Hello Fed, Low Interest Rates Do Not Promote Growth

Mish

Low and negative interest rates hurt Japanese banks. The ECB and the Fed need to pay attention.

What's Japan to Do?

The Wall Street Journal reports The World Should Watch Japan’s Attempts to Save Its Struggling Banks.

After 30 years of falling and even negative interest rates, many of Japan’s regional lenders have share prices of 0.2 to 0.3 times their book value—levels that would have been considered catastrophically low even a few years ago.

The Bank of Japan is offering commercial lenders an extra 0.1 percentage point in interest on their deposits with the central bank if they reduce their overhead ratio by certain benchmarks, or merge or integrate their businesses.

A marginal shift in interest rates on accounts held with the central bank might not sound like much, but Moody’s Investors Service rightly notes that given regional banks had an average return on assets of just 0.14% in the last fiscal year, an extra 0.1 percentage point return on large cash balances is nothing to sniff at.

Any institution that relies on interest income is going to be squeezed continually if rates remain low for an extended period, as bond market prices clearly expect them to. With less fee income, similar issues are likely to present themselves in regional lenders around the world.

Low Interest Rates Did Not Promote Grown 

Neither low interest rates, nor QE, nor wasted fiscal stimulus promote growth over the long haul. 

Japan tried all three for decades. The results speak for themselves, recession after recession. 

Zombification

Instead of promoting growth, artificially low interest rates promote zombification. 

Unproductive companies are artificially kept alive at the expense of more productive companies.   

  1. December 16, 2017: Zombie Corporations: 10% of Companies Depend on Cheap Fed Money
  2. July 19, 2019: Zombification Perfected: Negative Yield Junk Bonds Take Hold in Europe
  3. November 18, 2019: China, like Japan in the 1990s, Will Be Dominated by Huge Zombie Banks

Fundamental Strength of Capitalism

A fundamental strength of capitalism is that failed companies go out of business making way for new ideas and better models.

Yet, here we are. The Fed, ECB, Bank of China, etc., all strive to keep failed companies alive. Zombification is still on the rise.

Self-Inflicted Pain

I have been preaching this message for years. Low interest rates are a huge problem.

The ECB faces a worse setup than Japan with hugely negative rates. 

Think of it this way: Negative-yield bonds imply it is better to have 99 cents ten years from now than a dollar today. 

That is of course illogical, and in fact impossible in a free market. We see these things only because of failed manipulation by central banks.

Fed vs ECB

Whereas the Fed pays interest on excess reserves, the ECB charges interest. 

The process slowly bailed out US banks over time in the US but further crippled European banks.

Purposeful Destruction of European Banks?

Policy at the ECB was so questionable, especially given years of study of failed Japanese policy, that I often wonder if it was intentional. 

Here's the setup:

  • Mario Draghi, head of the Italian Central Bank replaced Jean Claude Trichet as head of the ECB. 
  • Troubled Italian banks were widely understood as crippled and unable to lend because of capital restraints and nonperforming loans.
  • Draghi forced more excess reserves into the system via QE. 
  • Draghi the went down the rabbit hole of negative rates charging crippled banks interest on excess reserves, further weakening the banks, and not just Italian banks. Look at Deutsche Bank for example. 
  • Why? 
  • By any chance was it to so destroy the European banks so that Germany would be forced to commingle debts and bail out Southern Europe?

That's plausible but against Occam's Razor that suggests simpler explanation are more likely to be correct.

The simple explanation is that Mario Draghi was just plain stupid. 

Will the Fed Go Down the Rabbit Hole?

Many believe so, but I don't (as least not that rabbit hole).

The Fed is beholden to the banks. It does not give a damn about consumers as long as it keeps the banks alive. 

Short-term, zombification and QE allows companies who could otherwise not pay back loans to do so. But negative rates that punish banks are another matter. 

The Fed understands this and it can see the problems facing the ECB and BOJ so it is unlikely to go there. 

Bond Bull Lacy Hunt Warns of a Huge Monetary Risk

I commented on the US setup twice. Both are worth a review.

  1. Aug 18, 2020: Bond Bull Lacy Hunt Warns of a Huge Monetary Risk
  2. October 22, 2020: Two Inflationary Tail Risks For US Investors

Those links contain observations by Lacy Hunt and me on what the Fed has done and what it might do.

