Don't Be Negative
No doubt we have all been told, perhaps even told ourselves, “don’t be negative”. At times It can be challenging not to comment on something we perceive as foolish. This is one of those times. We are hearing a lot of discussion about the possibility of negative interest rates in the U.S. Much of Europe and Asia have adopted negative interest rate policies. We are telling the Fed, “don’t be negative”. Ironically, we are very negative on the concept of negative interest rates. In mathematics, two negatives make a positive, so are we actually being positive? Make no mistake about it, we are being negative. In case we have left any doubt let us clearly state: we think negative interest rate policies are a foolish idea. They are a product of the failed monetary policies of the European Central Bank and Bank of Japan. More broadly, negative interest rates are a result of not accepting the limitations of monetary policy.
We’ve made no secret about our opinion regarding Keynesian Economics. While reasonable minds can debate differing economic theory, our belief continues to be that monetary policy should be a relatively small component, at most, of an overall economic plan. It should complement macro policy; it’s not designed to be the central component of an economic plan. Worse yet, when the intended consequences of low interest rate policies aren’t working, don’t compound the problem by pushing rates negative. Accept that your theory isn’t working. It's too late for Europe and Asia, but we are hoping The Fed heeds our warning. Let’s start with why we are concerned. The recently released minutes of the Fed meeting show that after the Fed governors were done complimenting themselves for orchestrating the economic turnaround, the Fed turned their focus to their newest acronym. ELB (effective lower bound). It is used more than a dozen times in the Fed’s latest minutes. Before the Fed coined this term, it was assumed and implied that zero percent was the lowest possible interest rate. ELB purposely and consciously changes this long-held assumption and conceptually allows for rates below zero, aka negative rates. The Federal Reserve has a dual mandate. Maximize employment and stabilize price inflation. The minutes expressed concern that conventional monetary policy may not be enough to accomplish this mandate. They proudly observed that their experimental policies didn’t have “adverse implications for financial stability”. Perhaps the Fed now has a third mandate, hope that unproven and experimental policies don’t destroy the financial system. The minutes went on to discuss additional alternative and non-conventional strategies for monetary policy. It appears that quantitative easing, the practice of expanding their balance through asset purchases, is now considered mainstream policy and no longer considered experimental.
It’s incredibly disappointing to us that nowhere in the minutes did the Fed discuss the possibility that negative interest rate policies might not be accomplishing their intended goal of stimulating economic growth. There have been several well thought out studies that suggest negative rates not only don’t have a stimulative effect, they actually harm economic growth. That is our view.
Why then is the U.S. so desperate to follow the monetary policies of the dismal economies of Europe and Asia? Japan and Europe instituted negative rate policies about five years ago. Their real GDP growth rates since then are barely positive, and have declined while the U.S. has maintained growth. Of course, the central bankers will defend their policies by arguing these economies would be in recession without their negative rate policies. Not being able to prove what the counterfactual would have been, it’s a convenient defense of their policies. The issues with negative rates are many, but the most obvious is this: the Keynesian concept that lower rates (cheap money) will stimulate growth by increasing demand only works when rates are above their natural (equilibrium) levels and are dropped below their natural levels. Put another way, money that was relatively expensive to borrow becomes relatively cheap to borrow. Due to quantitative easing and ultra-easy monetary policy, rates are already well below their natural rates and money has been incredibly cheap for a long time. An additional drop in rates will not materially increase demand. What we fear even more are the unintended consequences of negative rates. Negative rates create thin margins for lenders overseas, effectively taking away the incentives of European and Japanese banks to lend. Lending is decreasing, not increasing in these regions.
Here are a few more concerns:
Viability projections for pension funds, and therefore the corporations that fund the pensions, explode when the assumption is a negative return on bonds.
Pensions become underfunded and rather than invest in capital expenditures, corporations will need to true up their pension funds.
Real estate assets and stock market bubbles are created when investors don’t want to store their money in negative returning fixed income assets.
Negative rates appear to be creating disinflation, which creates a disincentive for consumers to spend money today.
If the future is going to be cheaper than the present, consumers will delay disposable income purchases.
The Federal reserve was created by Congress in 1913 "to provide the nation with a safer, more flexible, and more stable monetary and financial system". While we agree with the necessity of a central bank of the United States, we are troubled by the Fed's expansion and the increasingly larger role they are playing in the United States economy. The most recent data we could find on the Fed's website shows that in 2005 there were 17,717 employees of the Fed.
Our guess is that number is likely north of 20,000 today. We find this number troubling. Our belief is that economies should be driven by sound fiscal policy, and complemented with monetary policy. Expanding the role of central banks in an economy creates a moral hazard. It allows legislators to overly rely on monetary policy to fix what's ailing the economy. We see this in Europe and Asia, we are hoping the United States does not follow this same path.
The GreenPort Team