econintersect .com

FREE NEWSLETTER: Econintersect sends a nightly newsletter highlighting news events of the day, and providing a summary of new articles posted on the website. Econintersect will not sell or pass your email address to others per our privacy policy. You can cancel this subscription at any time by selecting the unsubscribing link in the footer of each email.

posted on 07 December 2015

The Mindless Stupidity Of Negative Interest Rates- Redux

by Lee Adler, Wall Street Examiner

Now that the ECB has added another notch to its mind bogglingly stupid, counterproductive policy of negative interest rates, I thought it would be a good time to recycle all of my golden gasser rants about just how dumb this course of action is. Apparently, this post will go on to immortality, as the evil that central bankers do lives on... and on... and on...

(October 10, 2014) Here we are in the midst of The Great Stagnation Middle Class Elimination and some central bankers and mainstream economists are promoting negative interest rates. One economist was quoted in a Marketwatch piece by Greg Robb as saying,

"...pushing rates into negative territory works in many ways just like a regular decline in interest rates that we're all used to."

OK. That's false. We know exactly what negative interest rates do since Europe has made a fine case study of it. They don't work just like a "regular decline in interest rates." I mean not that a "regular decline in interest rates," does what economists think it does, but that's another story. The issue here is how negative interest rates work.

Negative interest rate proponents ignore the basic tenets of double entry accounting.

Liquidity moves markets!

Click here to learn how you can follow the money.

Because there are two sides to a bank balance sheet, negative interest rates are the mirror image of positive rates. The move to negative rates imposes new costs on the banks, unlike low positive rates or ZIRP which reduce bank costs.

The greater the negative interest rate, the higher the cost imposed, which is the same as a central bank raising interest rates when they are positive. When the Fed lowers a positive interest rate, it lowers the bank's cost. But when there are trillions in excess reserves held by the banks as deposits at the Fed and the Fed lowers the interest rate to below zero, that becomes a cost to the banking system which it cannot avoid, except by using those cash assets to pay down debt.

So the banks in Europe did exactly what I said they would do in mid 2014 when the ECB announced negative deposit rates. It's exactly what any person with common sense would do, and therefore knew the banks would do. Those with the ability to do so pay off loans, which extinguishes deposits, thereby getting rid of the added cost. As opposed to stimulating growth, the European banking system shrinks. As opposed to encouraging borrowing and spending and economic growth, the policy encouraged deleveraging.

We know that it is categorically false the negative rates are working in Europe. But facts have a way of eluding mainstream economists and central bankers.

I wrote about this and also did a video on it in mid 2014 when the ECB went to the negative deposit rate. I showed that it would result in shrinkage of the ECB balance sheet because it would be an incentive for the banks to pay off their existing loans from the ECB in order to extinguish the offsetting reserve deposit. That is exactly what happened, both when the policy was first known immediately before it took effect, and ever since.

So the ECB was forced to institute outright QE to reverse that shrinkage. I then predicted that the banks would use part of the QE not to stimulate lending, but to continue to pay off outstanding ECB credit. That is exactly what has occurred. This is not rocket science. It's just common sense and paying attention to facts instead of ridiculous economic myths.

The European banks have been steadily paying down LTRO credit and MRO credit, month in and month out. That cancels out a portion of the growth that would otherwise accrue to the ECB balance sheet from QE. Not that that QE does an iota of good for the European economy - but that's tangential.

So what has happened to European bank deposits since the ECB instituted negative rates? They have shrunken. Has one single mainstream economist or proponent of negative rates mentioned that, ever? I suspect not. Because they either don't know, don't want to know, or do not understand that if you raise the costs of holding deposits then the deposit holders will get rid of them. And the only way the system as a whole accomplishes that is to pay off loans, using the existing deposits to do so. Sooner or later the hot potato of the negative interest bearing deposit lands in the lap of someone who will do just that - use a deposit to pay off a loan and extinguish the deposit.

But would it work differently in the US where the banking system cannot escape paying that cost because the Fed issued permanent reserves? Much of the ECB's balance sheet was in the form of loans that could be voluntarily repaid. Not so with the Fed. It bought assets with newly issued money that instantly became cash assets of the banks, held as reserve accounts at the Fed. The amount of cash in the system is fixed until the Fed decides it isn't. The cash can move from the reserve account of one bank to that of another. But the Fed's balance sheet is like the Hotel California. You can never leave.

The banks can unload their cash on other banks by buying long term assets from them. That gets rid of their reserve deposit at the Fed, but the cash just ends up in the reserve account of the bank that sold the asset. So maybe this starts a buying frenzy that pushes long term rates to zero because the banks will all want to exchange cash assets (reserves) for long term assets. That's apparently what happened in Europe as the system there shrank. But in the US some banks always end up holding the hot potato - the reserve deposit on which they must pay the cost.

Then what? Then you, Mr. or Ms. Banker try to recoup the cost. So you charge your depositors to hold deposits. What do they do? Rather than pay the interest on deposits, some pay off loans, extinguishing their deposits. They pay off their credit cards, their auto loans, even their mortgages, because there's an incentive not to hold deposits. The banks start to shrink, just like today in Europe. As their balance sheets shrink, their cash assets grow as a percentage of assets and the cost of the negative deposit rate on reserves at the Fed grows as a drag on earnings.

How can anything positive come from this?

Seriously, has anyone thought this through?

Can anyone show a clear example connecting the dots to show where negative interest rates have stimulated an economy? Can anyone clearly explain how charging an institution or business to hold deposits is in any way stimulative... not net stimulative, but stimulative AT ALL?

It defies common sense.

>>>>> Scroll down to view and make comments <<<<<<

Click here for Historical Opinion Post Listing

Make a Comment

Econintersect wants your comments, data and opinion on the articles posted. You can also comment using Facebook directly using he comment block below.

Econintersect Opinion

Print this page or create a PDF file of this page
Print Friendly and PDF

The growing use of ad blocking software is creating a shortfall in covering our fixed expenses. Please consider a donation to Econintersect to allow continuing output of quality and balanced financial and economic news and analysis.

Keep up with economic news using our dynamic economic newspapers with the largest international coverage on the internet
Asia / Pacific
Middle East / Africa
USA Government

 navigate econintersect .com


Analysis Blog
News Blog
Investing Blog
Opinion Blog
Precious Metals Blog
Markets Blog
Video of the Day


Asia / Pacific
Middle East / Africa
USA Government

RSS Feeds / Social Media

Combined Econintersect Feed

Free Newsletter

Marketplace - Books & More

Economic Forecast

Content Contribution



  Top Economics Site Contributor TalkMarkets Contributor Finance Blogs Free PageRank Checker Active Search Results Google+

This Web Page by Steven Hansen ---- Copyright 2010 - 2018 Econintersect LLC - all rights reserved