Tuesday, October 22, 2019

A Primer on Negative Interest Rates (Part 3): The War on Cash

Click here to read the original Cautious Optimism Facebook post with comments

8 MIN READ - The Cautious Optimism Correspondent for Economic Affairs and Other Egghead Stuff examines multiple worrisome proposals by central bankers to outlaw paper currency.

“It [negative interest rate policy] could take years… … if that means for a while savers have to eat their capital to survive, then so be it.”

-Willem Buiter, former Chief International Economist at Citigroup and negative interest rate enthusiast

The Economics Correspondent urges CO readers to watch the attached three-minute video interview in which Buiter articulates masterfully New Keynesian rationales and weapons for declaring war on cash and ultimately banning its existence entirely.  Translations follow below.


In Part 2 of this monetary economics series, we summarized the repercussions of negative interest rate policy in continental Europe. Just as policymakers intended, negative rates have inflated demand for government bonds thus making borrowing cheaper (in fact most European sovereign debt yields have gone negative), and commercial banks have been forced to take bigger lending risks while also passing on their costs in the form of negative rates imposed on their customers: specifically wealthy clients and corporations.

In fact, forcing bank customers to eat negative rates was a primary policy objective from the beginning, since demand-side theories require not only banks to expand lending, but also for companies and consumers to spend more.

In economics jargon “aggregate demand must be boosted to equal aggregate supply,” one of the foundational tenets of New Keynesian theory. And when faced with the prospect of their bank account balances losing 0.4% or 0.5% in value every year, consumers and companies are more likely to handle money like a hot potato and spend it quickly.

Rapid turnover of euro balances also raises monetary velocity and drives higher inflation, another of the ECB’s policy goals.

However policymakers have only achieved their objective against two of three targets: wealthy individuals and corporations. The third target, smaller retail depositors, remains elusive. Everyday bank customers may hold smaller balances and spend less than wealthy ones, but as a group there are so many of them that their collective wealth represents an untapped sea of funds that central bankers and technocrats are just aching to make them spend.

Unfortunately for the technocrats, it’s currently impossible to compel small depositors to spend more with negative interest rates since they can always avoid the negative rate by closing their accounts and converting their deposit balances into cash.

Wealthy bank clients and corporations can theoretically convert their balances to cash as well, but rarely do due to the sheer cost and risks associated with physically holding so much paper currency. And in the case of companies the massive inconvenience of making/receiving payments with employees, creditors, suppliers, vendors, etc… exclusively with cash.

Central banks and commercial banks were aware of these limitations long ago and always knew that wealthy individuals and companies would tolerate a mildly negative interest rate so long as the penalty remains lower than the cost of storing a lot of currency.

But small depositors are different. A bank customer with, say, a $3,000 balance doesn’t have to accept negative interest rates sitting down. He can close his account and withdraw cash which pays a superior yield of zero percent. $3,000 in notes doesn’t require a lot of space to stockpile—hence virtually zero cost—and most everyday transactions for the average consumer can be handled with cash.

Ironically, if central bankers and commercial banks actually attempted to impose negative rates on small customers, the mass cash withdrawals would result in a reduction of loanable reserves, credit would become more scarce, the money supply would contract, and inflation would reverse into deflation: all producing the opposite result from what policymakers had intended.


Not to be discouraged, central bankers and New Keynesian academics have been hard at work devising strategies to deny bank customers the cash option. In what has been dubbed “the war on cash” politicians, central bankers, and economists the world over have written multiple proposals for eliminating currency and banknotes. The recommendations range from phasing out large denomination notes only, thus raising the cost of storing a larger number of smaller denomination bills, to outlawing cash altogether.

Whatever proposals might be enacted in the future, once policymakers are satisfied they have sufficiently removed the everyday consumer’s cash option, they’ll reduce negative rates even further until private banks pass on the negative rate to even their smallest retail customers. Why not? Small depositors will no longer be able to flee into cash.

In case you think this is black helicopter conspiracy talk, or that “war on cash” proponents are powerless upstarts, think again. In 2015, a meeting of negative interest rate/war on cash economists and policymakers was held at the “Removing the Zero Lower Bound” conference in London to share strategies for pushing interest rates even further below zero.

