Several readers disagreed with my statement that “negative interest rates cannot occur naturally“.
Most of the disagreements involved “safekeeping”. Let’s take a look at one such comment along with my reply.
In response to Negative Interest Rates: Can They Ever Occur Naturally? What is the “Natural Rate”? Reader Thomas commented ….
I rarely disagree, but here I am. Safekeeping is an important function. Storage costs (for silver, not so much gold or fiat) can also be important. Bitcoin would be more expensive if bitcoin safekeeping and storage weren’t problematic. If bitgold proves itself over time, it may put a floor on interest rates. GLD would, if not for rehypothecation, various frauds on commodity accounts, etc. Of course if interest rates go negative enough, people will find cheaper ways to secure their wealth.
Email Exchange With Acting Man
Pater Tenebrarum at the Acting Man blog responded to my article with this Email thought …
If the natural rate were to fall to zero or into negative territory, we would all cease to consume altogether – all our activities would become future-oriented. In other words, we’d starve to death. So it is literally impossible for the natural rate to become negative, as long as time passes for us, i.e., as long as there is a “sooner” and a “later”.
I pinged back “Some confuse negative interest rates with storage fees. There is a legitimate role of paying a safe-keeping fee. But nothing is being kept safely. And there are already checking fees, statement fees, ATM fees, etc.”
Pater pinged back “Exactly, the storage fee analogy is not applicable in this case! It would only be applicable if the bank is 100% reserved, which almost no bank is. You are quite correct that the perverse move of the other gross market rate components into negative territory is a function of the fiat money system and what it enables the authorities to do.”
Both Pater and I would welcome 100% reserves and reasonable safekeeping fees. But let’s not confuse that with negative time preference.
Not Natural
As long as we are discussing what’s natural and what’s not, here’s a ping from Sitka founder Brian McAuley.
There is nothing natural about a purely fiat currency that can be inflated at will by a central bank. There will undoubtedly be a number of “unnatural” elements of that system that become visible over time, and negative interest rates may be one of them.
For most of human history, we used tangible things as a medium of exchange that were hard to replicate on demand, or at least took a lot of work to replicate or find: silver, gold, beaver pelts, even cigarettes in prison. Negative interest rates were impossible.
What we have now is just the latest modern innovation in finance, which not only enabled the inflation of a credit bubble over the past 40 years, but has also created the perceived need for negative interest rates to just keep the whole thing from collapsing. Incredible.
Is the Vault Empty?
In absence of central bank or government manipulation of fiat monetary systems, it is impossible for interest rates or time preferences to be negative.
Don’t confuse negative interest rates in a fiat world with safekeeping fees in a 100% reserve system.
Mike “Mish” Shedlock
Oh, what a tangled web we weave
When first we practise to deceive!
Both Pater and I would welcome 100% reserves and reasonable safekeeping fees. Mish
All citizens should be allowed to use their nation’s fiat via inherently safe, convenient accounts at the central bank itself and government provided deposit insurance properly abolished as well as all other privileges for depository institutions, aka “banks”, such as the lender of last resort and positive interest paying sovereign debt.
So citizens should be able to do much better than 100% reserve banking (which would be difficult to enforce anyway); they should be able to deal 100% WITH RESERVES (fiat balances at the central bank).
As for 100% private banks with 100% voluntary depositors, let them create all the deposits/liabilities they dare and let them be promptly foreclosed on when they fail to meet one.
So citizens should be able to do much better than 100% reserve banking
LOL – what a joke
Joke? How is it funny that citizens may not use their nation’s fiat except as unsafe, inconvenient physical fiat, aka “cash”? And must instead work through a usury cartel of government privileged depository institutions?
Central banks deposits for you and me
There is no need to “enforce” 100% reserved banking. The 100% reserving arises naturally from a complete lack of any even remotely possible external backstop.
As you allude to in your last paragraph, banks can still lend as much as they want, but what they lend out in excess of deposits will inevitably be limited to unbacked claims which carry the full faith and credit of no more than the lending bank itself.
“Enforcement”, and with it the creation of a privileged, and always and everywhere ultimately destructive, enforcing class; only becomes necessary once the possibility of obtaining a backstop funded by extortion from third parties, enters the picture.
