Friday, May 29, 2015

How Can We Have "Negative Interest Rates?"

I received this question from one of my students and the answer I thought would help advance all you aspiring, junior, deputy, official, or otherwise economists out there:

Well, the short version is that countries lie to their people about how the real world economy works.
People believe they can have their cake and eat it too, which ultimately means borrowing more than they can ever hope to pay back for both individuals and governments.
This leads to debts that become impossible to pay back and asset bubbles like the stock market or housing markets which inevitably crash.
Once the economy crashes, governments scramble to get it back on foot, NOT so much to grow the economy again, but to prevent people from paying the price of being so stupid as to borrow more than they could afford or for voting in politicians who spend more than their respective countries can afford.  To do this governments print off more money to pay for both the private and public debts, which is done through their central bank.  THis money does not pay back the debts directly, but rather buys those debts off of the people who foolishly made them:
Mortgage Backed Securities
Asset Backed Securities
and I predict in the new future student loans
This money does NOT end up in the economy (which would cause inflation), but ends up simply recapitlizating (or "shoring up") the poor finances of the banks and lending houses that made such stupid loans.  This, coupled with a harsh and recent memory of the financial crisis or latest bubble bursting, makes people reluctant to borrow this new money and so the financial system is awash with money that nobody wants to borrow.
In the end banks do not make money if they don't lend out their money.  But people want their money deposited and held safely in a bank account.  This means that banks would be providing a service (depository services aka "safe keeping") but have nowhere to lend it out to.  Thus, instead of paying interest on those deposits, they start charging. 
This occurs especially acutely, however, to banks or countries where they are deemed "more reliable" than others.  ie -  Switzerland.
Everybody wants to deposit their money in a Swiss bank because it is safe.  Additionally, people want to own Swiss Francs as opposed to Euros (which would be destroyed by Greece), US Dollars (which would be tanked by a housing bubble or student loan bubble, or just massive government deficit spending) or Chinese Yuan (which would be ruined by corruption and their own debt problems).
Alas, Swiss banks and Switzerland cannot simply be everybody's banker, and they must charge (ie - negative interest rates) on their depository accounts.
And that IS about as simple as I can make it and that leaves a lot on the ground.


Gunn said...

Just a couple of points:

QE has caused inflation, specifically asset price inflation. Just because main inflation measures deliberately exclude asset price inflation, doesn't mean that QE has been benign from an inflationary perspective.

The idea that banks 'safeguard' customer deposits is based on a misunderstanding of what modern banking is - whilst this idea was true back in the days of real money, when vaults would contain physical money, today most currency is simply entries in electronic ledgers. Further, and even worse, depositors are unsecured creditors and have no direct legal claim on the amounts they have deposited with the banks, beyond their status as unsecured creditors.

One reason for negative interest rates is that governments can then borrow as much as they like, and overspend to their hearts' content, because bond issuance no longer costs anything.

A second reason for negative interest rates is that there has been and continues to be a race to the bottom as countries try to devalue their currencies based on a misunderstanding that doing so is beneficial to their balance of trade. In order to devalue currencies, you have to make them yield less, i.e. the interest rate associated with a currency must go lower and lower. Even then, for most currencies negative rates are a nonsense, and would simply result in people pulling their deposits out of banks and holding them as physical cash.

There are basically two ways however that you can make negative rates work:

i. if your currency is so desirable compared to everything else (e.g. CHF) that people are willing to pay a charge to hold it in preference to other currencies

ii. you impose laws that prevent people holding money as physical cash

This is the reason why we're seeing more and more retarded economists coming out with articles about why moving to a cashless society stops crime/terror/bank-runs/civil disobedience. They're testing the waters to see if governments can impose the laws necessary to allow for negative interest rates.

Its also why we're seeing people publicly mulling laws to force e.g. pension funds to invest in government bonds instead of other financial instruments. In a world of negative yield, the only way to convince people to 'invest' with you is by holding a gun to their heads.

grey enlightenment said...

Hmmm...real interest rates can also be negative if the nominal yield on deposits is less than inflation

'Reality' Doug said...

Negative interest rates are proof that investors controlling a substantial portion of all investments conclude they will not be able to keep money or wealth better than they can keep their purchasing power by holding government bonds, which will be protected for being an essential to the Ponzi scheme the establishment has engineered and re-engineered since WWII.

minuteman said...

That's a good answer. I was telling someone about negative interest rates the other day, and they said" well why don't you just keep your money in cash". I had no good answer at the time, but paying for safe keeping is as good as any.

FSK said...

You left out inflation.

Suppose the actual interest rate is 1% but inflation is 5%. Then interest rates are negative 4%.

Real inflation is more than 5%. Don't believe the CPI.

Negative interest rates distort the economy. For example, suppose a corporation can borrow at 5%, build a factor with a nominal return of 10%, while inflation is 15%. The factory makes a profit of 5%, while it actually was destroying capital at a rate of 5%.

Negative interest rates lead to the "financialization" of the economy. With negative interest rates, you can make bigger profits by playing financial tricks than by actually making a product.

sth_txs said...

This is what aggravates about the economic reporting. Negative interests rates really amount to little more than legalized theft without being beaten over the head. The people are probably already stupid enough to believe that a cashless economy benefits them regardless of education level.

And to think a lot of MBA's out there put down commodity money as retarded and caused problems based on their functional stupidity taught in colleges all over the world.

I use a bank teller sometimes, and I always laugh at the FDIC plaque about your money being protected by the 'full faith and credit' of the US government. All FDIC can do is transfer the liabilities to a stronger bank that can make good your deposit.