Banning paper currency was a hot topic of discussion among the dignitaries representing:

-Harvard University
-Princeton University
-Carnegie-Mellon University
-University of Michigan
-Florida State University
-London School of Economics
-Imperial College of London
-The U.S. Federal Reserve System
-The European Central Bank
-The Swiss National Bank
-The Danmarks Nationalbank
-The Swedish Finance Ministry
-The Bank of England (retired)
-The Center for Economic Policy Research
-Generali France, S.A.
-Brevan Howard Asset Management
-Soros Investment Fund

Among the most eloquent champions of the war on cash was Willem Buiter, the then-Chief International Economist at Citigroup. His short interview from 0:34 to 3:18 summarizes perfectly the rationale, objectives, and weapons that zero lower bounders plan to employ against paper currency.

If the economics jargon is too difficult to follow, the Economics Correspondent has included translations below:


1) “The existence (inaudible) of currency of cash sets the lower bound of policy rates.”

Translation: The public's fondness of cash limits what we as policymakers can force them to do.

2) “Since currency is the culprit—cash—get rid of currency. Offer every man, woman, and child an account guaranteed by the central bank that cash currently does but allows negative interest rates to be set.”

Translation: Force consumers to surrender their already crummy central bank notes and drive them into an even crummier account that can be fully manipulated by central bankers. Buiter then addresses “dealing with the problem of the poor and ill” by generously “allowing” small denominations to exist.

3) “To tax currency… …require people to present currency once a year… …at the central bank or a branch office and have it stamped and give five pennies for every pound.”

But Buiter then squirms that “that’s kind of intrusive.”

Why is he worried about intrusion now?

Answer: “You have to enforce it.”

Oh, for a moment I was na├»ve enough to believe he might consider compelling the common folk to surrender their cash and eat negative interest rates “intrusive” too, but... never mind.

4) Buiter really turns up the heat at 1:56. His third solution is “To keep currency, but to end the fixed exchange rates, one-for-one, between currency and deposits.”

Translation: We central planners will still magnanimously permit you to use cash, but the central bank will charge you a large penalty every time you withdraw it from your bank. Once that penalty exceeds a high enough pain threshold, you will be rightfully deterred from using cash altogether and leave your money in the bank—subject to the negative interest rate we can then force you to eat with impunity.

5) At 2:56 Buiter incredulously claims “There is no right or wrong level of interest rate. The question is what level of interest rate is necessary to get aggregate demand to equal aggregate supply and create full employment.”

This is just more erroneous New Keynesian theory, only upgraded: with unlimited compulsion by the State to shepherd people and their money like cows into whatever cattle car they think—in their enlightened wisdom—is best for them.

His credo of “no right or wrong level of interest rate” harkens back to Nixon-era price controllers who saw no right or wrong price of gasoline either, thus clearing the way to force prices down arbitrarily and create shortages and an energy crisis. Or Venezuelan Chavistas who decided the “right” price was whatever they dictated, emptying store shelves of basic commodities. Or Zimbabwe’s central bankers who decided there was no right or wrong interest rate when they manufactured a giant hyperinflation a few short years ago.

6) And of course “If this means savers have to eat their capital to survive, so be it.”

How casually he unilaterally judges (like a eugenicist) who will be allowed to sustain themselves and how.

If you’re fascinated by this intellectual arrogance which economist F.A. Hayek dubbed “The Fatal Conceit,” there’s more from crusty Charles Goodhart, a former Bank of England Monetary Policy Committee member (equivalent to Federal Open Market Committee member at the Federal Reserve):

Goodhart touches on a favorite rationalization by zero lower bounders for phasing out high denomination notes: they’re used disproportionately by criminals, tax evaders, and money launderers. Harvard economist and former IMF Chief Economist Ken Rogoff also uses this excuse in his famous book “The Curse of Cash” to inch closer to their shared goal of unrestricted negative interest rates thrust upon the masses.

However, in a recent debate with Rogoff, George Mason University economist Lawrence H. White argued that many things are disproportionately used by criminals, tax evaders, and money launders—such as fast cars, fast boats, flashlights, and dark clothing. Also the Fourth and Fifth Amendments of the U.S. Constitution. Should we outlaw them too?


Rogoff has recommended phasing out the one-hundred dollar bill as a starting point for eliminating high denomination notes. Incidentally, a twenty dollar bill in 1975 had the same purchasing power of $100 today, so Rogoff is effectively arguing that the equivalent of the twenty in 1975 should be banned.

However, Rogoff and his like-minded colleagues still claim to care about our freedoms and he pleads "I view this as a balance between your right to privacy, an individual’s right to privacy, and society’s right to regulate, collect taxes, etc..”

Yet this promise that “giving up one more right will yield the ideal balance between regulating crime and the business cycle and preserving your freedom” has been invoked repeatedly over the last century, only to lead to another major crash and petitions to repeal additional freedoms.

