Hurdles to Negative Interest Rates. What Do You Think?

[EggShells]

I wrote the following in response to a report in The Economist on Andrew Haldane's suggestion of negative interest rates:

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Mechanically, imposing negative interest rates would actually be fraught with danger, from the authorities' point of view.

Remember, this needs to be done in two steps, as mentioned by Buttonwood. Cash must be abolished before rates go negative, or else people would just store physical cash to avoid negative interest.

The trouble comes from gold, silver and Bitcoin. These can be used instead of cash to escape negative interest. It's easy to ban an asset (cash) issued by the authorities -- they only have to remove the asset's legal status. With the non-state-issued sorts, an actual ban would have to be enforced, and countries would have to co-operate.

There would be a big incentive for a country to break rank on this ban, to enjoy a windfall in capital inflow. A lot would depend on the ability of the dominant world power (US) to whip countries into line. The country that breaks rank would also need to be able to defend itself militarily, or else another war might be waged for mysterious reasons to effect "regime change" in that country.

Another major hurdle is that the ban on cash would almost have to be announced for reasons other than negative interest (since the Western public won't enjoy handing power to their elites to reduce their wealth by arbitrary degrees.) Most likely, it would be following a major terrorist incident. Certainly, the ban on gold, silver, and Bitcoin would be announced under the same justification, but if enough of these assets are held by people who understand that the real reason is negative rates, the ban would probably not be effective.

Even under a unified Imperial China, before the 1500s, the state found it necessary to use the death penalty to enforce such a ban, aimed at propping up the state paper money. And China eventually went to physical silver anyway.

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[navaman]

It would be deflationary as the demand for paper currency grow.  In a deflationary environment, generally you don't want to hold hard assets or commodities.  Not all will go down in price when deflation hits; this merely a generalization.  There is the other problem in that the Fed would have to regulate not just the Discount Rate and Fed Funds rate but a whole slew of interest rates from AAA to High yield and a lot in between.

[EggShells]

It would be deflationary as the demand for paper currency grow.  In a deflationary environment, generally you don't want to hold hard assets or commodities.  Not all will go down in price when deflation hits; this merely a generalization.  There is the other problem in that the Fed would have to regulate not just the Discount Rate and Fed Funds rate but a whole slew of interest rates from AAA to High yield and a lot in between.

I think the goal of negative interest rates would be to stimulate spending and investment.  Say, safe assets like bank deposits are "paying" -2%.  This might make it attractive to buy corporate bonds at 3%.  Today, bank deposits can't go below 0% (or people would hoard cash,) and most corporations don't want to pay more than, say, 3%.  The 3 percent-point difference won't entice you to take the risk with corporate debt, but the 5 percentage-point difference will.  So the idea is to drag safe-asset rates down so that riskier assets look attractive.

If -2% doesn't do the trick, they'll try -3%.  At some point, people will be forced to part with their safe assets.

You'll want to hold hard assets if you can, since no one is taking away 2% of your gold or bitcoins every year.  In fact, the whole idea is to drive people generally into assets.  People would flock to real estate and stocks.  (They would use the law to exclude gold, silver, and Bitcoin from demand, since these assets have the potential to challenge money itself, which would challenge the entire basis of the elites' power.)

The inflation vs. deflation discussion would probably lose a lot of its traditional meaning.  The total amount of money in the economy might stagnate (relative to today, at least,) but the general picture is effectively inflation.  The amount of dollars you own might go down, but you're still going out and trying to find anything you can buy and driving prices artificially higher than they would be under the free market.  Today's inflation takes the form that each dollar saved buys less and less as time goes on (even when earning interest.)  Tomorrow's "inflation" might see prices staying at the same dollar amounts, but each dollar saved becoming 90 cents, then 80 cents.  It would be the same effect.

[navaman]

One thing about this scenario is that the real interest, ceteris paribus, is raised from 3% to 5%.  This by itself reduces demand for money and should reduce investment.  The company isn't borrow at 3% anymore.  It pays that 3% to bondholders and 2% to the bank; they aren't going to keep it in cash.  So now, you are back to 1% interest rates for a triple A seller, and bond buyers only willing to sell at 3%.

Another affect that we discussed is the fact the bond owners and cash holders will maintain their positions rather than sell which furthers the reduction of money supply and raises interest.  This will create a deflationary spiral due to Higher real interest rates.  A bigger point is that money is that this sends the market into an uncertain future with a small handful of people deciding what interest rates should be.  This is the opposite of free markets.  There are several effects here that economics can't answer as to which ones  are going to dominate in this scenario.

Looking back at the late 70's, you had the opposite problem which is too large to include here.  However, the central bank looked at the problem as a traditional trade off between output and inflation.  They tried to spur growth by increasing the money supply but only ended creating inflation.  One reason for this is single digit inflation isn't an inhibitor to growth.  The issue with this policy was that markets didn't respond to the Fed's actions the way the models say.  Bond markets sold off and so the Fed increase M again and again because they were looking at the nominal interest rate.  If they had been looking at the Real, history might be different.  That is the disaster of a small group of people deciding what prices and the discount factor should be.  In other words, central planning sucks and always will.