Although the Fed is unlikely to go down the negative rate rabbit hole, there are other rabbit holes the Fed might try. 

One of them is direct printing, making the Fed's liabilities legal tender or a medium of exchange.

Hunt suggests huge inflation risk if the Fed pursues that path. 

See the above two links for further discussion.

Mish

Comments (36)
No. 1-17
amigator
amigator

More evidence of what the real purpose of the Federal Reserve Act!

Scooot
Scooot

Negative rates also mean it’s cheaper for governments to borrow via the bond markets than issuing/printing money which has a higher rate, zero.

Jackula
Jackula

I suspect if Mr Market pushes US rates negative its game over for the current world financial system. I think the FED suspects this as well.

Mr. Purple
Mr. Purple

Judy Shelton and her consistent monetary views to the rescue! She apparently favors higher interest rates ... wait for it ... when there's a Democrat in office! Co-inky-dink!

"During the Obama years, she criticized the Federal Reserve's low interest rates.[29][30][31] During the Trump presidency, she advocated for the Federal Reserve to adopt lower interest rates as a form of economic stimulus. (Trump frequently criticized the Federal Reserve for not lowering interest rates.)[4][29][32] "

Sechel
Sechel

Low interest rates promote growht? maybe
But low interest rates also promotes mal-investment and causes savers to subsidize borrowers or perhaps more aptly transfers wealth from those with capital to thoe with primary access to credit

Mr. Purple
Mr. Purple

And what about JS's free-marketeer bona fides?

"Before Trump became president, she was a longtime advocate for free trade, but after he became president, she supported his administration's trade war with China.[6][20]"

Why it's as if Trump can make her forget all about her silly Nancy principles!

Spin the spinner, who knows what'll come up?

njbr
njbr

At what point does it become impossible to raise rates again?

Couldn't make it much above 2% last time (not even inflation) before the market was crying "Uncle".

Much more debt now--it's keeping the economy afloat.

Higher interest rates means higher repayment costs means failures of the impaired parties.

It a puzzle for the ages.

Eddie_T
Eddie_T

"Think of it this way: Negative-yield bonds imply it is better to have 99 cents ten years from now than a dollar today.”

Respectfully, think of it (just for a moment) in another way:

It is better to have 99 cents ten years from now than to risk having 0 .99 cents in ten days or ten weeks.

The logic being......that it is temporary safety that is of utmost importance.....in a time when deflation could occur ANY DAY in the form of a chain reaction that locks up the credit markets...which would result in a chaotic price restructuring of just about every asset you can name, including gold..but in this case more importantly....the Euro.

“The simple explanation is that Mario Draghi was just plain stupid.”

I’ll offer the alternative ......that it wasn’t stupidity, but fear driving Mr. Draghi....along with one other thing.....the idea that at some point he could hand off the problem to a successor, and float home on his golden parachute, with the worries of the world no longer his to worry about.

Which he did, more or less.

To understand Draghi, understand that he stood for one thing above all others...which was the preservation of the Eurozone and the Euro currency. As Draghi himself famously said, he would do “whatever it took to make that happen”...and that “it would be enough”.

None of this is in any way aimed at arguing against hard money....just an explanation of the forces that led to the bad situation we’re in.

Now they are floating these new bonds...the ones that are Eurozone Sovereign bonds by any other name....I forget what they’re calling them.....some kind of environmental “green energy bond”? Something like that.

For the Euro this is necessary....it’s been so obvious for a decade that the big problem is one currency but many sovereign nations, each in different economic circumstances, but each able to issue its own bonds. Necessary but not politically palatable.

One further thought:

"Whereas the Fed pays interest on excess reserves, the ECB charges interest. “

This is also not without consequences.....the primary one being support for the US dollar and every asset denominated in dollars. This is why the USD is so stubbornly strong in the face of our profligate spending....that and the fact that there is an awful lot of foreign debt that has to be repaid in dollars.

My thesis, right or wrong....is that we go even further down this crazy rabbit hole into negative interest rate territory....which can happen fairly easily if two small impediments are removed.

One is that cash would have to be eliminated.

The other is that all financial transactions would be completely transparent and traceable by governments....

Both these things could be done by adopting sovereign cryptocurrency and making other cryptos illegal.