The 100% reserving arises naturally from a complete lack of any even remotely possible external backstop. stuki moi
Not so since the banks could inevitably get away with some “cheating.”
But why should we care how much banks cheat IF:
1) They are 100% private*
AND
2) Their depositors are 100% voluntary**?
*e.g. no asset buyer/lender of last resort, no positive interest paying sovereign debt, no government-provided deposit insurance.
**As would be the case if all citizens were allowed to use their nation’s fiat via inherently risk-free, convenient*** accounts at the central bank itself.
*** Local post offices, ATMs and the Internet should be able to provide all the services a central bank MAY properly provide to the private sector and that does not include loans or the paying of interest, btw.
100% reserve banking is not a solution. Someone else would simply do the fractional lending. Loans create deposits, not the other way around.
Loans create deposits, not the other way around. economicsjunkie
Here’s a succinct description of deposit creation:
New money enters the economy in only two ways — either non-government borrows creating deposits (M1) or government spends, creating deposits (M1). Tom Hickey from http://mikenormaneconomics.blogspot.com/2016/08/david-f-ruccio-capital-on-strike.html
^ Precisely.
it’s all currency, not money. We could think of Safe Keeping Fees as…
Exactly! Not only is FRB currency not money,,,,it is actually debt. A promissory note, i.e.; a bond,,,,payable to the bearer in,,,,well,,,,nothing, I guess. Though I suppose a c-note could be exchanged for five $20’s. And each of those for two $10’s and yada.
‘Course, the day’s coming when the scrap value of the zinc in a penny will be worth more than the ink and paper in a dollar bill. Come to think of it, the $100 note and the $1 note contain pretty much the same materials. Hummm?
Here’s a little experiment for you. Try to pay your taxes with gold, silver, platinum, etc. and see if those will keep you out of court for tax evasion.
Hence it’s not precious metals that have backed fiat; it’s the taxation authority and power of government that have backed the value of precious metals when they have been used as fiat.
Should government buy $700 hammers? Then neither should it have needlessly expensive fiat.
When interest on fiat becomes uncalculable, fiat loses its meaning. The natural order of a society is not that of an individual, as real resources for the whole are not dispersed evenly but held in the hands of a few at any point in time, be it food in farms or supermarkets, fuel in storage etc.
When fiat becomes uncalculable, that is the medium of exchange within a society, necessary trade may be interrupted. The real rate becomes negative, that is to say it is worth more to not trade what is necessary, due to the real monetary losses incurred in a hyper inflationary environment, and that indeed does lead to starvation of society first, even though the individual will be working with a real positive rate of return as guidance. System failure.
This is why we should be very careful when we allow authority to set the value of currency, its interest. Negative interest signals that money is worth more in the future, that actually signals real goods and services will be worth less, will cost less. This signal actually retains spending, as opposed to stimulating it, it tells us that there is no calculation available in terms of the value of money, even as positive rates signal a return and inflation, negative rates do not signal any estimate that is calculable by logic except that any return on investment is not positive – that is all the logic that applies in the real world, the rest is financial accountants playing with fire.
Any person might be tempted so , to dump currency, but as cash itself is considered 0% interest, it would seem wiser to hoard it, or if you have little faith in, then the closest equivalent. The fact that negative rates are ‘offerred’ to states and big business only speaks for itself. If society kicks off the management for whatever reason, there will be no controlling the free interest on currency, and if the authority of that currency is lost, it may become worthless, a.k.a hyperinflation.
“People lived in a strange kind of tension. On the one hand there was the daily fight for survival, for food, and for heating fuel. “If we more-or-less manage to prevent the city of Cologne from collapsing completely, I shall get down on my knees and thank my Maker,” the city’s mayor, Konrad Adenauer, said.
