Banks Rebel Against Negative Interest Rates

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Central bankers are pressing onward with their failed negative interest rate experiment, oblivious to the damage that it is doing to banks and long-term investors like life insurers and pension funds.

Even more bizarre is the central bank assumption that by charging banks for reserves, they can force banks to lend. First, the very need to resort to negative interest rates results from crappy fundamentals. Entrepreneurs are not going to borrow to invest in new projects just because money is on sale. They invest because they see market opportunities; the cost of money being too high can constrain investing, but cheap money won’t produce loan demand in the absence of attractive projects. The only exception is activities where the cost of money is the biggest cost of doing business. That is the case for levered speculation.

Economists are way way late in the game acknowledging the need for more demand by calling for more fiscal spending.

But central banks ex the Fed act as if they can force business to take up the slack, as if banks can noodle them full of loans and they will be forced to invest and hire as a result.

Second is that banks have to be leery of making any long-term loans now. Even though no end of ZIRP and negative interest rates is in sight, they know if the monetary authorities ever are in a position to increase interest rates, they will show losses on intermediate and long-term assets unless they have adjustable interest rates. And the losses will be biggest on the riskier loans, since credit spreads typically widen in a tightening cycle.

So it should come as no surprise that banks are starting to try to find ways to circumvent the central bankers’ nutty scheme. As we reported in March, some small Barvarian banks said earlier this year they were looking into keeping cash on premises rater than pay for parking deposits with the Bundesbank. Yesterday, Commerzbank saber-rattled that it might follow suit. :

Lenders in Europe and Japan are rebelling against their central banks’ negative interest rate policies, with one big German group going so far as to weigh storing excess deposits in vaults.

The move by Commerzbank to consider stashing cash in costly deposit boxes instead of keeping it with the European Central Bank came at the same time as Tokyo’s biggest financial group warned it was poised to quit the 22-member club of primary dealers for Japanese sovereign debt…The policy cost German banks €248m last year, according to the Bundesbank….

The viability of the approach is open to debate. Holding cash in vaults would incur storage and insurance fees. The ECB’s decision to stop producing the €500 note will also make storing large volumes more difficult. But Adalbert Winkler, professor at the Frankfurt School of Finance and Management, said that if the ECB kept its negative deposit rate in place for a prolonged period, or increased it, more banks might decide to hold cash.

“The more central banks think that they can violate the zero-bound, the more likely it is that banks will look at ways to limit their costs,” he said. “And that means they will hold more cash if they can find efficient means to do so.”

C.P. Chandrasekhar and Jayati Ghosh gave a good high-level description of why this idea is wrongheaded but is nevertheless being attempted:

Thus negative rates are the consequence of policy makers betting on interest rate cuts to drive growth through multiple channels. To start with, they expect bank lending rates to come down and encourage households and firms to spend and/or invest more, thereby raising demand. Second, investors not wanting to pay governments for holding their money are expected to turn to asset markets like the stock market. That would raise financial asset prices and trigger the oft-cited “wealth effect”. With the value of paper or real assets rising, holders of those assets would be encouraged to spend more today rather than add further to accumulated wealth, spurring demand. Finally, since low and negative interest rates in a country would discourage foreign investors from investing in bonds and financial assets in the country concerned, the currency can depreciate, improving the competitiveness of exports.

The difficulty is that these expectations are not being realised. Households and firms are still burdened with debt, and so are wary about borrowing more, and banks are cautious of increasing their exposure to them even if pushed by the central bank. This could partly explain the thirst for government bonds, which has driven their yields to turn negative as well. On the other hand, with all countries relying on interest rate cuts, the effective depreciation of currencies, while significant vis-à-vis the dollar, is only marginal vis-à-vis one another. That neutralises the competitive benefits from depreciation relative to the dollar, with little chance of an export boom….

Why then are central banks and governments opting for this unusual stance? In a famous 1943 essay on the “Political Aspects of Full Employment”, the Polish economist Michal Kalecki had argued that if the rate of interest or income tax is reduced in a slump (to counter it) but not increased in the subsequent boom, “the boom will last longer, but it must end in a new slump: one reduction in the rate of interest or income tax does not … eliminate the forces which cause cyclical fluctuations in a capitalist economy. In the new slump it will be necessary to reduce the rate of interest or income tax again and so on. Thus in the not too remote future, the rate of interest would have to be negative and income tax would have to be replaced by an income subsidy.”

In the current context the problem is not that the interest rate that was reduced during the slump was not raised during an ensuing boom. The problem is that large reductions in policy interest rates when they were in positive territory did not counter the slump. But since governments have forsaken completely the option of relying on the fiscal lever to manoeuvre a recovery, they have no choice but to continue reducing interest rates, which have finally entered negative territory. Unfortunately, that too seems unlikely to trigger growth in the foreseeable future. It is only increasing the prospects of another financial bust.

