San Juan Mountains

San Juan Mountains
San Juan Mountains: Grenadier Range

Tuesday, February 9, 2016

The Folly Of Negative Interest Rates

The stock market whipsawed around yesterday, going from a low point of negative three percent to finally close down about one and a half percent on the day.  Last Friday the financial talking heads on the business news stations informed me that the market was dropping because Friday's jobs report was too good, thus causing short term investors and day traders to fear that the all powerful Fed would react by raising interest rates, choking off economic growth and creating a recession.  Yesterday that all changed.  By the end of the day those same financial gurus were informing me that the reason for Monday's drop in stocks had to do with the fear found in short term investors and day traders that the Fed was going to initiate a program of negative interest rates.  How those two directly opposite financial events could possibly be responsible for the exact same market reaction on Friday and Monday was not explained.  The concept of negative interest rates is a fascinating one.  Let's consider it for a while today.
According to Investopedia, "During deflationary periods, people and businesses hoard money instead of spending and investing. The result is a collapse in aggregate demand which leads to prices falling even farther, a slowdown or halt in real production and output, and an increase in unemployment. A loose or expansionary monetary policy is usually employed to deal with such economic stagnation.  However, if deflationary forces are strong enough, simply cutting the central bank's interest rate to zero may not be sufficient to stimulate borrowing and lending.  A negative interest rate means the central bank and perhaps private banks will charge negative interest: instead of receiving money on deposits, depositors must pay regularly to keep their money with the bank. This is intended to incentivize banks to lend money more freely and businesses and individuals to invest, lend, and spend money rather than pay a fee to keep it safe."
Contrary to the religious beliefs of economists who worship the State, the rate of interest in the economy is not and cannot be set by the Fed, or any other government organization.  The rate of interest in an economy is the average of all the individual rates of interest held by all market participants.  The rate of interest for each individual market participant is determined entirely by himself, as he appraises his life situation and economic goals.  The rate of interest exists, and this is supremely important, because everyone values the present more than the future.  No sane individual would ever make a deal in which he commits himself to loaning money to someone else in order to get less back later.  The reason a person wants more money back in the future is due to the simple fact that everyone values the present more than the future.  How much a person values the present in comparison to the future sets his rate of interest.
Some people might be willing to loan me $1000 if I pay them $1050 back at the end of the year.  That would be a 5% rate of interest.  Others would demand $1100 and some might be willing to loan it to me for $1030, a mere 3% rate of interest.  When all of these individual rates of interest are taken into consideration the real rate of interest, set by the free market, is established.  It changes all the time as market participants change their opinions about things, but at any given time there is an average rate of interest that is the same thing market rate of interest.
From what I have written it should be obvious to any person who does not draw a paycheck from the taxpayers, by way of the government, that a negative rate of interest is impossible.  The real rate of interest in the economy is never negative.  Nobody ever demands less money back on a loan.  Only government can cook up a scheme in which the absurd and contradictory notion of negative interest rates can allegedly become good fiscal policy.  Let's consider the definition of negative interest rates presented above to see if it sheds any light on the situation.
John Maynard Keynes was a British economist from whom the term "Keynesianism" has been coined.  Keynes was a God-of-the-Bible hating reprobate who worshiped civil government who wanted to give civil government power over all economic transactions.  In order to accomplish his goal he cooked up an economic theory that he knew would appeal to career politicians and State worshipers all over the world.  Keynes argued that ordinary citizens like you and me are really stupid and we constantly do really stupid stuff.  That quickly got the attention of elitist politicians who wholeheartedly agreed with his fundamental analysis of their subjects.  According to Keynes, economies go into recessionary periods because people become afraid and stupidly "hoard" their cash rather than spending it on shiny things.  When people keep their money rather than spending it on shiny things Keynes said something called "aggregate demand" drops, thus causing producers of goods and services to reduce their prices in order to ring up sales.  As they reduce their prices consumers decide to wait until prices drop even more so they end up hoarding even more cash.  The vicious cycle started by consumer stupidity must be fixed by the intervention of omniscient and beneficent government agents who enter the situation and solve the problem of insufficient aggregate demand by creating counterfeit money and giving it to their cronies to spend.  As their cronies spend the newly minted cash prices are able to start rising and we are all saved by the inflation the government has created.  Even dumb consumers eventually learn they need to start buying shiny things before they become more expensive and pretty soon producers are backlogged with new orders.  Presto, chango....the government planners have caused us all to spend ourselves to prosperity!  What a wonderful system, if only it were true.
I have dealt with the inanities of Keynesianism in many previous blog posts.  Do a search under that term if you want to read some of them.  Needless to say, economic growth is not brought about when the government floods the market with counterfeit dollars.  It is not possible to spend our way to prosperity.  All real economic growth comes from savings and investment, the very thing Keynes derogatorily declared to be "hoarding."  Aggregate demand, as all biblical economists understand, always takes care of itself.  People buy shiny things because they want them and to postulate that every consumer, en masse, makes the decision to buy something after watching a single price and making the purchase at the same time everyone else does is absurd.
Under the erroneous terms of the Keynesian theory a call for a negative interest rate can be used during periods of deflation, but the Socialist Democracy Amerika is not in a period of deflation.  Deflation takes place when the supply of money in the land contracts.  Here is a graph showing the rate of growth in the supply of money in the SDA over the past ten years.  Does it look like money is drying up to you?

