The dumb and dumber of negative interest rates

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On their face, negative interest rates seem dumb.  Are you really going to pay your bank interest for holding, and using, your money?

If so, I’d be glad to hold and use your money for free. I won’t charge you a penny. Just send it to me.

But negative interest rates actually are happening, and the reasons are explained in the following article — and they are the “dumber” part of this post’s title.

Negative Interest Rate Conundrum
Posted on March 17, 2016 by Yves Smith

Across the developed world the persistence of a phenomenon that was initially seen as a freak occurrence—negative interest rates—is now a cause for concern. One form the tendency takes is for central banks to set their policy rates, which signal their monetary stance, below zero.

The process was triggered by the European Central Bank (ECB). Under pressure to forestall deflation in the region, the ECB reduced its deposit rate to (minus) 0.1 per cent in June 2014.

Since then, according to the Bank for International Settlements (BIS), till January 2016 four national central banks, from Denmark, Sweden, Switzerland and Japan, have moved the interest ‘paid’ on part of their deposits with them to negative territory.

“Deflation,” i.e. a general reduction in prices — the opposite of inflation — might seem to be a welcome event. After all, doesn’t everyone like lower prices?

But the threat of deflation causes panic in financial quarters, and the philosophy is this: If consumers of any product know that tomorrow’s prices will be lower than today’s, these consumers will delay purchases, waiting for the lower prices.

And we’re not talking just about traditional “consumers,” people buying food, clothing and shelter. We’re talking about all consumers: Businesses buying raw and processed materials for subsequent process and sale.

So if everyone waits until tomorrow to buy things, and when tomorrow comes, they wait until the next tomorrow, and the next, what happens to Gross Domestic Product?

Right. GDP falls, and by definition, falling GDP is called “recession.”

What does that have to do with interest rates?

Inflation is the loss in value of money compared with the value of goods and services. In the U.S. that would mean more dollars are necessary to purchase any given amount of those goods and services.

The Fed, and other central banks, control inflation by raising interest rates. Higher rates increase the Demand for dollars, making dollars more valuable, aka “strengthen” the dollar.

Investors are more likely to invest in dollar-based investments: Bonds, notes, interest-paying bank accounts, and less likely to invest in goods and services (which brings down their price).

The formula is Value = Demand / Supply. When Demand goes up more than Supply, Value goes up.

There is a banking corollary to this:

The motivation for negative deposit rates is clearly to pressure or persuade banks to lend rather than hold on to reserves with the central bank.

For a bank, lending is a form of investing. Banks continually look for the “best” (safest and most remunerative) investments.

Banks earn money by lending, and by depositing reserves with the Federal Reserve Bank, and by purchasing T-securities. (The obscene, illegal, and so-far unpunished earnings that come from selling worthless mortgages to suckers, are not part of this discussion).

Even Fed Chairman Janet Yellen told a Congressional hearing that the US Fed would consider this (negative interest rates) option if it found it to be necessary.

Clearly, negative interest rates are an extreme, rarely considered, much less used, option — an option that only would be used when no other option is available. Right?

Well, maybe. Remember the formula Value = Demand / Supply?

The Value of a dollar is based not only on Demand but on Supply. Reduce the Demand, by lowering interest rates, and you reduce the Value, thereby fighting deflation.

But increasing the Supply of dollars would accomplish the same thing.

And how does the federal government increase the supply of dollars? By federal deficit spending.

And herein lies a gigantic absurdity.

Governments have succumbed to the pressure not to use debt-financed fiscal spending as a means of stimulating recovery.

America’s debt and deficit scare-mongers shriek that the federal debt and deficit are too high because they are “unsustainable” (the favorite debt scare-monger word.) The fiction goes like this:

Debt scare monger: “The debt is so high, America will not be able to pay it off, so we have to cut spending (on social benefits) or raise taxes (on the middle class). Like you and me, the federal government should live within its means (As spoken by President Barack Obama and numerous politicians, economists and the media).”

Voice of fact and reason: “But the federal government, being Monetarily Sovereign never can run short of dollars.”

Debt scare monger: “Oh sure, the government always can print money, but that would cause inflation. Remember the Weimar Republic and Zimbabwe.”

See the absurdity? Central banks say they must cut interest rates below zero to prevent and cure deflation, but nations cannot use deficit spending because that would cause inflation.

