Negative Interest Rates.

In response to slow economic growth some central banks have decided that instead of paying banks interest on excess reserves parked overnight at the central banks it will instead charge them interest. Presumably the assumption is that banks would thus be motivated to lend money rather than pay the central banks to warehouse it.

The Central banks of Japan, the EU, Denmark, Sweden and Switzerland have set negative rates on reserve deposits. These are not passed along to depositors. In effect, a bank with excess reserves have three choices: make a loan, lend the money to another bank or pay the “tax” associated with doing nothing with the money.

There are other negative rates. This chart from WSJ is very instructive. This shows LIBOR interest rates in US$, Euros, Pounds, and Yens. LIBOR is an Interbank rate. This is the rate a banks charges another bank to borrow money. Euro LIBOR rates are negative out to 1 Year.

Why do banks pay other banks to take money off their hands? The alternative is to pay even higher rates to, for example, the ECB for the privilege of holding onto their excess reserves. ECB charges 0.3% annual interest on excess reserves.

Negative rates also exist in government debt. There are now $7 trillion in sovereign debt with negative interest rates. People pay the governments to hold their money. The message is, “You want to make a risk free loan? Fine. You pay us to hang onto your money.”

And then there’s the fact that Japanese investors are getting so desperate to move their money out of their country that they’re paying big premiums to borrow U.S. dollars. Those payments have become so large that it’s actually become profitable for foreign investors to buy negative-yielding Japanese securities based on the currency swap, as Bloomberg News reporters Kevin Buckland and Shigeki Nozawa pointed out. The consequences of an unraveling of this trade are unknown.

There is a lot of conspiracy-type stuff out there suggesting that eventually these negative rates will bleed down to depositors but I don’t see this happening any time soon. I do se negative rates as a sign that central banks have lost control over their ability to stimulate the economy though monetary policy. To me the reason is that fiscal policy is so irresponsible and regulation is so onerous that monetary policy is useless. No matter how low rates were banks are discouraged from lending by regulations imposed by CFPB and Basel III.

The irony is that now we have central banks retaliating with monetary policy which is imposing fiscal policy in the form of a tax on idle money.

The underlying risk is that prodded to lend money rather than have it lost to the taxation of negative rates, banks will loosen their lending standards and incur losses.