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"Hey! If banks won't lend at low-to-zero
rates of interest, maybe we should try sub-zero rates instead..."
IT'S NO BIG DEAL at present – only about $200 in fact.
That
would hardly buy you a Mörrum shelf unit from Ikea, even if you did pay
in cash rather than charge it (only in white; requires assembly). It totals
only 0.25% annual interest on 48 million Krona over the last six days,
after all.
But
already running to SEK1,643 since last Thursday's decision, the true cost of Sweden's sub-zero deposit rate might start to add up.
Because this brave step into a new world of negativity is precisely what
academics and policy-wonks everywhere think the world needs to stall the
depression.
And
the minus 0.25% offered on Riksbank deposits in Stockholm
has made the impossible real.
"I
agree with Greg Mankiw that it is time for central banks to stop pretending
that zero is the floor for nominal interest rates," wrote former Bank of
England executive Willem Buiter in the Financial Times this spring. Professor
of economics at Harvard, Mankiw had asked in the New York Times "Why shouldn't the
Fed just keep cutting interest rates? Why not lower the target interest rate
to, say, negative 3 per cent?"
Why
not indeed? Oh sure, "If the economy is faced with a recession when
inflation is zero, the monetary authority is constrained [by] the fact that
the nominal short-term interest rate cannot be lowered below zero – the
zero interest rate bound," as a Fed paper put it in 1998, back
when Japan's deflation made a neat lab experiment for Washington's PhD-crazed
policy dreamers.
But
"Early mathematicians thought that the idea of negative numbers was
absurd," Mankiw went on this April, showing just how much smarter we've
all become since the end of last decade, let alone 2,000 years ago. And
"Today, these numbers are commonplace." Hence the calls from even mainstream investors for sub-zero rates,
gathering pace since the start of '09.
"At
that [negative 3%] interest rate," reckons Mankiw at Harvard, "you
could borrow and spend $100 and repay $97 next year. This opportunity would
surely generate more borrowing and aggregate demand."
Negative
3% rates would surely mean debtors didn't get chance, however. Because
creditors would receive only $97 for every $100 they lent. Which would leave
prospective debtors – wince, slap forehead – with no-one to
borrow from.
"I
think that most people would choose to invest in another country where
savings wouldn't lose 3% per annum," as Dr.Marc Faber noted in last
month's Gloom, Boom & Doom Report.
Or as John Maynard Keynes himself put it seven decades ago, "A long
series of substitutes would step into [domestic saving's] shoes –
foreign money, jewelry, the precious metals generally, and so forth..."
The
patron saint of nailing savers to redeem the over-indebted – and
nemesis of that "barbarous relic" Gold Bullion – Keynes thus
set about finding other ways to stiff the prudent in favor of borrowers. (His
euthanasia of the rentier was far more politically charged in the 1930s than
its tinkle suggests today, not least amongst his upper-class chums sitting
pretty in consols and gilts.) In especial, the big danger for any such policy
is that savers would just hoard cash at home instead, maintaining its nominal
tally rather than enduring a loss at the bank.
The
happy event of constant inflation was unknown as yet, remember. A loss of
real purchasing power under the mattress only happened to reckless
foreigners. Earning a yield on bank savings was, in the first-half of the
20th century, the natural order of things, rather than the necessity it
became on the back nine holes as the cost of living rose without ceasing.
Hence
the 2% rates set by the Bank of England in 1931 and held there for more than
two decades. Maintained above zero (barbarous fools!) it was "thrown in
the bin" as money historian Glyn Davis once put it. This attempt to
appease deflation would be matched only by Chamberlain taking tea with Hitler
in Munich.
Whereas
today...?
"The
world is awash in money and the incentive to borrow is huge," notes
former diplomat and M&A specialist Edward Harrison at the CreditWriteDowns blog.
"So,
is the Swedish announcement qualitatively different? On some level, it
is not." Which is true. BullionVault confirmed today in a call to
Sweden's central bank that the negative rate of 0.25% will only apply to
money held on its deposit facility by 'monetary policy counterparts'. Ahead
of last week's decision, those banking institutions chose to keep a measly 48
million Krone ($6m) with the Riksbank. They've not lent it more than SEK50m through
that facility since the start of the year.
And
just wait until Friday to see how much they left on deposit after last week's
decision!
