Central bankers are pressing onward with their failed negative interest rate experiment, oblivious to the damage that it is doing to banks and long-term investors like life insurers and pension funds.
Even more bizarre is the central bank assumption that by charging banks for reserves, they can force banks to lend. First, the very need to resort to negative interest rates results from crappy fundamentals. Entrepreneurs are not going to borrow to invest in new projects just because money is on sale. They invest because they see market opportunities; the cost of money being too high can constrain investing, but cheap money won’t produce loan demand in the absence of attractive projects. The only exception is activities where the cost of money is the biggest cost of doing business. That is the case for levered speculation.
Economists are way way late in the game acknowledging the need for more demand by calling for more fiscal spending.
But central banks ex the Fed act as if they can force business to take up the slack, as if banks can noodle them full of loans like geese and they will be forced to invest and hire as a result.
Second is that banks have to be leery of making any long-term loans now. Even though no end of ZIRP and negative interest rates is in sight, they know if the monetary authorities ever are in a position to increase interest rates, they will show losses on intermediate and long-term assets unless they have adjustable interest rates. And the losses will be biggest on the riskier loans, since credit spreads typically widen in a tightening cycle.
So it should come as no surprise that banks are starting to try to find ways to circumvent the central bankers’ nutty scheme. As we reported in March, some small Barvarian banks said earlier this year they were looking into keeping cash on premises rater than pay for parking deposits with the Bundesbank. Yesterday, Commerzbank saber-rattled that it might follow suit. . Japanese banks are also trying to slip the leash. From the Financial Times:
Lenders in Europe and Japan are rebelling against their central banks’ negative interest rate policies, with one big German group going so far as to weigh storing excess deposits in vaults.
The move by Commerzbank to consider stashing cash in costly deposit boxes instead of keeping it with the European Central Bank came at the same time as Tokyo’s biggest financial group warned it was poised to quit the 22-member club of primary dealers for Japanese sovereign debt…The policy cost German banks €248m last year, according to the Bundesbank….
The viability of the approach is open to debate. Holding cash in vaults would incur storage and insurance fees. The ECB’s decision to stop producing the €500 note will also make storing large volumes more difficult. But Adalbert Winkler, professor at the Frankfurt School of Finance and Management, said that if the ECB kept its negative deposit rate in place for a prolonged period, or increased it, more banks might decide to hold cash.
“The more central banks think that they can violate the zero-bound, the more likely it is that banks will look at ways to limit their costs,” he said. “And that means they will hold more cash if they can find efficient means to do so.”
C.P. Chandrasekhar and Jayati Ghosh gave a good high-level description of why this idea is wrongheaded but is nevertheless being attempted:
Thus negative rates are the consequence of policy makers betting on interest rate cuts to drive growth through multiple channels. To start with, they expect bank lending rates to come down and encourage households and firms to spend and/or invest more, thereby raising demand. Second, investors not wanting to pay governments for holding their money are expected to turn to asset markets like the stock market. That would raise financial asset prices and trigger the oft-cited “wealth effect”. With the value of paper or real assets rising, holders of those assets would be encouraged to spend more today rather than add further to accumulated wealth, spurring demand. Finally, since low and negative interest rates in a country would discourage foreign investors from investing in bonds and financial assets in the country concerned, the currency can depreciate, improving the competitiveness of exports.
The difficulty is that these expectations are not being realised. Households and firms are still burdened with debt, and so are wary about borrowing more, and banks are cautious of increasing their exposure to them even if pushed by the central bank. This could partly explain the thirst for government bonds, which has driven their yields to turn negative as well. On the other hand, with all countries relying on interest rate cuts, the effective depreciation of currencies, while significant vis-à-vis the dollar, is only marginal vis-à-vis one another. That neutralises the competitive benefits from depreciation relative to the dollar, with little chance of an export boom….
Why then are central banks and governments opting for this unusual stance? In a famous 1943 essay on the “Political Aspects of Full Employment”, the Polish economist Michal Kalecki had argued that if the rate of interest or income tax is reduced in a slump (to counter it) but not increased in the subsequent boom, “the boom will last longer, but it must end in a new slump: one reduction in the rate of interest or income tax does not … eliminate the forces which cause cyclical fluctuations in a capitalist economy. In the new slump it will be necessary to reduce the rate of interest or income tax again and so on. Thus in the not too remote future, the rate of interest would have to be negative and income tax would have to be replaced by an income subsidy.”
In the current context the problem is not that the interest rate that was reduced during the slump was not raised during an ensuing boom. The problem is that large reductions in policy interest rates when they were in positive territory did not counter the slump. But since governments have forsaken completely the option of relying on the fiscal lever to manoeuvre a recovery, they have no choice but to continue reducing interest rates, which have finally entered negative territory. Unfortunately, that too seems unlikely to trigger growth in the foreseeable future. It is only increasing the prospects of another financial bust.
In fact, Kalecki also explained why fiscal spending had been too low in the past. Businesses actually do not want to maximize profit, because a full employment economy give labor more bargaining power. It is more important for them to have more sway over workers and a higher status relative to them. Thus Kalecki argued that even though government could and should make up for the shortfall in business investment and hiring, businesses would resent that too, since an influential government that was play a positive role would also curb their power. So the mess we are in is ultimately rooted in class warfare, and far too few people at the top of the willing to make a major course correction. The result, and we foresaw in ECONNED, was the breakdown of the current economic paradigm. That appears to be starting now, as the abject failure of economic policy to produce prosperity or even adequate security for ordinary people is leading to voter revolts.