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

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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.

SMALL DEPOSITORS CAN REJECT NEGATIVE RATES

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.

THE POLICY PRESCRIPTION? BAN CASH

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
-Citigroup
-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:

https://www.youtube.com/watch?v=kp5aKDCVTzg

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 naïve 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?

JUST FORFEIT THIS ONE FREEDOM, AND PROBLEM SOLVED… AGAIN

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?

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

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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:
https://www.bloomberg.com/news/articles/2019-10-09/greece-draws-negative-yield-for-first-time-in-3-month-bill-sale

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.

A Primer on Negative Interest Rates (Part 2)

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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.

WILL BANK CUSTOMERS BE CHARGED NEGATIVE INTEREST RATES?

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.

WILL BANKS START PAYING ME TO BORROW MONEY?

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).

THE CURRENT SOVEREIGN DEBT PHENOMENON

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"

https://www.wsj.com/articles/germany-for-first-time-sells-30-year-bonds-offering-negative-yields-11566385847

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.

https://thumbor.forbes.com/thumbor/960x0/https%3A%2F%2Fblogs-images.forbes.com%2Fstephenchen%2Ffiles%2F2019%2F08%2FJPM-negative-yield-matrix.jpg

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.

A Primer on Negative Interest Rates (Part 1)

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5 MIN READ - Given CO’s recent spate of posts on negative interest rates, the Cautious Optimism Correspondent for Economic Affairs and Other Egghead Stuff takes a brief diversion away from his series on Healthcare in America to address the recent unorthodox monetary policy.

Recently we’ve read a lot about negative interest rates in the news. Statistics abound about $15+ trillion in worldwide sovereign debt trading at negative yields. Alan Greenspan predicts negative interest rates on U.S. Treasuries are a fait-accompli. Other articles focus more closely on global central bank negative interest rate policy and predictions swirl that commercial banks will soon start paying borrowers to take out loans.

The purpose of this article is to define clearly what negative interest rate policy is, how it works, and to differentiate explicit negative rate policy from central banks from its spinoff effects, such as falling yields on government debt which are more an aftereffect than direct policy itself.

NEGATIVE RATE POLICY

First of all, where does the explicit policy originate from? The answer is simple: central banks.

In the fallout of the 2008 global financial crisis and global recession, many developed economies in Europe plus Japan have spent a decade crawling out of the slump plagued by extremely slow economic growth and subpar recoveries. While governments argued over fiscal policy—some calling for deficit spending, some for austerity, most spending and taxing more and calling it “austerity”—central banks have tried to pick up the perceived slack with monetary policy.

For the first several years of the tepid recovery, central banks the world over engaged in quantitative easing (massive securities purchases paid for with freshly printed reserves to load banks up with loanable funds) and zero interest rate targeting in the hope that businesses would be lured into borrowing on the cheap and banks would lend more generously. The belief was that the newly manufactured credit would stimulate recovery.

Central banks have also been obsessed with reaching inflation targets (usually somewhere around 2%) in the belief that inflation is necessary to stimulate credit and spending (both consumer and business) since someone who believes his money will be worth less tomorrow is more likely to spend, invest it, or borrow more today.

Central banks also want to jumpstart inflation to dilute the real value of their government's debts, although they will never publicly say so.

However if banks aren’t in a generous lending mood, all those QE reserves will do little to spur inflation since the broader money supply grows only when banks lend and increase their customers’ demand deposit balances.

Now the Economics Correspondent believes the entire premise of stimulating credit and 2% inflation targets is fallacious from the start—which may explain why the more countries have pushed interest rates down and used more and more radical means to stimulate lending the more disappointed they’ve been with the lethargic results. However the debate over how effective stimulative monetary policy and inflation are towards promoting growth can wait for another time. The purpose here is to explain the official justification behind and mechanism of negative rates.

So after years of zero rates and loading banks up with reserves—trillions of dollars more than they are legally required to hold to back up their deposit liabilities—some central banks decided to pursue more radical policies and experimented with negative interest rates.

