“O brave new world with such people in it!”
Spoken by Shakespeare’s character Othello from the eponymous play, these words could apply equally well to the upside-down fantasy world of negative interest rates that we have entered.
To be sure, the problem with negative interest rates isn’t merely philosophical. It also has huge practical ramifications that, in the words of former Morgan Stanley chief economist Stephen Roach, “set the stage for the next crisis.”
Supply vs. Demand
When we speak about credit markets—which lie at the heart of banking and financialization—there are two fundamental sides to the equation just like any other market: supply and demand. Supply in this sense would encompass how available credit is: Are banks lending? How low (i.e. attractive) are interest rates? On the other side, demand would refer to how much credit people want and need: Are businesses borrowing? How much are businesses growing?
When the people entrusted with managing our various national economies set policies regarding the credit market (such as overnight lending rates, for example), they generally want to stimulate the demand side. No matter what’s going on with supply, you generally want greater lending and growth.
Instead, the use of negative interest rates is a measure that only influences the supply side of the problem. With little or no regard for aggregate demand, policymakers are only targeting lower interest rates and incentives to lend money.
Yet, if nobody is willing to take on more debt or spend more money, what good does this do? This is the tell-tale sign of a “balance sheet recession” wherein consumers are more concerned with saving money than spending it (or taking on more debt).
A balance sheet recession is an economic downturn that results from excessive debt in the private sector, causing consumers to be tight-fisted with their money. This is exactly what has followed after the financial crisis in 2008. Consumers are less willing to spend—the behavior that comprises 70% of the U.S. GDP—during times of economic uncertainty, so now the central banks must attempt to punish them for not spending (i.e. saving).
No Exit from NIRP
The use of negative interest rate policies (NIRP) has spread from a few isolated Northern European countries to now Switzerland, the European Central Bank (ECB), and Japan. It has even been mulled over as a possibility for the Federal Reserve just in case economic conditions remain stagnant for too long.
Moreover, when interest rates are negative, it means that holding gold that “yields nothing” is still a much better option than paying a fee for keeping your cash in a bank! This is precisely why the extreme measure of NIRP makes gold especially attractive.
Mr. Roach concludes with this chilling observation: “Central banking, having lost its way, is in crisis. Can the world economy be far behind?”
The opinions and forecasts herein are provided solely for informational purposes, and should not be used or construed as an offer, solicitation, or recommendation to buy or sell any product.