Going Negative

“More money cannot cure what too much money created.”

                                   Frank Hollenbeck

There’s nothing positive to say about negative interest rates.

If seven years of zero interest rate policy (ZIRP) has left the U.S. economy is such sad shape, how could negative interest rates help?  Negative rates have already been tried in Europe and Japan, and they have failed to boost the economy.

And yet some believe the Federal Reserve Board is considering replacing ZIRP with NIRP.  We’ve written plenty about the failings of ZIRP, or zero interest rate policy, and believe it would be foolish for the Fed to consider NIRP, or negative interest rate policy.

The bank of the future.

The bank of the future.

How does NIRP work?  As Zerohedge explained, “The process can be as simple as the central bank charging its member banks for holding excess reserves, although the same thing can be accomplished by more roundabout methods such as manipulating the reverse repo market.”

In other words, central banks created trillions of dollars in excess reserves throughout the banking system and now they want to charge banks for holding those reserves.  The idea is to coerce banks to lend the money, which should stimulate the economy. 

But if banks aren’t lending much money now, with interest rates near zero, will they lend money when interest rates dip below zero?  Will they reduce their cost of excess reserves by loosening their lending standards, which would likely increase bad loans, or will they pass the costs on to customers?

Loosening lending standards, you may recall, was what caused the last financial crisis, when banks were providing mortgages to anyone with a pulse.  And passing costs on to customers won’t be easy.  Bank customers have historically received a small amount of interest for putting their savings in a bank.  They’re not likely to want to pay banks for the privilege of letting banks use their money.

“In effect, the banks are being extorted by the central banks to increase lending or lose money,” Zerohedge says. “The banks have no choice. If they can’t find worthy borrowers, they must charge their customers for the privilege of having money in their checking accounts.”

Of course, banks don’t need consumers’ money anymore, since they have trillions of dollars in excess reserves magically created by central bankers that they’re already not lending out.  And consumers can just keep their money in a cookie jar, rather than have it depreciate in a bank vault.

Going Cashless

But don’t worry.  Central bankers are hard at work solving that problem, too.  All they have to do is get rid of cash.

“As long as there is physical cash, people will hold cash in times of uncertainty,” Frank Hollenbeck, an economics professor at the International University at Geneva, wrote in Mises Daily. “It is a wise alternative when all other options seem unproductive or irrational—and keeping cash in a bank at a time of negative rates is, all things being equal, irrational.”

Former Secretary of the Treasury Larry Summers has already advocated for elimination of the $100 bill, which he says would make the world a safer place, but ultimately central bankers may be coming after your $1s, $10s and $20s, too.

Without cash, consumers would be forced to keep their digital money in banks.  Then, of course, banks would be able to charge a premium for the luxury of holding on to your money for you.

Wouldn’t that be a boost for the economy?

You may wonder why central bankers would even consider negative interest rates.  Reasons may include:

  • Central bankers tend to be committed Keynesians, no matter how often Keynesian theories are proven wrong.
  • They have no other options, other than doing nothing. Doing nothing would, of course, enable the economy to adjust to conditions and heal itself, but, like legislators, central bankers believe they must do something—and the only thing they haven’t tried yet is to go negative.
  • By taking action, central bankers maintain control over economic policy. They have the power and are not likely to give it up. Didn’t Congress and the president used to make economic policy?

Historically, printing more and more money has led to hyperinflation.  Today, the economy has been in such more poor shape that, in spite of a historically unprecedented era of easy money policy, inflation has not even hit the Fed’s goal of 2%.

Just because we have not had hyperinflation yet doesn’t mean we won’t.  If central bankers keep printing more and more money, we can expect more and more debt, slow economic growth and, eventually, hyperinflation.

It may be a great time to buy gold.

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