What does that mean? Well it doesn’t mean (at least not for the foreseeable future) “banks pay retail borrowers to take out loans.” It also very rarely means “banks charge you negative interest on your deposit balances” although European banks may be reluctantly inching closer to that paradigm.

No, the first and most important salvo of negative interest rate policy was for central banks to begin charging their member commercial banks negative rates on idle reserves in excess of those they are required to hold (ie. so-called “excess reserves”).

Banks take deposits from customers (or obtain reserves from the central bank) and, in the United States, are only required to hold approximately 10% of those deposits in reserve while loaning the other 90% out. However if they cautiously choose to lend less and hold more in reserve, any balance above and beyond the 10% reserve requirement is considered “excess reserves” by the central bank.

During the Fed’s QE1, QE2, and QE3 the excess reserve balances of U.S. banks went through the roof: from virtually zero to a peak of $2.5 trillion in late 2014. The crisis-management policy goal at the time was to load banks up with reserves and telegraph a message to nervous depositors that their bank was in no danger of failing due to a bank run since they were holding vast quantities of reserves that could be converted to cash at any time. The huge excess reserve balances also served as an oasis of loanable funds that the Fed would urge or discourage commercial banks to lend or not lend whenever it wanted to stimulate the economy or hit the brakes.

So in light of world central banks becoming frustrated that commercial banks weren’t lending their own excess reserves aggressively enough, monetary policymakers in Europe and Japan began charging negative rates on excess reserve balances: starting at -0.1%.

To a commercial bank, this was a shot across the bow. A bank with, say, $100 billion in excess reserves sitting idle at the ECB knew that a year later it would only have $99.9 billion left, a loss of $100 million which is more than it sounds like when comparing it to the bank’s thinner profit margins. Thus an incentive was produced for the bank to lend more of that $100 billion out at a better interest rate than -0.1%.

After a year or so central banks became more aggressive. The rate on excess reserves was lowered further: to -0.25%, -0.4%, -0.5% and so on. Today the European Central Bank's (ECB) rate on excess reserves is -0.5%. Now the hypothetical bank's $100 billion excess reserve balance loses $500 million a year. The Bank of Japan’s rate on excess reserves is only -0.1%.

(see link for policy analysis of "pain" inflicted on European banks)

https://www.bloomberg.com/news/articles/2019-09-11/banks-wince-as-ecb-prepares-to-inflict-more-sub-zero-rate-pain

The Swedish Riksbank’s so-called deposit rate is a deeper -1.0% and has been negative since 2009 (uncoincidentally Sweden has inflated a new housing bubble). The Swiss National Bank’s so-called “sight deposit” rate is -0.75%. Denmark is also employing negative interest rate policy. Switzerland, Sweden, and Denmark all use their own currencies and don’t operate in the Eurozone common currency area.

Incidentally some news articles have reported that negative rate policy is designed to compel consumers and businesses to spend more. That’s mostly incorrect. The objective of negative rate policy is overwhelmingly to compel member commercial banks to lend more. While zero or near zero interest rates on savings and deposit accounts might motivate consumers and businesses to spend a little more, effectively positive rates won’t boost spending much and hardly to the levels that would result from charging retail and business bank customers a negative rate—something we haven’t commonly seen for reasons we’ll cover in Part 2.

HOW WELL IS IT WORKING?

The results of negative rate policy are mixed, but generally pretty poor. Policymakers in Europe in particular are having an increasingly difficult time justifying the procedure—especially in Germany, a nation of savers with a longstanding distrust of inflationary monetary policies.

One of the pitfalls of negative rate policy is that commercial banks might make riskier loans than they otherwise would—which increases the chance of defaults and possibly even crisis later. Ironically, should such a crisis occur politicians will automatically blame banks for lowering their lending standards.

The opposite risk is that banks may be reluctant to lend at superlow rates to what they perceive as risky borrowers and will elect instead to eat the negative rate—ie. make fewer loans or not lend at all since they can't charge a premium to compensate for the added risk. Monetary policy observers believe this calculus is already in play.