For example:

-In 1914 the architects of the Federal Reserve argued “Just let us force commercial banks to centralize all your (bank customers') gold reserves at our district banks and there will never be another boom-bust business cycle. Your monetary freedoms shall not be further infringed.”

The Depression of 1920-21, the second worst of the 20th century, struck six years later.

-Shortly afterwards the Federal Reserve and Congress argued “Just let us make commercial bank notes illegal and replace them with a central bank monopoly, and there will never be another major recession. Your monetary freedoms shall not be further infringed.”

-In 1925, the Bank of England argued “Just let us take away your legal right to redeem your cash into small gold coins, and allow you only to redeem in 400-ounce bullion bars (worth $500,000 at today’s gold price, practically irredeemable for all but the wealthiest depositors) and we can manage the economy into Utopian prosperity. Your monetary freedoms shall not be further infringed.”

The Great Depression struck four years later.

-After the Fed inflated the stock market and real estate bubbles of 1927-29, and then failed miserably to do the very job it was created to do during the 1929-33 crash, President Franklin D. Roosevelt argued “Just let us take away your legal and contractual right to redeem currency into gold and there will never again be bubbles, busts, or deep economic slumps. Your monetary freedoms shall not be further infringed.”

The Depression of 1937-38 followed four years later, the third worst downturn of the 20th century. From trough to peak, unemployment rose from 11% to 20% in just nine months.

-In 1971 Richard Nixon argued “Just let us delink the dollar from gold completely, even for international holders, end fixed exchange rates, and the economy can be fine-tuned by technocrats into perpetual moderation. Your monetary freedoms shall not be further infringed.” Twelve years later interest rates were 21% and unemployment was 11%.

-In 1971 the Federal Reserve argued “Just let us expropriate the value of your money a little faster with higher inflation and recessions will be ended and the business cycle solved.” Twelve years later the dollar was worth 38 cents and America was on its third recession.

-And now in 2019 the zero lower bounders are arguing “Just let us take away your ability to conduct commerce with paper money altogether, and there will be economic growth marking the end of deep recessions and sluggish recoveries. Your monetary freedoms shall not be further infringed.”

Why should anyone believe either claim today? That this is the last freedom they will ever erase, and that banning cash is the only policy tool they need to end bubbles, end financial crises, end deep recessions, and in case of any future recession, guarantee rapid and vigorous recovery forever? All those promises were already made during the founding of the Federal Reserve in 1914.

The western world has gone from private, competitive commercial bank note issuance redeemable in specie to a central bank monopoly of irredeemable paper, perpetual inflation, exchange rate manipulation, and soon the criminalization of cash completely.

What has the subsequent track record of the monetary central planners been? Have they kept their promises to end the economic boom-bust cycle forever, and forever abstain from contravening the public’s freedoms?

Thursday, October 10, 2019

Addendum to a Primer on Negative Interest Rates Part 2: Greek Short-Term Debt Incredulously Auctions at Negative Yields

Click here to read the original Cautious Optimism Facebook post with comments

1 MIN READ - A brief addendum to the Cautious Optimism Correspondent for Economic Affairs and Other Egghead Stuff's Wednesday article on negative yielding European debt.

Earlier this week the Economics Correspondent ran an installment on negative interest rates explaining why European investment-grade (aka not Greece) debt is trading at negative yields. The reasons include inflated demand due to large scale asset purchases by the ECB, commercial banks under pressure from central bank negative interest rate policy, and "bond flipping" by institutional investors who see the trend of central bank negative interest rates going lower and lower.

Regarding the last phenomenon (flipping negative yielding bonds), the COCEA on Wednesday noted: "This is the screwy world that occurs when central banks go negative enough."

Well evidently Europe has already devolved from screwy to downright perverse.

Negative yields are no longer just for safe investment-grade bonds. According to Bloomberg, Greece "the one-time bond-market pariah at the heart of Europe’s sovereign debt crisis, just completed a transformative journey by joining the region’s negative-yield club."

Read Bloomberg article here:


In case you're scratching your head over this news, you're not alone. Jon Day, a fixed income portfolio manager quoted by the article warns that "There remain substantial risks around Greece’s financial position and it remains vulnerable to a significant economic slowdown. Current yields on their bonds do not reflect this risk.”

Current yields are not reflecting risk accurately on the entire continent, one more consequence of central banks plowing recklessly ahead into the radically uncharted waters called negative interest rates. Just a few short years ago Greece effectively defaulted on its debt, needed multiple bailouts from the European "troika," and has still not fully shored up its fiscal position with necessary structural reforms, yet institutions are now paying Greece for the privilege of borrowing their money.

