Inflationomics

Negative Interest Rates

Let's say there's a banking crisis and banks stop lending money.  The economy contracts.  Voters become unhappy.  And nowadays it's the central bank's job to stimulate the economy.  So, what does it do?  It bails out the down-line banks, but the banks don't lend out the money they receive from the central bank...what then?  How can the central bank stimulate the economy if the down-line banks don't lend out the new money they just received?  It might go around the banks and buy bonds in the market place, or it might buy commodities or stocks in an effort to buoy the economy.  And if that doesn't work?  How else could a central bank stimulate an economy?  Why not lower interest rates for 7-8 years!  And if that isn't enough to stimulate the economy?  Why not impose negative interest rates on the banks that rely on the central bank for funds?  That means, charge the banks to hold their deposits.  They could surely find someplace to lend their money that would generate a higher return on their money than paying the central bank to hold their money, right? Enter negative interest rates.

How do negative interest rates work?  Theoretically, the depositor of funds into the system must pay the receiving party a “fee” to keep the funds “safe” rather than receive interest for his/her deposits.  You have to wonder why people would do this.  Isn't their saved money worth anything to anyone?  Or are the alternate uses of their money less safe?  Some people may opt out of this arrangement and find better uses (or at least attempt to find better uses) for their money.  More speculative uses of their money will be tempting. You will have the same results as with low interest rates, but more so.  And since the low interest rates didn't stimulate the economy after 7-8 years, why would negative rates?

Could it be that there is a limit to how much credit an economy can handle?  Could it be that investors can no longer find investments worth investing in?  Could it be that an economy that relies on the next Fed manipulation cannot invest for the long term?  Could it be that when the central bank unwittingly raises interest rates after a prolonged period of holding rates low, that it causes many overly indebted businesses to fail, thus creating the next banking crisis?

Historically, interest rates have never been as low as they are today.  That’s because today’s interest rates are being artificially manipulated by the central banks of the world.  This manipulation, of course, depends on peoples’ willingness to use the entrenched “system,” which includes the central-bank-dictated interest rate and fiat currency supply.  If the Fed sets the fed funds rate at 5%, that’s the rate the “system’s” users must use.  If the Fed sets the fed funds rate at 0%, that’s the rate the system’s users must use.  If the Fed decides to set the rate at a negative rate, anyone who wants to use the system will have to comply with the new negative rate.  It’s a cost of being a part of the system; i.e., the Federal Reserve System (for banks) in the United States and the U.S. dollar around the world.

Traditionally, a market rate of interest was determined by supply and demand of/for money, the creditworthiness of the borrower, and the rate of inflation.  To the extent the controllers of the system conform to these market influences, the system will work.  To the extent the controllers of the system deviate from the market influences, misallocations of scarce resources will occur.  Cities may be built without concern for its occupants. Money may be spent on military involvement around the world without concern for its results.

By using negative interest rates, central banks are doing more than just charging banks to store their money, they are pushing people to go outside the “system,” thus threatening, and perhaps hastening, the downfall of the whole fiat currency system.

Robert F. Sennholz

For comments, suggestions, or replies to the author, please e-mail