Questions on negative rates keep coming in: Where does the money go? Who
benefits? Will the Fed do the same? What’s Draghi up to?
A quick refresher course on paying interest on excess reserves vs.
charging interest on excess reserves is in order.
Q: Who has negative rates?
A: The European Central Bank (ECB), Sveriges Riksbank in
Sweden, the Swiss National Bank (SNB), the Bank of Japan (BoJ), and Denmark’s
Danmarks Nationalbank (DN) all have negative rates.
Q: Negative rates on what?
A: The above five countries have negative rates on “excess
reserves”. Switzerland also has negative rates on deposits. Most banks are
reluctant to put negative rates on deposits fearing banks runs and currency
hoarding.
Q: How much are we talking about?
A: Bloomberg Quick Take notes “more than $7 trillion of
government bonds worldwide offer yields below zero.”
Q: How do excess reserves come into play?
A: Central banks create them through monetary actions like
repos and QE hoping to get credit flowing.
Think of it this way: money is printed into existence even though there
are no creditworthy borrowers who want loans.
The irony is banks cannot lend excess reserves. Money lent by one bank
will simply appear as excess reserves when the money is deposited elsewhere.
Mathematically, someone has to hold every cent of money created by central
banks.
Q: Who collects the money?
A: If the central bank charges money on excess reserves, the
central bank collects the money. In general, bondholders pay money to hold
bonds with negative rates. Borrowers get paid to borrow. Yes, this is absurd.
Q: Who benefits from low and negative rates?
A: Asset holders benefit from cheap money, at least
initially. Asset prices went through the roof when ECB president Mario Draghi
issued his famous “Whatever it Takes” speech on July 26, 2012. Various
rounds of QE by the Fed also sent the stock market higher. The obvious
consequence is easy to explain: asset bubbles break, leaving banks and
borrowers in worse shape.
Q: Is there a limit to negative rates and resultant
bubbles?
A: There is always a limit. Everyone is guessing where it
is. At some point the greater fools run out or the consequences are such that
policies are abandoned. It’s possible we hit the limit today (March 10,
2016), given the strong reversal following ECB announcements by Draghi,
initially interpreted to be a huge bazooka. As it appears now, the bazooka
backfired. See Draghi’s “Shock and Awe” campaign morphs into “Shock and Aw
Shucks” for further discussion.
Q: Why doesn’t the Fed resort to negative rates?
A: Given negative rates have proven to be of negative
benefit, why would the Fed want to? However, central banks don’t see in those
terms. Here are a couple of reasons I presume the Fed does understand:
- Negative rates hurt bank profits.
- The Fed pays interest on excess deposits. This is a
back-door, free-money handout to banks that everyone ought to be
protesting. Over time, the the Fed has bailed out the banks in numerous
ways.
- The US has numerous money market funds that would
immediately be destroyed if the Fed implemented negative rates.
Money market funds are not in vogue in Eurozone as they are here. Banks
can always raise other fees to mask negative deposit rates. Money market
funds cannot do the same.
Q: If negative rates hurt bank profits, why has Europe
and Japan embraced them?
A: I suspect Draghi believes asset bubbles and equity
support will do more for the Eurozone than lost bank profits. Given the
collapse of economic bubbles is very damaging, Draghi is very wrong.
Never underestimate the propensity for central bank stupidity.
Mike “Mish” Shedlock
