Editor's Note: We're sharing this Wall Street Examiner column with you today because negative interest rates are destroying trillions of dollars in wealth in Europe right now, cheered on by some of the "smartest" economists in the world – who want to bring NIRP here. Here's Lee Adler with some facts that show why negative rates are a horrible idea…
There are troubling signs that the doves at the Federal Reserve are considering a negative interest rate policy (NIRP) as a way to handle "the next crisis" – and there's always a next crisis…
NIRP is a monetary policy tool that sets interest rates below zero. A recent MarketWatch article on NIRP said it has a "'Dr. Strangelove' feel."
I have to agree. They're a lot like nuclear warfare in that they're so extreme, so irrational and destructive, that they fly in the face off all common sense and decency.
But this is the Great Stagnation Middle Class Elimination. You can bet that the "General Jack D. Ripper" faction at the Federal Reserve is thinking the unthinkable – and thinking about it incorrectly.
Consider this quote from that MarketWatch article:
"…pushing rates into negative territory works in many ways just like a regular decline in interest rates that we're all used to."
That's patently false – so much so that it borders on insanity.
They don't work just like a "regular decline in interest rates" – not that a "regular decline in interest rates" does what economists think it does, but that's another story.
The issue here is that central bankers don't even seem to understand how negative interest rates work, or why they're so destructive to individual wealth and entire economies…
The Rest of Us Learned This in "Money 101"
Negative interest rate proponents ignore the most basic tenets of double-entry accounting.
Because there are two sides to a bank balance sheet, negative interest rates are the mirror image of positive rates. The move to negative rates imposes new costs on the banks, unlike low positive or zero interest rates, which reduce bank costs.
The greater the negative interest rate, the higher the cost imposed, which is the same as a central bank raising interest rates when they are positive.
When the Fed lowers a positive interest rate, it lowers the bank's cost.
But if the Fed were to lower the interest rate to below zero, those $2.3 trillion in banks' excess reserves held on deposit at the Fed become a cost to the banking system.
Not only that, but it's a cost banks cannot avoid, except by using those cash assets to pay down debt.
This isn't just a theory…
We Have a Real-World Example to Go On
European banks did exactly what I said they would do in mid-2014 when the European Central Bank (ECB) announced the negative deposit rates.
The banks did what anybody with any common sense would do, and the ECB knew it… Under NIRP, anyone with the ability to pay off loans (and extinguish offsetting reserve deposits) does precisely that, thereby getting rid of the added cost.
So, as opposed to stimulating growth, from the time the ECB announced NIRP in June 2014 until January 2015, loans outstanding in the European banking system actually declined by $18 billion. That may not be a big drop, but it’s exactly the opposite of what the policy makers expected.
As opposed to encouraging borrowing and spending and economic growth (you know, the good stuff), the policy encouraged deleveraging.
About the Author
Financial Analyst, 50-year charting expert, finance + real estate pro, and market analyst; published and edited the Wall Street Examiner since 2000.