Several years ago, news organizations described the inventors of new financial instruments as “financial engineers.”
Since then, the Great Recession has taught us that a financial Mr. Hyde, not a Dr. Jekyll, conceived some of these innovations.
I put into this category negative interest rates, which is when depositors pay interest to keep money in an account rather than receiving interest.
While it sounds crazy, the European Central Banks, in trying to stimulate the eurozone economy, cut key interest rates below zero more than a year ago, and Japan embraced this policy last month. Now, central banks that hold nearly a third of all sovereign debt have imposed negative interest.
The Pacific and Atlantic oceans separate America from Europe and Asia, but we cannot stop the spread of this idea to our shores. The probability that we will have negative interest rates in the U.S. by December 2017 has risen to about 18 percent, according to Merrill Research Global Research.
For the first time, the U.S. Federal Reserve is holding a stress test that includes a scenario to measure bank solvency if they held negative-yielding Treasury securities. This is important because the banks hold large Fed deposits, and because negative interest rates would impair bank earnings.
Federal Reserve chairwoman Janet Yellen said last week that, although the legal issues surrounding negative rates have not been vetted, she is not aware of anything that would stop the Fed from pushing rates into negative territory if policy makers thought it was necessary.
Central banks consider negative rates when they want to reinvigorate their economies and their other monetary options, such as historically low interest rates and massive purchases of bonds, have become ineffective. Negative interest rates would encourage banks to take their money out of the Fed, instead using this cash to make more loans and/or to invest in higher-yielding assets in order to earn profits.
Our economy could use help. There is a disconnect between positive Main Street economic numbers and the financial markets’ negative statistics: Our economy is growing at 2.5 percent, and our unemployment rate is 4.9 percent, but the financial markets, while not always an accurate predictor, have been suffering. Consider:
¦ The S&P index is down over 10 percent year to date.
¦ Oil has fallen below $ 30 per barrel, down more than 70 percent since 2014.
¦ 10-Year Treasury declined to 1.68 percent, sinking more than 50 basis points since the beginning of the year,
¦ The bank sector (XLE) on Thursday traded at its lowest level since October 2013.
Have negative interest rates worked? Not so far.
Since their introduction in Europe, economic growth there has remained an anemic 1.3 percent (half of U.S. growth rate), global stock markets have tumbled and the euro has fallen by 20 percent against the dollar. In theory, a decline in the currency should raise the price of imports, helping to combat deflation. But because consumer demand has remained weak in this region, prices have dropped 0.6 percent.
Since the Bank of Japan announced negative rates in the middle of January, the Yen has strengthened and the Nikkei has dropped 11 percent, the opposite of the central bank’s goals.
Negative interest rates are irrational. A fundamental economic principle is that the amount saved in an economy will equal the amount invested in new physical machinery and new inventories. Because negative interest rates retard saving, this policy will in the long run hamper investment, the engine for economic growth.
Since 2008, central bankers have unleashed a series of monetary bazookas without triggering meaningful economic growth. Negative interest rates are the latest gimmick. Until we see concrete positive results, let us keep our powder dry and maintain our current monetary policy.