Never mind that national deficit spending primarily funds such social services as Social Security, Medicare, Medicaid, aids to education, and food and housing for the lower income groups. Helping the lower income groups is the last thing the rich bankers wish to do.

And that is not the only problem with negative interest rates:

The movement of rates to negative territory reflects the desperation that has overcome governments, as they find that deep rate cuts have not had the desired effects of stalling the downturn and ensuring recovery.

What a surprise. Those below-zero rate cuts don’t don’t even work. They don’t stimulate an economy.

Who could have guessed — other than any thinking person. Rate cuts reduce the amount of interest money a central bank pays into the economy.

The interest on T-securities (T-bills, T-bonds, T-notes) adds dollars to the economy. Dollars are the lifeblood of our economy. Adding dollars is stimulative; subtracting dollars is recessive.

So negative interest rates, in theory used for fighting deflation (which causes recessions), actually cause recessions, the very thing that deflation causes and the reason deflation is so feared.

Thus the title of this post, “Dumb and dumber”: Doing “A” to prevent “B” despite the fact that “A” causes “B.”

Increased deficit spending not only would:
1. Prevent deflation and
2. Grow the economy and
3. Pay for science, education, infrastructure and myriad other benefits, but also
4. Pay for benefits to the lower income groups, thereby narrowing the Gap between the rich and the rest.

So expect Janet Yellen to continue worrying about deflation and hinting at negative interest rates “if necessary,” while saying nary a word about increased deficit spending.

Like her predecessors, she’s a bought-and-paid-for politician, owned by the rich, who want the Gap widened.

And as for us, the public. We can’t seem to figure it out. So I guess that makes us dumb, dumber, and dumbest.

Rodger Malcolm Mitchell
Monetary Sovereignty

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Ten Steps to Prosperity:
1. Eliminate FICA (Click here)
2. Federally funded Medicare — parts A, B & D plus long term nursing care — for everyone (Click here)
3. Provide an Economic Bonus to every man, woman and child in America, and/or every state a per capita Economic Bonus. (Click here) Or institute a reverse income tax.
4. Free education (including post-grad) for everyone. Click here
5. Salary for attending school (Click here)
6. Eliminate corporate taxes (Click here)
7. Increase the standard income tax deduction annually Click here
8. Tax the very rich (.1%) more, with higher, progressive tax rates on all forms of income. (Click here)
9. Federal ownership of all banks (Click here and here)

10. Increase federal spending on the myriad initiatives that benefit America’s 99% (Click here)

The Ten Steps will grow the economy, and narrow the income/wealth/power Gap between the rich and you.
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10 Steps to Economic Misery: (Click here:)
1. Maintain or increase the FICA tax..
2. Spread the myth Social Security, Medicare and the U.S. government are insolvent.
3. Cut federal employment in the military, post office, other federal agencies.
4. Broaden the income tax base so more lower income people will pay.
5. Cut financial assistance to the states.
6. Spread the myth federal taxes pay for federal spending.
7. Allow banks to trade for their own accounts; save them when their investments go sour.
8. Never prosecute any banker for criminal activity.
9. Nominate arch conservatives to the Supreme Court.
10. Reduce the federal deficit and debt

THE RECESSION CLOCK

Recessions begin an average of 2 years after the blue line first dips below zero. A common phenomenon is for the line briefly to dip below zero, then rise above zero, before falling dramatically below zero. There was a brief dip below zero in 2015, followed by another dip – the familiar pre-recession pattern.
Recessions are cured by a rising red line.

Monetary Sovereignty

Vertical gray bars mark recessions.

As the federal deficit growth lines drop, we approach recession, which will be cured only when the growth lines rise. Increasing federal deficit growth (aka “stimulus”) is necessary for long-term economic growth.

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Mitchell’s laws:
•Those, who do not understand the differences between Monetary Sovereignty and monetary non-sovereignty, do not understand economics.
•Any monetarily NON-sovereign government — be it city, county, state or nation — that runs an ongoing trade deficit, eventually will run out of money.
•The more federal budgets are cut and taxes increased, the weaker an economy becomes..