Bizarrely enough, goods were no longer in short supply. There was simply no stable currency to buy them with. As the later Chancellor Hans Luther noted in 1923, Germany threatened to “starve with full barns.” ”
http://www.spiegel.de/international/germany/millions-billions-trillions-germany-in-the-era-of-hyperinflation-a-641758-2.html
Before there was capitalism there was family money. Risk capital for projects that might be profitable came from wealthy families pooling their savings and building, say, a new barn. Other sources of venture capital were sovereign rulers. Think Columbus funded by Queen Isabella of Spain. Then in Venice the invention of double entry book keeping and banking was one hot spot of capitalism. Even though this early system was theoretically a 100% reserve gold backed banking system bankers soon realized they could lend out more than 100% of their gold by printing IOUs and “funding” loans as part of the payment system. To the extent this happened the gold backed money supply expanded. This expansion was effectively a forced savings imposed on society by the banks. If this new credit money funded successful ventures (often ship voyages for spice and silk) no one was the wiser and the loans were repaid. Occasionally individual banks went too far and some ships “didn’t come in” lost in storms or to pirates. That bank would get in trouble. The currency (IOUs) it had issued would become suspect. Depositors would all demand gold. The bank would experience a bank run and it would fail. But capitalism was born and this new mechanism for funding entrepreneurs was a huge improvement over funding by a few rich families. The secret of capitalism is the cheating by banks by lending out more than they have deposits (reserves). Don’t be too eager to reinstate 100% reserves and enforce same rigorously as this truly is throwing the capitalist baby out with the banking crisis bath water.
As long as individual banks who “got in trouble” had no access to a backstop, the overall banking system can still be 100% reserved. Each bank’s notes simply trade at a discount to specie. How much of a discount varies, and may well, in practice be 0% for most banks most of the time. But any traded claim on specie issued by anyone, is still backed by no more than the full faith and credit of the issuer. And anyone who accepts such a note as payment in lieu of physical metal, is fully aware of this.
The banking and payment system only transitions from a sound one to a thinly veiled scam, once some bank gets to issue notes backed not just by itself, but by a government with the authority, read practical ability, to tax others.
We are living in Alice’s Economic Wonderland in the Central Bank era. When governments and central banks have totalitarian authority to do whatever they want, then wars on cash, gold price manipulations, fiat currency shenanigans, negative interest rates, and Whatever the Imagination Can Dream Up are part of the economic landscape. Think about Bolshevik economics.
I think Sitka has defined it right. We have a highly unnatural system. In that context, “natural interest rates” are inherently “unnatural.” In other words, in an unnatural system imposed by dictat, the unnatural is natural. Really, much less confusing to just talk about “interest rates,” period. No doubt the Cheshire Cat and Red Queen would concur.
I would like to hear examples of negative interest rates outside totalitarian central bank fiat currency systems. Impossible, not necessarily. But I agree, you need examples of negative interest rates separate from storage fees to make the case. Pater indicates the possibility with 100% reserve banks, and there must have been a few during medieval history, most likely in Italy’s city-states. Starving to death need not be the outcome of a small portion of assets held at negative rates.
You might consider any tax a negative interest rate . You invest your time and energy , you get paid , but there is a negative rate on that payment .
You might consider fiat as a negative rated investment . You earn at a given rate , but due to the almost inevitable inflation of supply , the value of the cash you hold decreases over time .
We’re used to it , bring it on …. !
The market rate for risk free short term claims to bank reserves (e.g. Treasury Bills) tends toward zero because banks will always try and loan out excess reserves to maximize income. Risk free rates on longer term would just be the cumulative anticipated rate on the short term instruments, and if that is low, then long term rates will be pretty low as well. Inflation expectations would probably be the only major factor.
Central banks have usually intervened throughout the decades by selling such short term instruments to keep the rate from falling below the desired policy rate, and a few years back they simply started paying a fixed rate on bank reserves outright (same effect in the end).
Then they started realizing that they may as well buy those bonds back, thinking they’ll somehow stimulate the economy by replacing long term bonds with bank reserves in private bank accounts. It didn’t occur to them that changing the term structure for risk free investments doesn’t do all that much, other than lower loan rates here and there (see mortgage rates).
They could just have left the rates at zero to begin with and not issued any long term bonds at all, if they wanted to. But most people don’t actually know how the financial system they operate in works. lol
Logically There’s nothing abnormal about a near or equal zero percent interest rate on completely risk free investments, we’re just not used to it practically, since we’ve rarely ever seen it.
