A central theme of this website has been to predict and then analyse the trend towards negative interest-rates. It is an adjunct of a world where central bankers feel the need to apply ever stronger doses of monetary stimulus as previous doses disappoint. Another way of putting this is that the junkie style culture they have pursued requires ever larger hits. At the moment the main outbreak of negative interest-rates surrounds the Euro area where the European Central Bank has reduced its main interest-rate to -0.2%. This has forced Switzerland and Denmark into a corner where they have reduced to -0.75% and it was only last Thursday that I analysed the reduction to -0.35% by the Riksbank of Sweden.
The concept of central planning is also on the rise as we see capital controls (more literally deposit controls and a closed stock exchange) in Greece and all sorts of machinations,edicts and threats in China against sellers of equities. In China what goes up is apparently not allowed to go down! Although to be fair it is general central bank policy that equity prices should be pushed higher with the Bank of Japan most explicit on that front under Abenomics. Also central banks like to see house prices rising with the Bank of England at the forefront of a group which again includes Sweden’s Riksbank where policy in recent times has driven house prices higher. So in asset markets the message from central bankers is “come on in the water’s lovely” as they tease us with hints of capital gains. This of course provides us with an alternative to cash savings and whilst it only applies to a section of them it is another attempt to move us away from them.
The Proposal To Scrap Cash
The paragraph above showed pressure on some types of cash holdings via an attempt to make both holding equities and investing in houses more attractive. Of course these have quite different risk profiles and so there are plenty of other types of cash holdings in existence. So it was inevitable that someone would have what they consider to be a brainwave and suggest scapping it entirely! As it happens Willem Buiter (who was my tutor for a year at the LSE) of Citi suggested it back in April so let us examine the rationale.
Central bank policy rates have been constrained by a perceived or actual effective lower bound (ELB) on nominal interest in recent years. The existence of the ELB is due to the existence of cash (bank notes) – a negotiable bearer instrument that pays a zero nominal interest rate.
The essential point here is that 0% is something of a rubicon in interest-rate terms because depositors and savers have an easy alternative once interest-rates fall below it. They can simply hold cash and avoid the negative interest-rates that the central bank is prescribing for the economy’s health at that point. Of course whether the central bank is correct in prescribing such medicine is a moot point but let us indulge that line of thought for a moment.
Following this logic and noting where we are makes central bankers unhappy as to coin a phrase the perception that their policies are “maxxed out” may grow.
We view this constraint as undesirable and relatively easily avoidable from a technical, administrative and economic perspective.
You may note the “relatively easily avoidable” and we get an explanation of how.
We present three practical ways to eliminate the ELB: i) abolish currency, ii) tax currency or iii) remove the fixed exchange rate between zero-interest cash currency and central bank reserves/deposits denominated in a virtual currency.
You may note that as Debbie Harry put it “One way or another” this paper has plans on your cash!
Tucked away in it was a rather damning view of Quantitative Easing (QE) and the emphasis is mine.
The option to lower interest rates significantly below zero would have been valuable in the past as an alternative to large-scale asset purchases (QE) by the Fed and the Bank of England and today in Japan and the euro area. Compared to QE, significantly negative interest rates would create fewer financial stability risks and political legitimacy risks.
Central bankers out of office seem suddenly to have a different view of house and equity market prices rises don’t they? “Wealth effects” suddenly morph into “financial stability risks”.
How long might interest-rate go? The example quoted is that of the Taylor Rule which would have had interest-rates at -5% back in 2009. At such a level you can see that cash would be very attractive and why the official view would head towards abolishing it.
Is it the banks again?
If we move to Bank of England research we see the central banking view of the money supply.
Whenever a bank makes a loan, it
simultaneously creates a matching deposit in the borrower’s bank account, thereby creating new money……Most money in the modern economy is in the form of bank deposits, which are created by commercial banks themselves.
You can see that the broader measures of the money supply would head south rapidly if individuals withdrew money from banks to hold cash. This is in many ways what we are seeing play out in Greece right now. Negative interest-rates would create yet another credit crunch.
So far I have put this at 0% for simplicity but as Willem Buiter points out there are costs to holding it.
Storage, safekeeping, insurance, transportation and handling costs of currency imply that the effective lower bound on interest rates is not zero, but somewhat negative (and uncertain).
The ECB has set interest-rates at -0.2% because it thinks the ELB is there. Actually I think that we have a zone between 0% and -2% depending on individual solutions. Also this is in the rational world whereas us humans are prone to Ying and Yang changes and in an irrational one the ELB would be 0% and could if you think about it (fear of deposit haircuts) perhaps even be perceived to be positive.
What do the Danes think?
Denmark cut interest-rates to -0.75% back on February 6th so we have some information on the effects of such a move. Here are the latest thoughts of its central bank. It is happy that wholesale money markets have followed its move but the retail sector is much less clear.
Banks have not introduced negative interest rates for households, probably reflecting that negative interest rates could induce some households to cash in their bank deposits.
So 0% is proving to be a rubicon although not in all areas.
The rate of interest on corporate deposits moved into slightly negative territory for the first time in April 2015.
One area is to my mind outright dangerous.
Insurance companies and pension funds (the I&P sector)…… For the I&P sector, the rate was substantially negative in both March and April.
How will industries that offer long-term contracts many of whom rely in effect on positive interest-rates work in a world of negative interest-rates. I recall a comment pointing out that UK pensions now had illustrations showing negative returns well what if the average expectation becomes that?!
On the other side of the coin some mortgage borrowers will be doing something of a jig.
.Interest rates on adjustable rate loans with fixed interest periods up to and including three years fell into negative territory in January and February.
Before all this happened it was easy to assume that banks would plunge deposit rates into negative territory but it would appear that they are afraid to do for the reason stated below.
If bank customer deposit rates fall into negative territory, customers can convert their deposits to cash.
Banking would then begin to eat itself.
Savers may be mulling the trends above and letting out a sigh of relief about the apparent 0% barrier for retail deposit rates. But should they move to ban or tax cash it would disappear and they should be very afraid of the likely next step! Meanwhile the Willem Buiter view confirms that standing up for savers is very unpopular in both official and banking establishments.
Many of these will refer to negative nominal interest rates disapprovingly as ‘punishing savers’. Most of that is simply people talking their own books and/or a failure to distinguish between nominal and real interest rates.
He even tries a bit of what he presumably considers abuse by labelling such thoughts as “German” and counters by arguing this.
. But it is important to highlight that discouraging saving (and encouraging spending) is not a bug of significantly negative interest rates, but a feature.
I am not sure that savers would think that! Here we get to the nub of the issue which is twofold. Firstly central bankers have shifted the balance between savers and debtors in the credit crunch era to “improve demand”. However this shift has required ever higher doses of measures as we see interest-rates not only be reduced but we face the possibility and maybe probability that on this road we need ever more cuts in interest-rates. We are always on the edge of a cure which turns out to be a mirage and repeat. Or as Taylor Swift put it.
I knew you were trouble when you walked in
Trouble, trouble, trouble
I knew you were trouble when you walked in
Trouble, trouble, trouble
In essence we are back to the central bankers thinking they know better than us, of which the easiest critique is the existence of and record so far of the credit crunch.