Banks may also choose to use their reserves to buy existing debt instruments instead—a form of lending only that it’s not new lending—and the newly injected money will simply spill over into asset markets, as it has in Sweden which is now experiencing a new housing bubble and the entire globe which is witnessing the makings of a sovereign debt bubble.

Austrian and classical economists have complained for a century that central banks forcing interest rates down artificially, unbacked by real public savings (ie. actual deferral of consumption), distorts economic calculation and misleads entrepreneurs into embarking on long-term debt-fueled business ventures for which inadequate saved resources actually exist. Negative interest rates, they argue, only distort coordination of saving and investment further.

Central bank governors the world over have complained that growth isn’t really picking up in their countries and vowed to do “whatever it takes” to stimulate more lending. Hence negative rates on excess reserves have gone lower and lower. Yet they are pushing further into uncharted territory and have no historical guide to properly assess the risks they’re creating with such radical policies.

WHAT ABOUT THE FED?

In the United States, the Federal Reserve has not implemented negative rates and it’s still very far away from doing so. Just last week the Fed cut its interbank lending rate to 1.75%—still very positive—and even the IOER (interest on excess reserves) rate only recently fell to +1.8%.

However the Fed does reserve the right to implement negative rates if it feels necessary. Most experts believe that would be in the aftermath of another deep recession like 2008-09. In fact Janet Yellen addressed the subject near the end of her term as Fed Chairperson before Congress, testifying that the Fed had no intention of enacting negative rate policy anytime soon but might consider it in a future slump if the governors felt all other policies were proving ineffective (see link for more info).

https://www.businessinsider.com/janet-yellen-doesnt-rule-out-negative-interest-rates-2016-5

In Part 2 we’ll discuss what negative interest rate policy means for commercial bank customers (retail and business) and government debt markets.

The Economics of Healthcare in America #2: Another Myth that Won’t Die: “U.S. Infant Mortality Rates are Among the Worst in the Developed World”

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 is continuing his overseas holiday... which won't stop him from continuing the CO series on healthcare economics and disparaging the legend of America's allegedly subpar infant mortality rate.

CBS laments that "U.S. infant mortality rate
 worse than other countries"

In Part 1 of this Economics of Healthcare in America series we discussed why allegations that average lifespans in America rank among the lowest of industrialized nations are fictitious, and why in fact the USA is the best country in on earth for anyone interested in living as long as possible.

In Part 2 we examine another common false indictment of the American medical system’s allegedly poor outcomes: U.S. infant mortality rates are the worst among industrialized nations.

Here are a few typical headlines that propagate what is in effect a myth, most dispatched with socialized medicine or at minimum more government control of healthcare as the prescribed solution:

“Among 20 wealthy nations, US child mortality ranks worst, study finds”

-CNN, 2018

“America's Infant Mortality Rate Higher Than Other Rich Countries”

-Time, 2018

“Our infant mortality rate is a national embarrassment”

-Washington Post, 2014

“Why Infants May Be More Likely to Die in America Than Cuba”

-New York Times, 2019

“Newborn survival rates in US only slightly better than in Sri Lanka” (The Guardian—UK, 2018)

As is the case with average lifespans, the conclusion is derived from another example of ripe apples vs rotting oranges statistical comparisons, the gap between the apples and oranges being so expansive that it’s mindboggling anyone would use such statistics to draw infant mortality disparities at all. For example, the U.S. counts all infant deaths whereas other developed nations exclude many of their frailest births. Thus when overseas infants expire their deaths aren’t counted in what would otherwise be a subsequently raised mortality rate.

Most of the key differences in statistical collection methods can be found in three sources (links below):

-The Washington Times

-Science Daily citing research from Texas A&M University’s Medical and Public Health schools

-Occupational Medicine and Family practice Physician and health policy writer Dr. Walt Larimore

And although the COCEA enjoys authoring his own annotations for CO Nation readers, this column is an occasion where citations from those articles/studies will illustrate the vast differences in measurement methods between nations more capably than the COCEA’s own prose.