Whoa!
There were so many great ideas posted by readers.
1.) MISH and Pater make an irrefutable argument that I have to abandon the notion negative rates are a storage fee.
2.) I would argue there is no natural interest rate since interest rates fluctuate. I would agree 0 is the lower bound because it is illogical lose money on a deposit when one could hold physical cash. From 1940’s interest make an exponential increase for 40 years. From 1980 to present interest rates have undergone an exponential decrease. The range of interest rates has been a factor of 10! That’s not statistical noise.
i think people are arguing over words….
if I put a dollar in a bank , and for whatever reason, at the end of the year I have less than a dollar….i’m doing something stupid.
eod
If wealth is being destroyed in a currency area, people with currency have no incentive to lend the currency (default risk greater than interest rate). If real estate is priced too high, it is possible the only way to sell the real estate is for a bank to offer negative interest rates, which might happen if the bank owns the real estate, de jure or de facto. I’d rather eat today than wait until tomorrow to eat, and daily/monthly consumption is perhaps 40-70% of the economy, so in a healthy economy, interest rates will be positive. If I invest in new plant, equipment, or people, then I expect to earn more than I spend – again, positive real interest rate.
There is a difference between a safety deposit box, in which I expect my valuables will sit untouched until I withdraw them, and a bank deposit which is immediately loaned out . For the former, I would expect to receive no interest and to pay for storage. The latter is subject to negotiation, and if a bank is viewed as risky, I expect a higher rate of interest. If a bank only makes fully secured loans, and does not have significant risk of frictional loss, I might accept a negative rate of interest. Note that this is not true of any bank in the western world/China/Japan. Fractional reserves, unsecured loans, bankruptcy, fraud, legal issues all make the “natural” rate of interest greater than zero.
Add in government waste, fraud, malinvestment, increasing prices, and an acceptable rate of interest in 2016 might be 4% (price increases) + 2% (taxes) + 1.5% (real return) for a total of 7.5% (what some pension plans use in actuarial calculations for NPV). Trouble is, I can’t get that rate of return for B– risk, let alone AAA. Nor 6% (zero real return). If price increases were 0% or negative, I might accept a rate less than 0%. But it wouldn’t be my preference. Yet the savings rate is about 5%, because (some) people don’t want to live paycheck to paycheck. I’d rather have interest rates of 6-7.5%, yet I save even at interest rates of 0%.
Yet complicating all the above is what will the purchasing power of your monetary unit be when you pull it from the bank.
Many in the 1930s depression naturally panicked with the extreme losses. However a few who escaped the severity of the mean loss, later came to realize that their purchasing power had actually increased.
Is there a storage fee for digital credits? And if we all lived forever, would we care when we were repaid loaned out money?
Even within the context of a freely floating irredeemable fiat money system it would be conceivable for risk free interest rates remain unmanipulated, if the Fed just stayed out of selling T bills to prevent short term rates from falling below the (arbitrarily) declared target rate. If they do get involved, then whether rates are positive or negative, they are manipulating rates. Without intervention, risk free rates would tend towards zero.
I suspect CB intervention in the interbank lending rate is partly motivated by a desire to stop interbank counterparty risk fears from even slightly developing any pattern of deviation in overnight rates between banks. This snowball effect happened with Bear Stearns and then Lehman with disastrous consequences. To do this successfully the CB must set a window rate below the market rate of the strongest collateralized bank in the system which these days is very low. Close to zero.
Interesting, although I would think that that wouldn’t require any upwards manipulation of rates. The Fed could let rates drop where the market takes them and stand ready to purchase short term instruments (or even just lend against such collateral) when the market interbank rate spikes up due to some unavailability of interbank lending.