•No nation can tax itself into prosperity, nor grow without money growth.
•Cutting federal deficits to grow the economy is like applying leeches to cure anemia.
•A growing economy requires a growing supply of money (GDP = Federal Spending + Non-federal Spending + Net Exports)
•Deficit spending grows the supply of money
•The limit to federal deficit spending is an inflation that cannot be cured with interest rate control.
•The limit to non-federal deficit spending is the ability to borrow.

Liberals think the purpose of government is to protect the poor and powerless from the rich and powerful. Conservatives think the purpose of government is to protect the rich and powerful from the poor and powerless.

•The single most important problem in economics is the Gap between rich and the rest..
•Austerity is the government’s method for widening
the Gap between rich and poor.
•Until the 99% understand the need for federal deficits, the upper 1% will rule.
•Everything in economics devolves to motive, and the motive is the Gap between the rich and the rest..

MONETARY SOVEREIGNTY

6 thoughts on “The dumb and dumber of negative interest rates

  1. Hi Roger… I have been a reader of your blog for quite some time, and have a copy of your book. You have better helped me understand many of the factors that drive our modern economy. I thank you for that.

    However, no matter how often I am reminded of the fiscal realities of Monetary Sovereignty… the mainstream views (propaganda), have become so pervasive that I think it is naive to call the actions of the right, the left, or the in-between, as dumb, or dumber.

    Personally, I am of the view that (as noted in some of your other posts on “The Gap”), that the goals of the “Elite” (1%) are the exact opposite of what they profess. In short, they really want to:

    1. Cause deflation and
    2. Contract the economy and
    3. Cut spending for science, education, infrastructure and myriad other benefits (to the 99%), but also
    4. Reduce benefits to the lower income groups, thereby (widening) the Gap between the rich and the rest.

    It is us, (the 99%) who are ignorant of “modern monetary mechanics”. The 1% are well aware and actively exploiting our ignorance. Asset price inflation via the stock market (which greatly benefits the 1%) has been achieved (and now it’s time for the short positions)… Meanwhile… the rest of us fight over the cost of health, schooling, and housing.

    Unfortunately… We (the 99%) are the dumb and the dumber.

    That is how it appears to me at least.

    Like

  2. If consumers of any product know that tomorrow’s prices will be lower than today’s, these consumers will delay purchases, waiting for the lower prices. ~RMM

    Is this a true statement? Not from my experience of the American public in general, and my wife, in particular; instant gratification and all that it implies.
    Put a dollar into the hands of the average citizen and they will spend it. It seems the only time personal savings increase is when the economy turns down and people are apprehensive of the future.

    The history of electronics has always been cheaper prices, for example. Yet, I have purchased numerous computers and televisions over the decades.

    I have had more than one argument with my wife over delaying a purchase, and I’m only asking her to wait until seasonal sale periods, maybe a few months at most. Her retort is, “I worked for it and I want it NOW.” I can’t disagree with her, since she works long and hard for a living.

    I think my wife and the average American will gladly spend today no matter the money saved in delayed purchase. It’s the American way, or perhaps just human nature.

    If this logic is more representative of reality, the calculus of the deflation argument needs to be reassessed.

    Like

    1. Yes, there is legitimate disagreement about whether deflations always have that effect.

      While deflation tends to exist with recession — during recessions, people spend less and prices fall — one can argue about which causes which, or whether they both are effects of the same cause.

      It would be perfectly logical for people to wait for lower prices, but logic is not a human strong suit.

      Consider those people who stand in line to buy the latest iPhone, when a week later they can buy the same phone without standing in line. Where is the logic in that?

      Retailers generally believe that many people wait for Christmas/year-end sales, when prices are lower. But many purchases cannot be delayed.

      Food cannot be. Houses can be. Cars can be. Clothing, somewhat. Medical, less likely.

      It also depends on wealth status and the individual items. Will a rich person delay buying a car if he knew prices would be lower next year? Probably not. A poor person? Maybe.

      You say you argue for delaying purchases. Your wife wants to buy now. So who of you represents the so-called “average American”?

      Bottom line: Mathematically, if there were only a small increase in the percentage of people who wait for prices to fall, that can move an economy from moderate growth (2% for instance) to recession.

      Depending on a whole host of factors, I would guess that if just an additional 3% of Americans decided not to make key purchases this year, we would slip into recession.

      The banks believe deflation causes recession and they act accordingly.

      Like

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