In fact, Kalecki also explained why fiscal spending had been too low in the past. Businesses actually do not want to maximize profit, because a full employment economy give labor more bargaining power. It is more important for them to have more sway over workers and a higher status relative to them. Thus Kalecki argued that even though government could and should make up for the shortfall in business investment and hiring, businesses would resent that too, since an influential government that was play a positive role would also curb their power. So the mess we are in is ultimately rooted in class warfare, and far too few people at the top of the willing to make a major course correction. The result, and we foresaw in ECONNED, was the breakdown of the current economic paradigm. That appears to be starting now, as the abject failure of economic policy to produce prosperity or even adequate security for ordinary people is leading to voter revolts.

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24 comments

  1. redleg

    Why couldn’t the current paradigm continue, resulting in feudalism 2.0? That seems to be the endgame of trickle down.

  2. harry

    So now hillary is confirmed as our new master, what will fast Larry and DE Shaw do? Cos I know Larry believes in fiscal now. Will the blue republicans win congress and the Prez? Cos I don’t believe in the bipartisan fairy

    1. Adamski

      Remember DeLong, Krugman and the trillion dollar platinum coin? If Congress blocks fiscal stimulus they’ll have to do it that way. I hope Summers becomes Treasury Sec for that reason, rather than someone who does believe in the bipartisan fairy. The real problem is Clinton who triangulates to the right at every opportunity. Obama pushed for a stimulus, but will she? if she’s too chicken for that then she’d reject a trillion dollar coin too. Not respectable enough, even if a new recession begins?

      The coin can have Hillary’s visage on both sides (two faces). One can be the smug face and the other can have the raised eyebrows face which is her ‘tell’.

  3. [email protected]

    Good to see the individual banks getting into cash hoarding. This whole Idea of negative rates comes from the final crash of monetarism, which was junk from the start. The idea that economists are now going to shove their broken theories down our throats no matter what was just one more way for them to try to savage their wasted careers, and hopefully it will be the last.

  4. diptherio

    You would think that some CBs taking interest rates negative, while others didn’t, might result in capital flight to the zero/positive interest countries

      1. craazyboy

        Even funnier – after an additional 5 seconds of thought – the Fed has accounts already for the “primary dealers” whom happen to be the 19 largest financial institutions in the world.

    1. MLS

      What matters is real rates, not nominal. Thus, while nominal rates are lower in Germany and Japan than the US, deflationary forces in each have pushed real rates further into positive territory. The US, despite higher nominal rates, actually has more accomodative policy thanks to a higher inflation rate.

  5. Older & Wiser

    The article rightly describes the “goose stuffing” phenomenon and its obvious, foreseeable consequences.
    Kudos for that.
    But curiously enough not a word is mentioned under current and near future circumstances about the possibility of, say, 1% of worldwide savings funneling into a rush for arch-famous tangible financial assets such as gold and/or silver.

    Go figure.

  6. weinerdog43

    “…the abject failure of economic policy to produce prosperity or even adequate security for ordinary people is leading to voter revolts.”

    And when voting does nothing to alleviate the problems faced by ordinary people, eventually, the revolts will be with pitchforks. It’s maddening to witness the intransigence of the powers that be to this impending disaster.

    Unfortunately, considering the millions of armed, pissed off Americans, pitchforks are rather quaint.

    1. nowhere

      We can all just channel our anger by going to see “The Purge: Election Year” and wait for football.

  7. cnchal

    . . . Businesses actually do not want to maximize profit, because a full employment economy give labor more bargaining power. It is more important for them to have more sway over workers and a higher status relative to them. . .

    Many businesses are maximizing profits, and those business leaders couldn’t give two hoots about status over their workers, most of whom are in China.

    . . . The result, and we foresaw in ECONNED, was the breakdown of the current economic paradigm. That appears to be starting now, as the abject failure of economic policy to produce prosperity or even adequate security for ordinary people is leading to voter revolts.

    Globalization was sold as bringing prosperity to everyone, but it is a lie. The lessons learned are that you can be axed at a moments notice and the work you did is gone, with the resultant extra profits ending up in the executives pockets that made the decision to axe your job. It’s a circular swirly down the toilet bowl logic by those at the top. If you don’t want to pay workers here, and you don’t want to pay workers there, eventually no one can afford to buy your stuff.

    That’s what $2 trillion in ‘offshore’ profits is about. That money isn’t circulating anymore It has been taken out of the real economy and transferred to the financial economy, looking for a place to grow, interest and paper asset wise. It could be a contributor to negative interest rates, but does anyone think eclownomists (thanks Jim) might look at it this way?

    1. Synoia

      Offshore profits is a bookkeeping game for Tax Evasion.

