A Cycle of Addiction
November 26, 2019·4 comments·In Brief
Central banks created negative interest rates to shock sluggish economies back to life. Instead, they've engineered a trap that can't be escaped. Withdrawal causes collapse, so policymakers keep pushing rates lower. The system that was supposed to be temporary emergency measure has become structural addiction.
• The original diagnosis may have been wrong. Negative rates were meant to fight deflation and spark inflation through spending. Thirty-five years of increasingly aggressive policy later, inflation never materialized in any major developed economy. What if the prescription caused the disease?
• There's $15 trillion locked in securities that pay you nothing. Pension funds and insurance companies own negatively yielding bonds not for income but for the hope that central banks will push rates even more negative. These investors are locked into a bet that can only be won if policy gets worse.
• Banks are trapped in a squeeze they can't escape. Negative rates destroy bank profitability, but banks can't pass those costs to borrowers without killing loan volumes. The system that was supposed to help the real economy is actively harming the mechanism that allocates capital to it.
• Low rates created massive overcapacity across industries. Firms invested in projects that only made sense at artificially suppressed rates. Now global industries have excess supply and no pricing power. The policy designed to create inflation created the conditions for permanent disinflation.
• Central banks have removed the escape route. Raising rates now would create catastrophic capital losses for pension funds and trigger bank failures. They're locked in. What happens when an entire financial system becomes dependent on something that's actively causing harm?
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Comments
In a world of negative interest rates where is the price incentive for the banking system to allocate capital to areas of the economy that carry default risk? Who is providing working capital loans to emerging businesses in negative rate countries? As this experiment evolves I become more deeply convinced that the model is deeply flawed and agree that it is damaging potential growth.
Can we rename Permanent Open Market Operations to Forever Open Market Operations…?
Calling Negative interest rates a Social policy is wonderful. It is a peculiar form that serves those who can borrow large amounts and invest it in whatever pays even the smallest return. On the other hand it ruins savers who’ve stupidly been working and putting money aside.
So social as in socialite, maybe.
We are already seeing the beautiful results of that policy in demonstrations across the world.
As for pension funds needing the capital gain provided by even lower rates to make up for the absence of return, it is investment as pass the parcel. So who is the last buyer? Will central banks buy bonds above par and hold them to term to lock in a loss? That should really produce interesting results.
Great article, well reasoned, makes way to much sense. It’s all going to end very badly one day. It’s just, the current narrative says that day is a gazillion years from now… So just keep buying.
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