Questions on negative rates keep coming in: Where does the money go? Who benefits? Will the Fed do the same? What’s Draghi up to?
A quick refresher course on paying interest on excess reserves vs. charging interest on excess reserves is in order.
Q: Who has negative rates?
A: The European Central Bank (ECB), Sveriges Riksbank in Sweden, the Swiss National Bank (SNB), the Bank of Japan (BoJ), and Denmark’s Danmarks Nationalbank (DN) all have negative rates.
Q: Negative rates on what?
A: The above five countries have negative rates on “excess reserves”. Switzerland also has negative rates on deposits. Most banks are reluctant to put negative rates on deposits fearing bank runs and currency hoarding.
Q: How much are we talking about?
A: Bloomberg Quick Take notes “more than $7 trillion of government bonds worldwide offer yields below zero.”
Q: How do excess reserves come into play?
A: Central banks create them through monetary actions like repos and QE hoping to get credit flowing.
Think of it this way: money is printed into existence even though there are no creditworthy borrowers who want loans.
The irony is banks cannot lend excess reserves. Money lent by one bank will simply appear as excess reserves when the money is deposited elsewhere. Mathematically, someone has to hold every cent of money created by central banks.
Q: Who collects the money?
A: If the central bank charges money on excess reserves, the central bank collects the money. In general, bondholders pay money to hold bonds with negative rates. Borrowers get paid to borrow. Yes, this is absurd.
Q: Who benefits from low and negative rates?
A: Asset holders benefit from cheap money, at least initially. Asset prices went through the roof when ECB president Mario Draghi issued his famous “Whatever it Takes” speech on July 26, 2012. Various rounds of QE by the Fed also sent the stock market higher. The obvious consequence is easy to explain: asset bubbles break, leaving banks and borrowers in worse shape.
Q: Is there a limit to negative rates and resultant bubbles?
A: There is always a limit. Everyone is guessing where it is. At some point the greater fools run out or the consequences are such that policies are abandoned. It’s possible we hit the limit today (March 10, 2016), given the strong reversal following ECB announcements by Draghi, initially interpreted to be a huge bazooka. As it appears now, the bazooka backfired. See Draghi’s “Shock and Awe” campaign morphs into “Shock and Aw Shucks” for further discussion.
Q: Why doesn’t the Fed resort to negative rates?
A: Given negative rates have proven to be of negative benefit, why would the Fed want to? However, central banks don’t see in those terms. Here are a couple of reasons I presume the Fed does understand:
- Negative rates hurt bank profits.
- The Fed pays interest on excess deposits. This is a back-door, free-money handout to banks that everyone ought to be protesting. Over time, the Fed has bailed out the banks in numerous ways.
- The US has numerous money market funds that would immediately be destroyed if the Fed implemented negative rates.
Money market funds are not in vogue in the Eurozone as they are here. Banks can always raise other fees to mask negative deposit rates. Money market funds cannot do the same.
Q: If negative rates hurt bank profits, why has Europe and Japan embraced them?
A: I suspect Draghi believes asset bubbles and equity support will do more for the Eurozone than lost bank profits. Given the collapse of economic bubbles is very damaging, Draghi is very wrong.
Never underestimate the propensity for central bank stupidity.
Mike “Mish” Shedlock
Why does it feel like bond yields want to go higher? I recall that US yields troughed at the announcement of further QE. But I seems to me that inflation shouldn’t have a prayer of showing up unless the USD gets crushed. How can the dollar get hammered if the Fed doesn’t go negative?
I suspect this is a case of the “foreign exchange tail, wagging the bond market dog”.
In the currency markets nowadays, daily moves of 1%-2% are almost common place.
The government bond is just a vehicle to use to play the F/X market and various currency crosses. A negative yield of a fraction of 1% (annual) makes little difference to these traders (speculators).
I would be very interested to hear what Mish has to say in this regard.
Prices of housing and healthcare are important drivers of inflation and are mainly affected by domestic factors, meanwhile foreign capital is coming in, much of it from China, looking to buy real estate.
Banks historically performed two distinct functions in our credit economy. They were the trusted third party to every single transaction through our payment system. And two; they loaned credit money into existence every time someone borrowed bank money. You really appreciate this when you learn the unique legal treatment of chartered banks in regards to their ability to legally commingle funds deposited by savers with demand deposits created by banks when they lend. When a bank funds a loan it credits funds into a demand account identical to a savings account, except no one put money into the demand account, it’s just created by the bank in funding the loan by a book keeping entry. Banks can do this without going to jail because it’s uniquely legal under their charter and no one is the wiser because of their other key role in operating the payment system, wherein savers can spend their demand deposits by buying goods and services with the bank debiting the buyers account while crediting the sellers account. This overlapping of the two functions: bank lending and bank payment intermediation is what ultimately got us into this mess. Over time this ability to create credit money that spends just like savings has created about $50 trillion of private sector debt. The central banks don’t understand this first debt problem but they do worry about the viability of the payment system. They saw this system freeze up during the GFC because interbank trust broke down and interbank lending of reserves froze up. Ever since the CB’s have been flooding the system with reserves and cleaning up bank balance sheets by buying hinky loans and other interest bearing assets for cash. Since cash has near zero real yield ordinarily it’s not surprising to see the real yield on cash reserves at the Fed near zero. What’s historically weird is we have slight deflation so nominal rates on reserves are slightly negative. The real problem is the amounts of reserves building up is huge because the CB’s keep misdiagnosing the problem as a payment system liquidity freeze instead of a credit system overload by too much private sector bank debt.