I tend to think they manipulate risk free rates upwards because lazy people with money like it. It’s what I would do if I was corrupt and had to set up a new fiat money system. 🙂
In responding I’m having an epiphany. The fed is trying to manage now just as they did the S and L crisis. The SL crisis happened when saving and loans offered higher interest than FDIC member banks with an implied identical risk due to implied govt guarantee of SL deposits. These bad actors then loaned the oceans of money they acquired foolishly building strip malls everywhere leaving taxpayers as bagmen. The fed answer then was to liquidate the bad assets and to tell the S and L guys: no more. They are trying to do the same thing now viewing the shadow banking sector as the current S and L player thinking the shadow banks played the same game; offering higher yield while winking and nodding that risk was back stopped by govt. This is actually correct to a degree and it explains what the fed is now doing. Unfortunately the real problem goes way beyond analogising with the S and L crisis. The problem now, world wide, it too much total private debt. This the fed and other CBs have no clue how to fix.
If you follow what’s happening right now it seems the fed is trying to let markets resume function in the non shadow banking sector a bit at a time. Money market is the first sector being told: No more implicit back stop. If you have to break the buck, go ahead, and don’t come crying to us. This is imminent to happen in October and LIBOR is climbing now because of it. So my take is CBs are protecting (back stopping) the core FDIC member bank system but trying to push the shadow banks out of the nest one by one. First it was GE capital being told to delever. Now it’s money markets told no more promising you’re as good as cash. If this succeeds the next sector I suspect will be holders of mortgage backed paper who enjoyed a defacto govt back stop during the crisis.
Shadow banking. Not non shadow banking. Oops.
“The problem now, world wide, it too much total private debt. This the fed and other CBs have no clue how to fix.”
I don’t think the CBs can fix it. Too much private debt is the result of insufficient net private saving. The latter can only be addressed via a recession or large public sector deficits (e.g. tax cuts a la Trump) which would boost private net saving, the latter obviously being the less painful option. https://beinglibertarian.com/sectoral-balances-private-saving/
“Both Pater and I would welcome 100% reserves and reasonable safekeeping fees.”
I believe it existed earlier as outlined in this link…
http://www.pbs.org/newshour/making-sense/is-your-money-safe-at-the-bank-an-economist-says-no-and-withdraws-his/
What I expect when negative rates go too high is it will give raise to anti-lending banks doing as above.
In fact a “Savings Bank account” Union would be a good idea if the CBs continue in this vein. The Union members will pull their money out all at the same time and deposit at the anti-lending bank. This should be a good gun to the CBs head unless they make everything cashless. The currency in circulation would not be enough to service the request and notes have to be printed. I am sure this can bring a few banks down… Let us see what the CBs do then.
All said, this battle between the CBs and people will be interesting to say the least. While I am willing to bet on the winner (timing unknown), it is sad that the central bankers cannot be hung from the nearest lamp post because of the rule of law…
Brian Mcauly repeats the oft made mistake of stating that “for most of human history, we used tangible things as a medium of exchange”. This is not true. Barter only takes place among people who do not trust each other and do not even trust any type of money system. Most exchange takes place in terms of credit. Whether people kept an account with the local shop-keeper or ancient Sumerians drank ale and kept an ccount wiht the local ale-woman (Sumerian “money” was backed by barley and silver), they did not actually exchange stuff — they kept track and often settled accounts only once per year at harvest, on the threshing floor. Of course when trading commerically with strangers from far away, silver was exchanged while transacting. But whether you look at villages or tribes, most exchange took place without anything but numbers being tallied. Prices were often reckoned in terms of some basic staple, and using notes (money) as claims to barley in lieu of hours worked or goods delivered is a millenia old practice.
All true, but capitalism and banking as we know it had to wait for double entry book keeping.
“A positive or negative price premium emerges in all deals concerning deferred payments.” – Mises, Human Action.
So, gross/nominal interest rates can in fact be negative while natural/real interest rates remain positive yet sufficiently low. Time preferences are extended with reduced demand relative to supply of money (overall), and it appears that what’s left of the money markets are expecting long-term deflation. Whether those expectations are valid or not is another matter.
“In absence of central bank or government manipulation of fiat monetary systems, it is impossible for interest rates or time preferences to be negative.
Don’t confuse negative interest rates in a fiat world with safekeeping fees in a 100% reserve system.”