Should Europe go into recession and Greece enter another crisis and again partially default on its debt (which would once again introduce systemic contagion as banks, insurers, and pensions across the continent hold their bonds), expect the usual left-progressive/socialist crowd to once again attack "the free market," financial institutions for their "greed," and the "capitalist" bond underwriters for misrepresenting Greece's financial position and inherent risks.

But anyone with a functioning memory should make no mistake about where the mispricing of risk really originated: the European Central Bank. New Keynesian policymakers forcing interest rates into negative territory across the continent have artificially inflated demand for sovereign debt, and effectively imposed price floors on government paper that would never have paid negative yields in a freer, less radically distorted securities market.

Tuesday, October 8, 2019

A Primer on Negative Interest Rates (Part 2)

Click here to read the original Cautious Optimism Facebook post with comments

6 MIN READ - The Cautious Optimism Correspondent for Economic Affairs and Other Egghead Stuff discusses what negative interest rate policy means for retail bank customers and the recent plummeting of government bond yields into negative territory.


Central bank policy aside, one of the public concerns about negative interest rates is that banks will begin passing on their negative rate losses (charged by the central bank) to their customers in the form of negative rates on deposit balances.

There have been reports of banks in Europe charging more fees on account balances for very wealthy clients or even calling them negative rates, but the preponderance among average retail customers has been very low. Banks can still recoup most of their negative rate losses by tying free checking to other, more profitable financial services, trying to make up the losses with additional fees, simply lending more as the central banks want them to, or buying securities that produce a higher yield than the central bank’s negative rate.

But the greatest reason that banks are reluctant/slow to enact widespread negative rates on their customers is cash withdrawals. Depositors always have the option of avoiding those negative rates by withdrawing their money in the form of cash and stuffing it under the mattress.

Cash has a yield of zero which is a lot better than -1%. So both banks and the policymakers pressuring them know that pushing negative rates too hard on retail customers could backfire, badly. So much cash could be pulled out of the system that the broader money supply contracts and the policy produces deflation and less lending—the precise opposite of its stated objective.

(the Economics Correspondent will write in more detail soon about the cash option and so-called “war on cash” that many central banks and governments are drawing up to counter the cash withdrawal option)

Instead of small retail depositors, large commercial customers and wealthy individuals are more likely to be the first negative rate target of commercial banks since a major corporation holding, say… $500 million in a deposit account, is less able to convert its balance to cash than the average retail customer.

For a corporation, holding $500 million in physical cash is complicated and risky. It’s difficult to pay all the bills to suppliers, vendors, creditors, and employees using cash. It’s also dangerous and expensive to store that much cash in a vault or a room.

So banks, central banks, and policy makers know that in theory they could get away with a mild negative rate on very large balances since the costs of withdrawing cash and storing it, plus risks, would be greater than simply eating a modest negative rate of -0.1%.

Also, pushing negative rates on large corporate customers and wealthy individuals is easier to sell politically. After all, corporations and the wealthy have committed the sin of making and having a lot of money. Plus politicians can easily validate the policy by blaming both scapegoats for the sluggish economy because "they aren't doing their part to vigorously invest and spend their cash hoards on jobs.”

But once the public sees negative interest rates adopted as a widely accepted practice on large commercial and individual balances, they should worry. One of the necessary preconditions to moving on to smaller retail balances (the other being abolishing high denomination notes, as the 500 euro note has already been discontinued) will have been cleared and everyday retail bank customers will be closer to entering policymakers' crosshairs.


Some news articles have gone so far as to suggest current negative interest rate policy already means “banks will pay you interest to borrow.” And a handful of loan rates in Europe have been noisily reported as going negative. For example, very short-term mortgage rates (less than five years) in Denmark have gone slightly negative. However when factoring in processing fees that the lenders charge the effective rate is still slightly positive.

For the average retail customer being paid to borrow is highly unlikely although I wouldn’t rule it out completely in the long term. If central banks push negative rates down far enough, a bank could theoretically be willing to take a loss on a retail loan if the loss is smaller than letting its excess reserves sit idle and earn an even worse negative rate.

For example, if (heaven forbid) central banks ever charge member banks a more extreme negative rate of -3% on idle excess reserve balances, and a commercial bank was having trouble finding enough borrowers on 1% loan rates, it might consider lending at -0.5% since losing 0.5% a year plus charging processing fees is a lot more attractive than losing 3% a year.

