Central banks the world over have lowered interest rates almost to zero– i.e., they have adopted a zero interest rate policy (ZIRP)– with the hope that cheap credit will revive moribund economies. Central banks have expanded their balance sheets by printing money to buy assets, which we Americans call an “open market operation”. If it buys the government’s own bonds, the process is called “monetizing the debt”. These are just fancy names for printing money out of thin air in order to buy something. Whether the central bank buys an asset from an individual or a government bond from the Treasury itself, the money winds up in someone’s bank account and the banking system’s reserves expand. (The seller’s checking account goes up, a liability for the banker, and the bank’s offsetting asset is an increase in reserves held at the Fed.)
Keynesians who support this practice believe that printing money and reducing the interest rate will increase the bank’s propensity to lend and public’s propensity to borrow and spend. This increase in aggregate demand will push the economy forward. Evidence of success would be a slow rise in inflation–i.e., prices–and a steady reduction in excess reserves. (When banks lend, they credit a checking account. Their “reservable liabilities” go up, which increases their required reserves and lowers their excess reserves. Total reserves remain the same, however.)
Despite ZIRP and multiple quantitative easing programs, whereby the central bank buys large quantities of assets while leaving interest rates at practically zero, the world’s economies are stuck in the doldrums. Their only accomplishment seems to be an increase in public and private debt. Therefore, the next step for the Keynesian economists who rule central banks everywhere is to make interest rates negative; i.e., adopt NIRP. 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. Remember, it was the central bank itself who created these excess reserves when it purchased assets with money created out of thin air. The reserves landed in bank reserve accounts at the central bank when the recipients of the asset purchases deposited their checks in their local banks. Now the banks have liabilities that are backed by depreciating assets; i.e., the banks still owe their customers the full amount in their checking accounts, but the central bank charges the banks for holding the reserves that back the deposits. In effect the banks are being extorted by the central banks to increase lending or lose money. 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 or, as is happening in some European banks, the banks try to increase loan rates to current borrowers in order to cover the added cost.
In European countries where NIRP reigns, so far the banks are charging only large account holders. These large account customers are scrambling to move their money out of banks and into assets that do not depreciate. The scramble for high grade securities has resulted in some securities being sold at a premium; i.e., the customers will get back less than they invested. How can this be? Well, the premium amount is less than the charge by the banks, so the large account customer is slightly better off. He loses somewhat less money. But this really does not solve the problem; it just means that the excess reserves are moved somewhere else, creating the same problem for the bank of the asset seller. Once reserves are created by the central bank, they can be destroyed only by a reversing open market operation by the central bank itself; i.e., it sells an asset, and the reserves flow back into the central bank.
But that is not what the central banks want. They want to force the banks to lend money in order to avoid the excess reserve charge. They appear poised to increase the so far nominal cost of a half percent or less. If the central banks can charge a half percent, they can charge anything they wish and, given the Keynesian mindset that led to the insanity of negative rates in the first place, probably will do so.
Negative rates violate numerous tenets of Austrian economics. For example, the basis of Interest rates is consumer time preference, described by David Howden in an article written almost three years ago about the loss of Canadian manufacturing.
Time is a factor necessary for production, and unique in the sense that we cannot economically allocate it like other inputs. The choice of time is always “sooner or later” and never “more or less” (as is the case with other input factors). Interest rates help us determine how soon we should consume a good, or how long a production process should be. Low interest rates imply that the future is not heavily discounted. At a low rate you will be willing to wait a longer period of time to realise the enjoyment of consumption or the profits of an investment. High interest rates invoke the corollary – you will want to consume earlier, or employ production processes that pay off in as short a time as possible.
Dr. Howden goes even further to show how central bank production of money out of thin air in order to drive down the interest rate causes disequilibrium between borrowers/investors and savers (the very purpose of the interest rate in an unhampered economy is to create equilibrium between these two groups), disequilibrium in the time structure of production (primarily an overinvestment in longer term projects), and the inevitable boom/bust business cycle that results from the fact that real savings had not increased to provide the real goods necessary for the increased investments. First businesses go bankrupt, then the banks, then the population as a whole.
But can’t the central bank just print more helicopter money to save everyone? Unfortunately, no. More money cannot cure what too much money created; i.e., higher and higher prices and loss of production.
Of course, an economy that has been thrown into disequilibrium by negative interest rates may display many weird anomalies before succumbing to the “crack up boom”, as described by Ludwig von Mises. Alasdair Macleod of Gold Money dot com suggests that an early indication of loss of confidence in money is a commodity boom in precious metals. Prices rise faster and faster and production collapses. The public understands that the monetary authorities have no intention of reversing their negative interest rate policies and restoring sound money and banking. In a mad rush to save their wealth from total destruction, the public will start to buy what it hopes to be assets that will not depreciate. This sets off a huge boom in some asset categories; thus the “boom” portion of Mises’ “crackup boom” scenario. But the crackup follows on the boom’s heals.
The real pity is that falling prices eventually create the conditions for a normal economic revival. Deflation is not a death spiral as the Keynesian believe. The public’s demand to hold money will be satisfied when their reserves of money balances are sufficient in relation to the price level, they are once again confident of the future, and are willing to invest for the long term.
The suppression of interest rates has been unnecessary and harmful. Nevertheless, expect more central banks to follow the early leaders– Switzerland, Sweden, Denmark, and even upon occasion the European Central Bank itself–into negative interest rate territory. The crying shame is that it will not work and will cause great harm to hundreds of millions of people. It may even collapse Western civilization.
Patrick Barron