[jaysabi]

I wrote the following in response to a report in The Economist on Andrew Haldane's suggestion of negative interest rates:

---------------------------------------------------------------------

Mechanically, imposing negative interest rates would actually be fraught with danger, from the authorities' point of view.

Remember, this needs to be done in two steps, as mentioned by Buttonwood. Cash must be abolished before rates go negative, or else people would just store physical cash to avoid negative interest.

The trouble comes from gold, silver and Bitcoin. These can be used instead of cash to escape negative interest. It's easy to ban an asset (cash) issued by the authorities -- they only have to remove the asset's legal status. With the non-state-issued sorts, an actual ban would have to be enforced, and countries would have to co-operate.

There would be a big incentive for a country to break rank on this ban, to enjoy a windfall in capital inflow. A lot would depend on the ability of the dominant world power (US) to whip countries into line. The country that breaks rank would also need to be able to defend itself militarily, or else another war might be waged for mysterious reasons to effect "regime change" in that country.

Another major hurdle is that the ban on cash would almost have to be announced for reasons other than negative interest (since the Western public won't enjoy handing power to their elites to reduce their wealth by arbitrary degrees.) Most likely, it would be following a major terrorist incident. Certainly, the ban on gold, silver, and Bitcoin would be announced under the same justification, but if enough of these assets are held by people who understand that the real reason is negative rates, the ban would probably not be effective.

Even under a unified Imperial China, before the 1500s, the state found it necessary to use the death penalty to enforce such a ban, aimed at propping up the state paper money. And China eventually went to physical silver anyway.

Switzerland has had negative interest rates for a stretch now. http://www.tradingeconomics.com/switzerland/interest-rate However, I don't know if consumers are being charged a negative rate, or if it's only the banks being charged a negative rate by the central bank, and the banks are just eating the loss to keep from alienating consumers.

[EggShells]

One thing about this scenario is that the real interest, ceteris paribus, is raised from 3% to 5%.  This by itself reduces demand for money and should reduce investment.  The company isn't borrow at 3% anymore.  It pays that 3% to bondholders and 2% to the bank; they aren't going to keep it in cash.  So now, you are back to 1% interest rates for a triple A seller, and bond buyers only willing to sell at 3%.

Another affect that we discussed is the fact the bond owners and cash holders will maintain their positions rather than sell which furthers the reduction of money supply and raises interest.  This will create a deflationary spiral due to Higher real interest rates.  A bigger point is that money is that this sends the market into an uncertain future with a small handful of people deciding what interest rates should be.  This is the opposite of free markets.  There are several effects here that economics can't answer as to which ones  are going to dominate in this scenario.

Looking back at the late 70's, you had the opposite problem which is too large to include here.  However, the central bank looked at the problem as a traditional trade off between output and inflation.  They tried to spur growth by increasing the money supply but only ended creating inflation.  One reason for this is single digit inflation isn't an inhibitor to growth.  The issue with this policy was that markets didn't respond to the Fed's actions the way the models say.  Bond markets sold off and so the Fed increase M again and again because they were looking at the nominal interest rate.  If they had been looking at the Real, history might be different.  That is the disaster of a small group of people deciding what prices and the discount factor should be.  In other words, central planning sucks and always will.

Central planning certainly sucks.  I was just now reading about Thomas Jefferson -- he had the foresight to oppose the central bank which is the institutional cornerstone of the bank-politician alliance designed, really, to extract wealth from the rest of society.  Who gave these people the right to plan our economic lives anyway?  It might not be surprising that, after the central bank was dismantled by Andrew Jackson, and a rising USA threatened to become a major force outside the modern world system, Britain sided with the Confederacy in the Civil War, even though Britain had abolished slavery a few decades before.

I'm absolutely opposed to granting negative-interest power to the elites.

Real interest is nominal interest minus inflation.  So in our example, let's suppose inflation was 0% (just randomly), the real interest would be 3% for those corporate bonds.  The authorities could drag safe-money interest arbitrarily low -- and the lower that gets, the higher inflation should be, since people will want to circulate money in the economy rather than hold it.  So the real interest could be made as low as the authorities want, in theory.  (The company pays the 3% but will try to avoid the 2% by pushing its purchases forward -- this is the inflationary effect.)

It's true that existing bonds would become more valuable the lower the central bank sets the rates.  But bonds eventually mature, and anyway these holders could cash in their winnings immediately by selling their bonds.  Unless they bet on rates going lower during the life of the bonds, selling vs. holding would be a neutral decision.  Cash owners would tend to part with their cash since they're losing cash as it sits in the bank. The authorities would have the power to make them lose more, if the current policy doesn't achieve the desired effect.