We are in an Irving Fisher debt deflation pure and simple. Deflation means negative real rates on cash reserves puts nominal rates below zero. That’s what we are seeing world wide.
“Banks can do this without going to jail because it’s uniquely legal under their charter..” But who would accept a check written on funds that are not there except another cartel member?
“Switzerland also has negative rates on deposits.”
This begs a question…
Is there a run on deposits in Switzerland? If not, why not?
Only on very large deposits, basically they are fighting CHF appreciation, trying to make the FX speculators leave.
I look at all of this as theft myself. If our rates go negative my fiat is out of the banks. I am sure that before we do anything in the USA capital controls will come into play big time. I know we have some now like how much a person can take out but the elimination of cash is coming if the bankers and government can get away with it.
Barter will be the way to go!!!
“Q: Who benefits from low and negative rates?
A: Asset holders benefit from cheap money, at least initially. ”
Mish, that looks like the macro view, but what about the micro view?
Why does a bank buy a bond that lowers its’ profit?
In the US they have to – Agreement with the Central bank.
In Europe I do not know if they have to but the cost of insuring vault cash is more than the negative return for parking money at the ECB.
Good question and I meant to put that one in.
Mish
Q. Is it actually possible in some circles to get paid for borrowing money? Seems like a nice job.
When normal people can borrow at negative rates, there won’t be a place to put the money without having to pay even more interest than we get paid. We won’t be able to borrow at -1% and stash the cash. Instead the money will go into a savings account that charges 2% interest.
That’s certainly not going to happen.
“Think of it this way: money is printed into existence even though there are no creditworthy borrowers who want loans.”
The central governments are borrowing and spending like crazy. You should not skip over this point. At negative interest rates there is no limit to the amount of money central governments can borrow and spend. About half of what Japan spends is newly printed money. It should be obvious how this will eventually fail, but most people don’t seem to see it yet.
Absolutely – debt is monetized everywhere
In Japan it’s close to 100%
Mish
No US government debt (US Treasuries) have been “monetized” at all in the US, nor will they be in the future.
Helicopter money is a REALLY slippery slope; should it ever become a monthly benefit, immediately buy all the silver coins you can and a revolver while you’re at it.
No central bank ever “gives” money away to anyone. The Federal Reserve versions of QE were all ASSET PURCHASES of existing securities from member US banks which had NO NET GAIN at all from QE. Those member banks sold existing securities (MBS instruments and US Treasuries) to the Federal Reserve for which the proceeds were deposited into their excess reserves accounts inside the Federal Reserve. There certainly was not nor will there be any “helicopter money” at all from the Federal Reserve.
“Never underestimate the propensity for central bank stupidity.”
I wonder how much of it is stupidity. In the beginning, The FED had regional rates, not one size fits all. Each region had its own economic characteristics. They also planned to buy short term corporate paper, to support business during recessionary times, when banks would be hesitant to lend. Then came WW1. Wilson had the FED buying government paper to support the war. In 1951, supposedly Truman ended FED independence.
Something i read a while ago was along the lines that Bernanke was going to let chips fall as a result of the recession, but upon relaying his plan, he had a little talking to and the plan changed to what occurred. Bernanke knew QE didn’t work, but did it anyway for an ulterior purpose.
Mellon wanted to let the chips fall in 1930, but Hoover was aghast at the idea of nature taking its course. Thus was the birth of what under Roosevelt, became the New Deal.
The government distorts everything it touches and since WW1, that includes the the central bank.
Mish posted:
“Q: If negative rates hurt bank profits, why has Europe and Japan embraced them?”
My 1.996 cents:
No matter what you call ‘negative interest rates’, in the end, they are simple a ECB tax on the banks who cannot escape them and are compelled to pay up at least a minimum amount.
Maybe this is why they exist, the Q of course is, how profitable are they actually? Might be an idea to do some back of envelope addition(if the figures are handy), it probably is a tidy ole sum.
The EU has long been keen to introduce direct taxes, so using the ECB to directly tax the banks is not that far fetched.
And, can those losses be offset from the regular tax that banks pay in the respective countries they reside in?
It would not surprise me if banks could not offset them, in the same way that there is already a rule that prevents German taxpayers from offsetting losses incurred by negative IRs on private/business accounts.
The Federal Reserve just DOUBLED the amount of interest paid to banks on excess reserves on December 16, 2015 from 0.25% to 0.50% and the amount of funds in excess reserves of the banks (which is where nearly all of the QE funds went) is around $2.6 trillion. The Federal Reserve is taking a very difference course from NIRP and will likely very soon increase the IOER (Interest On Excess Reserves) rate to 0.75% in the next round of rate hikes of the only 3 interest rates they set.
Correction: “different” not “difference” above
who are these investors investing in negative-yielding sovereign bonds (say 10-year Swiss bonds or 10-year Japanese bonds which are yielding negative yields). What are their motivations?