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.
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