, what negative interest rates are really projecting are low-to-no growth and zero-profit environments for the entire global economy sometime in the future, where businesses simply cannot make money. Not now, but perhaps soon.

In the Great Depression, when it came to such price volatilities for, say, farmers, the government instituted a series of agricultural subsidies to keep the farms profitable so they could pay their mortgages.

The implication of no growth and deflation today are that all businesses will come to the government seeking subsidies. We already see it in agriculture. Education. Health care. Housing. Whether it is loan programs for customers or outright grants. There will be more.

This is why capitalism cannot survive no growth. Economies would naturally revert to some form of subsistence, where the need to trade is reduced greatly. But investors demand return on investment. Remember, it’s a world without profits. In a no-growth, deflationary environment, those who over-produce are the ones who get punished by markets. So businesses will demand subsidies for their surplus stock, or for not producing at all, as in the Depression.

Of course, this is all madness. Negative interest rates have never really been tried before. And if they fail to jumpstart the economy and inflation now, the implication is that deflation and low-to-no growth are already at hand. Can you say, “Sell?” It’s almost as if central banks are trying to create the conditions for a bear market. Maybe they’ll ban those, too.

Robert Romano is the senior editor of Americans for Limited Government.

  • Jean Langford M.

    The first tactic in the Confiscation of citizens Savings by banks and the GOVERNMENT…TO pay 20 Trillions in massive debt and shore up 65 trillions in unfunded liabilities…FARCE!.

  • jerry1944

    I dont even like the little i get now off my whats in my saving Worked and saved to draw it and now its hardly worth it With negative i sure would keep it in a log are some place the government wouldnt find it

  • Paul Allen

    They will do anything except allow governments to lower taxes, lower or eliminate fees, and shrink themselves to manageable levels.

    The problem is socialism taking, and taking, and taking, and giving a tiny bit back, and hording the rest for the rich bankers. Eventually the money wells dry up, which is where we are at now.

  • pduffy

    Can you see now why the Constitution required that only gold and silver coin be used as money? None of these games are possible when the money is a valued physical commodity which cannot be ‘printed out of thin air’. The founders knew about the notion of a fiat currency and the evils that it presented, and all of their fears have come to pass as we have destroyed the notion of money itself with these games. The world must learn this lesson, do not give ‘central banks’ power over the money supply, especially when this power involves creating currency out of thin air.

  • Nice to see some real optimism in these gloomy days!
    I agree that NIRP means incredible chances for the progress of our society.
    Best thing is that with zero ROI, it doesn’t make a lot of sense to accumulate that weird stuff called “money”. And obviously, 95% of banks will become obsolete. Cheer up, the future could be a lot better than we thought!

  • Gail Newman

    The large banks are keeping high reserves in large part due to the regulations demanded by the Demicrat Party’s socialistic brainchild, Dodd Frank. Big banks are not making critical loans to small business innovators/ start ups who are the actual employers of the vast majority of Americans. The great number of governmental regulations can be handled by big banks and big businesses. In fact, big banks and big business are crony socialists who encourage regulations. They have put most small community banks and many small businesses out of business.

  • Chicken Tractor

    But European monarchs were known to call in all the gold currency, melt it down into smaller coins, return the same no. of coins and pocket the difference, thus devaluing the currency. You might think only the spineless would turn over their coin but of course if you got caught you’d be headless. Nowadays? As one of the excuses for ditching cash is that it is the currency of criminals and terrorists we can expect the same label for holding onto our PMs. I bide my time to convert mine into real wealth; arable land with clean water and the tools to work it.

  • pduffy

    The fact that it’s possible to ‘dilute’ a system based on a physical commodity does not negate the truth of the original intent of the statute which requires the use of a valuable, pure commodity as money. The people cannot be tricked, they know if the gold has been watered down. Paper has NO intrinsic value, but pure gold and silver do. If the king (or government) corrupts this process, his act of corruption does not take away the value of pure gold, as he has just reduced it’s quantity in the money. The real issue here is the character of the government – if they have character, they won’t corrupt the money supply, and if they don’t they will corrupt it out of their greed. But if the system is based on corruption in the first place (paper which can be burned), there is no question about the corrupt nature of the system. This is why the founders wrote that statue – it’s a test of the character of the government, by which this government has completely failed.

  • Red

    This is crazy but I can see bankers pulling a scheme like this. Crooks.

Back to top

Copyright © 2008-2016 Americans for Limited Government