Far fetched? I don’t think so.

nzyank
nzyank

Isn't this just a suppy-demand issue? - too much money sloshing around chasing limited investment opportunities, driving down yield and driving up asset prices? There is a tremendous amount of wealth out there that is not being productively invested. Is this a failure of the capitalist/small governement model? Private enterprise is not creating sufficient investment opportunities? Some blame government regulation for this, but I don't buy into this. Negative yields is a powerful tool to get people to invest the cash, the problem is they would just invest in real estate or stocks, and increase those bubbles. What investmentments would make sense? Maybe government infrastructure projects, further investing in education, investing in social welbeing programs - all of this gets the money back out into the community working. some form of weath or other higher taxes might be necessary, or maybe MMT is the mechanism to get the money working again. Some are woried about inflation, I would worry more about deflation.

nzyank
nzyank

Also - this is not a monetary policy issue the fed can solve by itself. Fiscal policy needs to do the heavy lifting - tax and spend (or print and spend) combined with right government led initiatives, but only a remote chance of this happening in a sufficient and appropriate manner given state of politics and disagreement in the US.

Eddie_T
Eddie_T

The other thing I’d try to point out.....is that we shouldn’t confuse the “explanations” for the Fed gives to the public and the dumb journalists.....for their policies....with their real motivations.....because the two are often different. Maybe always different, at this point.

I doubt anybody at the Fed is fooled into thinking that perpetual low interest will create new growth .......n a world with real limits to growth......that have little to do with monetary policy....

What it does is to keep the debt bubble from collapsing today or this week...and hopefully this month and this year. I’d say this is one objective.

“Stimulating the economy” is a smokescreen....a convenient one...for doing anything and everything necessary to keep this late stage Ponzi afloat.

Which is financial repression of all non-elite taxpayers......and punishing savers of cash. In pursuit of inflation.....needed to inflate away the massive debt. That is the Fed’s other unstated goal.

Reform...whether it be by means of gold-backed money...or just more prudent interest rate policies that reward savings.....would seem to me to be an unlikely outcome for this road we’re on.

I don’t fear inflation....as an investor I am set up to profit from inflation.....but I do fear deflationary events....that negatively impact asset prices in a rapid and chaotic way.......because it can make anyone, or at least most of us, very poor, and very quickly.

Eddie_T
Eddie_T

"Some are worried about inflation, I would worry more about deflation.”

Me too, as I just said in another comment.

That’s because you have assets..

Inflation steals from the poor and pays down the debt.....a hidden tax on working people and the elderly.

People with substantial assets fear deflation more....people with NOTHING fear inflation more.

If the Fed does something that sets inflation on fire.......poor people can’t eat or pay rent.

But if the Fed allows a credit lock-up to lead to a depression (another name for rapid uncontrolled deflation) then investors lose much of the nominal value of their tangible assets.....and (much worse) perhaps ALL the value of their intangible assets.

The Fed works for their member banks best interest....and they are people who DO have lots of assets......so you can see how the game gets slanted to make it work for them.

The BIG PROBLEM.....how do you get inflation in a low growth/no growth world with a whole laundry list of strong deflationary factors that you can’t control?

And more importantly, very modest inflation that people can adapt to.....because people can adapt to anything if the change is slow enough.....but when inflation, especially food and rent, is bad...they have difficulty adapting.

LouMannheim
LouMannheim

Back in the day I was taught that among other things a currency needs to be a store of value. Who honestly believes that anymore?

megaculpa
megaculpa

When all you have is a hammer, everything looks like a nail.

Too much BS
Too much BS

Zero inerest rates are a Robbery of seniors life's work of savings. Negative rates empties the banks accounts of what's left over from the Zero rates .

BigGringo
BigGringo

Maybe the reason that they have low interest rates and slow growth is that they have had a stagnant population for 35 years. There is no growth there! And, there is a free market for interest bearing instruments. If the free market deems that these instruments shouldn't pay interest, how is the central bank going to make it different?

KidHorn
KidHorn

"Think of it this way: Negative-yield bonds imply it is better to have 99 cents ten years from now than a dollar today."

Not exactly. What they imply is the market thinks rates will go more negative. It make no sense to buy something for a dollar, hold it to maturity, and end up with 99 cents. What makes sense is to buy something for a dollar and then sell it for $1.01 to the FED who doesn't care about the -2% yield.


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