Safekeeping plays a bit role. But you did not address the fractional reserve system that exists. US currency only about $1.5 trillion (M1 about double). It is IMPOSSIBLE for everyone to hold their net worth in cash … and in a deflationary environment for assets … the least “bad” alternative might be to hold digital currency in negative yield account.
In a article written by bond king Bill Gross titled “Going To the Dogs” Gross described some of the current economic conditions we face. Gross states, “The universe of negative yielding notes and bonds in Euroland now total almost $2 trillion. These policies have unintended consequences, we have been busy digging our own financial grave.
The result of these interest rate games has been that many of the most financially responsible people are hunkering down and saving more while many non-savers have gone on a “spendathon” and reacted by taking on more debt. The article below looks into why this effort to offset the dwindling buying power of the public sector by encouraging them to take on more debt will not end well.
http://brucewilds.blogspot.com/2015/03/low-interest-rates-and-unintended.html
You defend the assertion that a negative rate is impossibly naturally simply by, well repeating it over and over….
““If the natural rate were to fall to zero or into negative territory, we would all cease to consume altogether – all our activities would become future-oriented. In other words, we’d starve to death.”
Why? Let’s say we experience a rate of -5% interest. That would tell me I would trade $0.95 of consumption a year from now for giving up $1 of consumption today. Why would I do that? One option is the squirrel who saves nuts for winter which I cited in earlier comments. He experiences negative interest rates (if he saves 100 nuts, he cannot consume more than 100 nuts in winter, most likely he will consume less than 100 since some will end up lost, stolen or spoiled). Winter is hard but a small amount of consumption will get him through winter while gorging himself even more in summer won’t make it easier on him. He’d rather save 100 nuts in the summer than binge eat them right now and hope the extra fat will make it easier for him to get thru the winter.
Second, the natural rate ties together demand for borrowing with the desire to consume now rather than later. Very simple, prices change. If the price of corn falls, that means the market doesn’t ‘need’ as much corn. Some farmers will switch to a different crop. If the price rises, then farmers will be tempted to switch fields back into corn producing ones. Interest is the price of supplying forgone consumption.
Why would a market reward people for not consuming? Well consider an economy at full employment that is nearly overheating. People are consuming and supply can barely keep up. It would be a good idea to increase supply but that would mean supplying less in the short term in order to build the capital needed to increase supply. If we could convince people to not consume today then that could provide the ‘breathing room’ to increase supply by building up capital. Such people could be ‘rewarded’ by being granted rights to get additional consumption tomorrow when it will presumably be easier to satisfy with all the new capacity online. Hence ‘interest’ when it comes to loans or profits when it comes to equity investment.
If an economy is not having any trouble meeting present and expected near future demand for consumption, why should it reward saving with a positive return? If an economy needs more consumption rather than savings why would it be unnatural to have a negative interest rate?
If you are willing to receive a negative interest rate, then send me $1000. I’ll send you $950 next year.
Your comment implies that sending a stranger money at an interest rate of -5% beats investing money interest free at currently ~ +0.6%.
Which tells me you either don’t understand the concept of comparative relative asset pricing & interest rates, or you’re playing dumb.
Negative or positive, it is irrelevant. What should matter is the spread between (what would have been) the natural interest rate and the ‘artificial’ –i.e. de facto– rate. It might be more alarming a wide negative spread from, say, 4 pc to 1 pc, than from 1 pc to -1 pc.
I am fascinated by the idea that buying a negative-rate bond is in fact paying for a bond that you should own only months or years later. The interest lost until nominal ownership would be equivalent to the negative yield during that period.
In other words, you are owning now an instrument that will only start paying interest years after you payed for it. If I’m not wrong here, you are converting a bond into a future!
I’m no economist, Mish. Correct me if I’m wrong.
Negative yield looks at yield to maturity. A bond will typically have a face value that is repaid at maturity.. 1, 3 or10 yrs for example. That is the assumed investment. It will also have coupon payments, which are understood as the interest.
If a bond has a face value of 100, say a total of 20 in coupon payments as well, and you pay 125 for it, you are in negative yield.
You will collect the coupons along the way, and the face value will be repaid at the end, the only way to make a straight profit is to sell it at an even higher price to someone else along the way.