So as you read on, note that the gap between American statistical approaches and those of other advanced economies becomes so great that citing “the developed world's worst infant mortality rate” devolves into a proverbial farce. Anyone who invokes that rallying cry simply lacks even a cursory understanding of other nations’ lax measurement standards.

We begin with...

I. Establishing the definition of infant mortality:

“First, let’s start with the definition. The World Health Organization (WHO) defines a country’s infant mortality rate as the number of infants who die between birth and age one, per 1,000 live births...

“WHO says a live birth is when a baby shows any signs of life, even if, say, a low birth weight baby takes one, single breath, or has one heartbeat. While the U.S. uses this definition, other countries don’t and so don’t count premature or severely ill babies as live births or deaths.”

-Dr. Walt Larimore

II. “The CDC ranks the United States 27th of the 34 developed nations, with 6.1 infants of every 1,000 live births dying within their first year of life… [but] there’s a statistical explanation for America’s standing in the CDC rankings. It may be that Americans put a higher value on human life among the least fortunate among us. In most developed nations, premature births are recorded in the statistics as miscarriages or stillbirths. The lives that doctors in those places don’t attempt to save are never recorded as ‘live births.’”

-Washington Times

III. American doctors’ attempts to save premature babies yield higher official mortality rates that don’t burden countries that simply let their infants die:

“Many countries don’t try to save infants born prematurely or with severe birth defects. U.S. doctors go to extraordinary lengths to give these infants a chance at life. Such best efforts often fail, and the death becomes a misleading statistic…

“When the CDC excluded births before 24 weeks of gestation, the American infant-mortality rate fell from 6.1 infant deaths per 1,000 live births to 4.2, a number comparable to the rest of the developed world’s figures.”

-Washington Times

IV. Other countries exclude births under a certain weight or length while the U.S. does not:

“What counts as a birth varies from country to country. In Austria and Germany, fetal weight must be at least 500 grams (1 pound) before these countries count these infants as live births, [former NIH Director and former President and CEO of the American Red Cross Bernadine] Healy notes.”

-Washington Times

“In other parts of Europe, such as Switzerland, the fetus must be at least 30 centimeters (12 inches) long, [Bernadine] Healy notes. In Belgium and France, births at less than 26 weeks of pregnancy are registered as lifeless, and are not counted…”

-Dr. Walt Larimore

V. The U.S. counts babies that die within their first 24 hours of life while other countries do not:

“…Some countries don’t reliably register babies who die within the first 24 hours of birth…”

-Dr. Walt Larimore

VI. Excluding underweight babies from the statistics makes at least one of the “leading” nations’ mortality rates appear more favorable:

“Norway, which has one of the lowest infant mortality rates, shows no better infant survival than the United States when you factor in Norway’s underweight infants that are not now counted [source: Nicholas Eberstadt, American Enterprise Institute].”

-Washington Times

VII. Higher availability of fertility drugs in the U.S.—itself an indication of a more obliging system—skews infant mortality statistics:

“And the US has more mothers taking fertility treatments, which keeps the rate of pregnancy high due to multiple-birth pregnancies [which have lower survival rates].”

-Dr. Walt Larimore

VIII. Bad health habits of pregnant teens and expectant mothers drive infant morality rates up, but have nothing to do with the quality of American medical care:

“Plus, the U.S. has a high rate of teen pregnancies, teens who smoke, who take drugs, who are obese and uneducated, all factors which cause higher infant mortality rates.”

-Dr. Walt Larimore

IX. Once again comparing ethnic apples to apples produces more valid correlations than monitoring national averages since countries like Sweden, Japan, and Iceland don’t have large African or Native American populations that are more prone to SIDS:

“There are racial and ethnic differences in infant mortality that might help explain the differences between the United States and Europe. For example, African American and American Indian/Alaska Native babies are at higher risk of SIDS than Caucasian, Hispanic or Asian American babies. As most other developed countries have a comparatively small population with African heritage (and very few people of American Indian descent) these statistics might also help explain the numbers.”