"Nevertheless,"
CreditWriteDowns goes on, "it is the [world's] most aggressive policy
and the fact that they are charging negative interest rates for deposits is
unprecedented. This does make events in Sweden
something to watch."
How
did Sweden
get to make history and break "the zero bound" before anyone else?
First, like a high-performance auto from Saab – handed to Swedish
ownership by GM last month, incidentally – Riksbank policy runs on a
smooth and relentless engine. This unfailing machine sets the deposit rate
precisely 0.5% below the repurchase rate for loans using government bonds as
security. That, in turn, is 0.5% below the central-bank's lending rate.
So
with the lending rate down to 0.75% and the repo rate cut to 0.25%, the
deposit facility must pay 0.25% less than zero.
Secondly,
the Swedish economy is a mess, forecast to shrink by 5% or more in 2009 with
deflation in wages, housing and shop prices pretty much guaranteed. So third,
and most crucially, the blue-sky thinkers of Scandinavian policy got their
chance to huff and puff at all those dark clouds of depression.
Indeed,
deputy governor Lars Svensson – a colleague of Ben Bernanke's at
Princeton and advocate of Credibly Reckless Inflation – asked for a
reservation against last week's decision to be noted. Because he wanted the
main policy rate, the repo rate, cut to zero instead of 0.25%. He wanted it
left at zero for the next 12 months, too. Which would have meant a negative
0.5% deposit rate at the Riksbank – likely to raise more press and
academic attention than the paltry coverage given to the 0.25% default agreed
in Stockholm.
"I
know the Riksbank's move is just a tiny step," gushes one adoring US academic, "but so far as I
know this is the first time any real world central bank has adopted the
proposal we have been discussing on this blog. [Don't you love that use
of 'real'...?] And Lars Svensson is on the cutting edge of macro, [so] if he
was behind this decision it bodes well for the future acceptability of the
negative interest on reserves concept."
And
it's here, we guess, that the absurd becomes livid in Washington, if not
London, Frankfurt or Tokyo. Because the Federal Reserve, as you may recall,
made much hoo-ha in late 2008 of starting to pay interest on excess commercial
banking reserves. The apparent aim, back then, was to encourage US banks to keep
excess cash with the Fed – over and above the legally mandated minimum
– thus ensuring "efficiency" by enabling the banks to lend
more into the economy. It's underpinned by that extra cash at the central
bank, right?
Furthermore,
the opportunity of paying a little extra interest on those reserves –
over and above short-term rates in the market – would encourage excess
cash to flow back to the Fed when Great Depression 2.0 is over, and Ben
Bernanke gets round to writing the last chapter of his 1930s' history live,
in real time.
But
that's a long way off yet, as stock investors and even Gold Prices seem to be
signaling. "Reserves created by the Fed have increased by a staggering
$858 billion in the 12 months ended May," notes Paul Kasriel at the
Northern Trust, while "excess reserves on the books of depository
institutions have increased by almost as much, $842 billion." All told,
therefore, some $1.7 trillion is sitting doing nothing when it could be
losing value through the magic of negative rates of interest.
Could
that be the next gambit? Hell, add a tweak or two to the new banking
regulations, and it could become illegal not
to lend money forced on a bank by the Fed! "If all of this seems too
outlandish," as Harvard professor Greg Mankiw puts it, just go back and
re-read his pitch in the New York Times. Because little should
surprise us except the willingness of central bankers and the academics
advising them – all jollied up on a merry-go-round of
university-to-official tenure and back – to do anything, whatever it
takes, to force you to stop saving and keep spending like it's 2006.
"Liquidity
is ample, even excessive. Capital is scarce," says Willem Buiter, ex-Bank of England
policy-wonk and now committed FT
columnist. "A panoply of central bank and government financial
interventions...has not done enough to get [the banks] lending again on any
scale to the household and non-financial enterprise sector."
So
hey! If low-to-zero rates of interest aren't working, maybe negative rates of
interest will...?
Wince,
slap forehead. Back to the lab.
Adrian
Ash
Head
of Research
Bullionvault.com
City correspondent for The Daily Reckoning in London,
Adrian Ash
is head of research at www.BullionVault.com – giving you direct access to investment
gold, vaulted in Zurich, on $3 spreads and 0.8% dealing
fees.
Current gold price, no delay
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