      All the money is swirling around look for gain, but really belongs to the shareholders’ and should be paid in dividends, and thus taxed.

  8. noraa

    Second is that banks have to be leery of making any long-term loans now. Even though no end of ZIRP and negative interest rates is in sight, they know if the monetary authorities ever are in a position to increase interest rates, they will show losses on intermediate and long-term assets unless they have adjustable interest rates. And the losses will be biggest on the riskier loans, since credit spreads typically widen in a tightening cycle.

    I’m fuzzy on the reason why banks would show losses on loans that are performing, but they have a lower interest rate than current market rates. Isn’t that cash flow which represents the asset still whole? Is that because they have to pay higher rates on their liabilities?

  9. Matt

    The “solution” as in Kalecki’s time (1943!) will be a martial law war regime. Only in that way can capital feel confidence that full employment won’t produce uppity workers. Yet even under those conditions, the 1943-45 period in the USA at least featured a broad strike wave – no concentrated mass industrial strikes (except for John L Lewis’ UMW) as these were formally banned – but a great diffusion of small-scale actions that in total involved a greater number of workers than ever before. In addition, war rationing forced workers to save whatever wage gains they made.

    Now it is less likely that there would be rationing and forced savings, but more likely is police repression.

    The Postwar is over. We have now entered the Prewar era. The “Homeland” is already a designated battlefront.

    1. Lambert Strether

      I’m not so sure. Past performance is no guarantee of future results. What Greece teaches is the importance of the 1%s control over the payments system.

  10. hemeantwell

    Never was “none of the above” more necessary.

    Which is why I, to my surprise, am starting to think of a Green party run by Sanders/Stein as more of a practical possibility, not just in the sense of something like “showing the DP elite that the DLC is over,” but rather organizing a more basic realignment.

    Thanks for referring to Kalecki. That short piece of his is one of the great system logic-revealing political economy treatises.

    fwiw, I’ve started referring to HRC as “12495,” what she paid for the Armani jacket she wore while giving a speech on inequality. (thank you, CNBC!) It’s also suitably dehumanizing, reflecting her concoction by image meisters. Give it a try, good arguments will ensue, and the move “oh, so you’re going to vote for Trump” is easy to parry.

    For the sake of balance, at least, Trump needs something similar.

  11. flora

    Thanks for this post. The CBs are pushing on a string and wondering why that doesn’t work.

  12. charles 2

    It is more important for them to have more sway over workers and a higher status relative to them.

    Even if there is a backward section of the economic elite who thinks that way, I think it is not the majority. The majority of the economic elite simply wants the workers to “disappear” thanks to tooling and advanced automation ; not to disappear into irrelevance, no ; just to disappear in the same way than migrants disappear in the mediterranean sea when their boat capsizes….

    The most uncomfortable truth of the centuries to come may be that the only sustainable way to ensure “prosperity for everyone on earth” is that “everyone on earth” is actually a population of about 100 million individuals who originate mainly from today’s 1 percenters.

    Look at the action of the 1-percenters through the prism of that assertion and their current behaviour is quite rational without necessarily imply pettiness. The future will tell if is is a self-fulfilling belief or a self-destructive one.

    All I can say is that I regret to have procreated kids who have such a little chance to be part of a sustainable world. Biggest mistake of my life. But the most distressing is to witness around me so many people who refuse to acknowledge that same mistake. This is going to end in blood and tears…

    1. Yves Smith Post author

      No, this is empirically not true. If they wanted higher profits, they would be firmly in favor of more government deficit spending, which would stimulate demand, and more government spending on basic research and infrastructure, which subsidizes what they do. They’s support single payer, which would end their need to pay for medical insurance.

      Their stance on single payer ALONE proves the thesis. As a cab driver in Australia understood immediately the implications of employer provided heath care. He said, “That’s evil. It gives the boss too much power over his employees.”

      Companies are actually liquidating. They are not maximizing total profits. They’d pursue higher revenue strategies if so. They are looting their companies and bizarrely, stock market reward them for that short term. What the short-termist stock market prefers is NOT profit maximization, despite the blather otherwise. And CEOs are incentivized to manipulate stock prices however they can, by playing accounting games, by buying back stock, by engaging in fads like outsourcing whether or not it is really best for the business. That is not even remotely the same as maximizing profit. I hate to tell you but your comment reveals how you’ve been indoctrinated and are not even seeing obvious proofs that other behavior is really what is at work.

      Please read the Kalecki essay in full. It’s extremely cogent and you’ll see how he forecast, with uncanny accuracy, where we are today:

    2. different clue

      Are your children figuring out ( or trying to figure out) how to do their small part to pull the 1 % down with themselves if indeed themselves are going down? Are your children figuring out how to do their small part in flinging bubonic-plague-infected-corpses over the gates of the gated communities?

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