-Science Daily

X. American ethnic diversity goes beyond just SIDS when counting infant deaths:

“The ranking doesn’t take into account that the U.S. has a diverse, heterogeneous population… …unlike, say, in Iceland, which tracks all infant deaths regardless of factor, but has a population under 300,000 that is 94% homogenous. Likewise, Finland and Japan do not have the ethnic and cultural diversity of the U.S.’s 300 million-plus citizens.”

-Dr. Walt Larimore

XI. The OECD warns that it’s misleading to compare countries with such widely differing methods for tabulating infant mortality metrics, but that doesn’t stop American socialized medicine proponents from doing it anyway:

“Even the Organization for Economic Cooperation and Development, which collects the European numbers, cautions against using comparisons country-by-country. ‘Some of the international variation in infant and neonatal mortality rates may be due to variations among countries in registering practices of premature infants (whether they are reported as live births or not),’ the OECD says.”

-Dr. Walt Larimore

XII. And finally more American infants die in car accidents per-capita than other developed nations:

The U.S. has a much higher rate of per-capita infant deaths in car accidents since car ownership and usage rates in the U.S. far surpass that of other industrialized nations. While infant deaths in accidents are a tragedy, they have nothing to do with the quality of America’s medical system.

-COCEA’s note

So when summing up all the ways in which other developed countries exclude infant deaths to pad their statistics, it’s plainly obvious that allegations the United States ranks near worst in infant mortality rates among developed nations are simply false.

When adjusting for such statistical differences, America’s much lower infant mortality rate reflects even more favorably when factoring out higher uses of infertility drugs (more readily available in the U.S. than in the allegedly superior medical systems of other countries) and high teen pregnancy rates and pregnant teen drug usage. Nevertheless the USA’s supposedly abysmal infant death rate endures as a perennial myth—dispatched from the lips of the establishment media to the ears of progressive readers/viewers who recycle it uncritically and repetitively.

And of course those statistical padding/differences between countries are never mentioned in those same news stories in an another example of FDR Secretary of State Cordell Hull’s famous quip that “A lie will gallop halfway round the world before the truth has time to pull its breeches on."

For more detailed reading on the art of statistically compiling infant mortality rates, go to:

https://www.washingtontimes.com/news/2014/oct/3/editorial-the-statistics-of-life/

http://www.drwalt.com/blog/2009/07/06/health-myth-1-“the-us-has-one-of-the-highest-infant-mortality-rates-in-the-developed-world”/

https://www.sciencedaily.com/releases/2016/10/161013103132.htm

ps. The COCEA chanced upon the infant mortality myth once again while reading “The Myths of Modern Medicine: The Alarming Truth about American Health Care” by healthcare consultant John Leifer. His insert credits include consultant to healthcare firms and founding a newsletter that featured contributions from Bill Clinton and Newt Gingrich. In his first chapter Leifer slams the U.S. healthcare system for its inferiority to countries with socialized medicine.

His proof?

You guessed it, a few paragraphs on America’s poor life expectancy and atrocious infant mortality rates. Nowhere was there any mention of America’s #1 ranking for life expectancy when comparing like ethnicities across developed countries (not even an attempt to dispel the counterargument, he just didn’t bring it up) or the widely different methods for calculating infant mortality in statistically stringent America versus laughably lax other countries. Instead Leifer simply writes “our national ranking of twenty-fifth in life expectancy” which places us “behind all the other rich countries and a few poor ones” and “our infant mortality rate, as measured against other wealthy nations, is the highest in the world.”

As a supposed “authority” on healthcare, one would expect Mr. Leifer to know better than simply peddling recycled one-liner myths without diving just a little deeper into the numbers. So what kind of expert is this author? Or does he really know better but prefers concealment and dishonesty?