[EggShells]

Switzerland has had negative interest rates for a stretch now. http://www.tradingeconomics.com/switzerland/interest-rate However, I don't know if consumers are being charged a negative rate, or if it's only the banks being charged a negative rate by the central bank, and the banks are just eating the loss to keep from alienating consumers.

I believe the rates are only mildly negative and only between the banks and the central bank.  They can't really go significantly negative since, ultimately, savers have the option to hold physical cash.

[jaysabi]

Switzerland has had negative interest rates for a stretch now. http://www.tradingeconomics.com/switzerland/interest-rate However, I don't know if consumers are being charged a negative rate, or if it's only the banks being charged a negative rate by the central bank, and the banks are just eating the loss to keep from alienating consumers.

I believe the rates are only mildly negative and only between the banks and the central bank.  They can't really go significantly negative since, ultimately, savers have the option to hold physical cash.

Even a mildly negative rate should cause consumers to hold cash over depositing it. It must be insignificant enough that the banks will eat the loss and not pass it on to consumers, however the point of negative interest rates still confuse me. In theory, it depletes the money supply, so actually rewards savers; as long as consumers aren't bearing the cost of the negative interest and it is only between banks and the central bank.

[Possum577]

Remember, this needs to be done in two steps, as mentioned by Buttonwood. Cash must be abolished before rates go negative, or else people would just store physical cash to avoid negative interest.

The trouble comes from gold, silver and Bitcoin. These can be used instead of cash to escape negative interest. It's easy to ban an asset (cash) issued by the authorities -- they only have to remove the asset's legal status. With the non-state-issued sorts, an actual ban would have to be enforced, and countries would have to co-operate.

There would be a big incentive for a country to break rank on this ban, to enjoy a windfall in capital inflow. A lot would depend on the ability of the dominant world power (US) to whip countries into line. The country that breaks rank would also need to be able to defend itself militarily, or else another war might be waged for mysterious reasons to effect "regime change" in that country.

Another major hurdle is that the ban on cash would almost have to be announced for reasons other than negative interest (since the Western public won't enjoy handing power to their elites to reduce their wealth by arbitrary degrees.) Most likely, it would be following a major terrorist incident. Certainly, the ban on gold, silver, and Bitcoin would be announced under the same justification, but if enough of these assets are held by people who understand that the real reason is negative rates, the ban would probably not be effective.

There's no way that cash could be banned without the public knowing it. Negative interest rates don't benefit the government or banks so there would be no incentive to support negative interest rates for the long term. It's an option of last resort for temporary relief and it can't be implemented in all aspects. First, banks can't get away with charging to keep assets with them (I realize you know this since you make the point about hoarding cash). Second, the effort wouldn't force people to borrow money they don't need to borrow. Third, it would reinforce more investment in stocks, etc., which wouldn't help the economy.

Negative interest rates is a short term solution to help get through a tough spot, that's it.

[pattu1]

Even a mildly negative rate should cause consumers to hold cash over depositing it. It must be insignificant enough that the banks will eat the loss and not pass it on to consumers, however the point of negative interest rates still confuse me. In theory, it depletes the money supply, so actually rewards savers; as long as consumers aren't bearing the cost of the negative interest and it is only between banks and the central bank.

A mildly negative exchange rate would make consumers treat banks as safe deposit boxes, where a small fee (negative interest) is paid to keep your cash safe. Consumers might still go ahead and deposit their money.

[EggShells]

There's no way that cash could be banned without the public knowing it. Negative interest rates don't benefit the government or banks so there would be no incentive to support negative interest rates for the long term. It's an option of last resort for temporary relief and it can't be implemented in all aspects. First, banks can't get away with charging to keep assets with them (I realize you know this since you make the point about hoarding cash). Second, the effort wouldn't force people to borrow money they don't need to borrow. Third, it would reinforce more investment in stocks, etc., which wouldn't help the economy.

Negative interest rates is a short term solution to help get through a tough spot, that's it.

For the public, there's no difference between saving a dollar and seeing it lose purchasing power every year on the one hand, and having that dollar become 95 cents, then 90 cents.  Both are effectively inflationary, even if prices don't go up in dollar terms in the latter case.

I agree with your point about negatives rates being "preferred" to be short in duration.  The trouble with that is shown by the situation today, which is the equivalent of what you're talking about.  The authorities would love to be able to raise interest rates.  They'd love policy rates to be able to become significantly positive, with market rates slightly higher, with the economy growing nicely on its own, and with monetary policy back to the neutral stance (ie doing nothing.)  But here we are, 8 years into the crisis, and rates are still zero.  The ultimate problem is the overall system, that allows the elites to issue assets and support them with state power, to benefit issuers.  When the distortions and malinvestments caused by this manipulation finally creates a financial crisis, they must push interest rates down, for as long as necessary, to lend more (artificial) support for asset prices, to avoid even more economic pain.  More pain would be politically problematic for the elites, since the public might eventually see through this system and demand that politicians change it.