                            https://research.stlouisfed.org/fred2/graph/fredgraph.jpg?hires=1&g=3nCy


Even if we were currently experiencing deflationary conditions in the SDA, that is not a bad thing.  In fact, deflation is good.  The Keynesians get it all wrong when they praise inflation and condemn deflation.  I posted an article to this blog proving that point previously.  It can be found here if you are interested.
A fatal flaw in the negative interest rate theory is the belief that people will flock to banks to borrow money simply because banks have money to loan.  That belief is simply untrue.  People do not borrow money simply because banks have money to loan.  People borrow money when they want to borrow money, not because banks want to make loans.  It is the bank customer that initiates the loan transaction, not the bank itself.  This fact has been clearly illustrated over the past several years as the Fed engaged in various quantitative easing programs.  Those programs did not result in an acceleration in the rate of loan growth.  On the contrary, that money was taken by the banks and put on deposit with the Fed as an "excess reserve."  Look at this graph showing the amount of excess reserves on deposit with the Fed since QE began:

                              https://research.stlouisfed.org/fred2/graph/fredgraph.jpg?hires=1&g=3nUt

All that money the Fed created, for the most part, ended up back at the Fed.  That is a good thing since if it had actually worked its way into the economy we would be experiencing Jimmy Carter era type inflation right now.  My point is simple.  Interest rates are near zero right now and banks have trillions of dollars to loan but commercial and industrial loans have not exploded.  Look at this graph:

                          https://research.stlouisfed.org/fred2/graph/fredgraph.jpg?hires=1&g=2LD9

The Fed can set interest rates on the negative side of the ledger and all it will do is punish banks for not being able to loan the money out.  If banks could make more money loaning it out to customers today than they can by keeping it on deposit with the Fed, they would be doing so.  The fact that they are not doing so tells you all you need to know.
Finally, the bottom line behind negative interest rates is the idea that it "is intended to incentivize banks to lend money more freely and businesses and individuals to invest, lend, and spend money rather than pay a fee to keep it safe."  In other words, the government interjects itself into the voluntary business transactions of banks and their customers in a vain attempt to force banks to make loans and customers to accept them.  The concept of a negative interest rate is not an incentive, it is a form of coercion designed to force people to do things they would not ordinarily do and, if they do not conform to the wishes of the government, they will suffer financial penalties.  Is that what we want the government to be doing in our economy?  Making matters even worse, if the federal government is successful in forcing people to borrow money that they would not ordinarily borrow, all that has been accomplished is the sowing of seed for the next cycle of inflationary boom followed by a recession and economic collapse.  Any cycle of economic growth that is the creation of negative interest rates is not real.  It is unsustainable and will eventually collapse.  And that will end up, as government intervention in the free market inevitably does, doing more harm than good.
 

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