However credit risk is still a major factor. A bank leaving its reserves idle eats a negative interest rate but it’s guaranteed to lose no more. Lending at a -0.5% rate might seem like a better deal, but if the borrower is a credit risk then the prospect of losing 25% or 50%, or all of the principal in a default might deter the bank from making the loan anyway.

In any event, the negative rates central banks are charging their member banks in Europe and Japan are hardly low enough to warrant widespread retail lending at negative yields. And in the United States, where the Fed is paying positive interest rates—approximately +1.8% on excess reserves at the time of this writing—the prospects of Americans being paid to borrow money are very remote (exception: Uncle Sam).


However, paying someone to borrow is precisely what commercial banks in Europe have been doing… just not with their retail customers, but government debt instruments.

There's been a lot written recently about European government debt yields going negative and predictions that it may be coming to the United States soon.

In light of central bank negative rate policy it becomes easy to understand why. If a European commercial bank is paying a -0.5% rate on excess reserves to the ECB, yet it feels its pool of available borrowers is too risky to lend to at 1% or 0%, then it sees investment grade government debt (meaning not Greece), even slightly negative yielding debt, as a better alternative.

Given the bad choices of paying -0.5% to the ECB, or lending to risky borrowers, European banks probably view German government Bundesbonds as a good alternative. Yet with other European banks also chasing German bonds—in addition to central banks which are already engaged in large scale government bond purchases—the inflated demand can push the bond's market price above the principal or face value, drive the effective yield below zero, and banks will still buy it.

Click link to read Wall Street Journal column on "Germany for First Time Sells 30-Year Bonds Offering Negative Yields"


Here’s a mathematical example using dollars instead of euros for simplification: A European bank might buy a two-year bond with a principal/face value of $10,000 and pay $10,420. Even though the bond pays a 2% coupon ($200 a year for two years or $400 which is a 2% rate), the bank ultimately only gets $400 in interest plus the $10,000 redemption for a total of $10,400. Since the bank paid $10,420 it loses $20 on the entire transaction or an effective yield of approximately -0.1%.

But losing 0.1% on a very safe debt instrument is better than losing 0.5% to the ECB, or losing 100% of the loan principal on a retail or risky commercial borrower who defaults.

Furthermore, the phenomenon of central banks plus commercial banks scrambling to buy whatever government debt they can find has led to a new and novel bout of bond speculation. Enter peripheral players: pension funds, insurers, and institutional investors who can plainly see the trend of central banks pushing negative rates lower and lower. And they are also buying negative-yielding government debt, not for the negative yield, but rather in the hope that they can sell it at an even higher price later… the equivalent of bubble-era house flipping, only this time with government bonds.

This is the screwy world that occurs when central banks go negative enough.

For a list of negative yielding bonds by country click this link.


It’s no coincidence that all negative yielding countries are either European or Japan as the ECB and BOJ are the prime instigators of negative rate policy, along with the Swedish Riksbank, Swiss National Bank, and the Danmarks Nationalbank.

With yields in Japan and Europe going more and more negative, banks are looking elsewhere for safe instruments and demand for U.S. Treasuries, already extremely popular even before negative interest rate policy began due to the U.S. dollar’s global reserve currency status, is rising.

Although the Federal Reserve isn’t engaged in negative rate policy on excess reserves, the consequences of negative rate policy in Europe and Japan are spreading to American shores. The prospects of this trend continuing is what has prompted market observers and even Alan Greenspan to predict that negative yields on U.S. Treasuries are an inevitability.

And this would of course please no one more than the U.S. government: both Congress and President Donald Trump (or any other president for that matter). What politician wouldn’t savor the idea of being able to borrow and deficit spend even more with less consequence? Imagine being able to borrow a trillion dollars to spend on buying votes and only having to pay back $980 billion ten years later!

Which presents another possible unintended and worrisome consequence: negative rate policy may encourage a new chapter of bloated government debt rising far beyond even the indefensible levels already prevalent in developed countries. Imagine giving more liquor to an alcoholic but this time paying him to drink it. The outcome is not likely to be good.

Of course one cynical view could be that negative government bond yields facilitating even more borrowing is a feature, not a bug, of negative rate policy. The Economics Correspondent, himself never a fan of central banks and their symbiotic relationship with governments, is very open to that theory, especially considering policymakers’ sincere but misguided belief that their negative rate policy is beneficial to the economy. If you think you’re both stimulating the economy while providing cheap financing to the very government that grants you a legal monopoly on currency and reserves issuance, how can you not view the result as a win-win?

In Part 3 we’ll take a close look at the so-called “war on cash” and see what strategies elite policymakers are already drumming up to force retail bank customers to eat negative interest rates on their deposits one day.