There is no free lunch and this will not end well. I’m talking about the policy of depending on central banks to ‘stimulate’ global economies out of their self-induced trap of spending and printing way too much money. To make my point about how far from the reality of financial discipline and responsibility we have come, some economies are now relying ‘negative interest rates,’ or NIRP to be that silver bullet that finally brings economic prosperity. Nothing could be further from the truth.
Essentially the policy charges an investor for deposits if they put money in the bank. The exact opposite of the time value of money. In other words, spend the money now or it is worth less in the future. Central bankers hope this policy will ‘force’ those with cash to spend it instead of save it. Of course, this effect may indeed happen for a short period of time. There very well may be people who spend the money instead of saving it as many people have been doing now for decades. Financial irresponsibility begats financial irresponsibility. But the major consequence of negative interest rates will not be what central banks intended. There will be a whole raft of unintended consequences. Just as there has been with Quantitative Easing and Keynesian economics. Simply put, the policy will be a further long term drag on the economy, reducing growth and faith in the global financial system.
The unintended consequences of negative interest rates on the soundness of the banking system are what bother me. No one knows what wholesale adoption of this policy will do to the strength of the banking system in global financial markets. Will it weaken investors faith in banks? Will it hurt their capital levels? Will it in the long run cause further damage? Most likely the answer is yes to all of these questions.
Does anyone really believe that negative interest rates will finally get Japan out of its self-made economic hole? The problem in Japan is that the government never allowed failed banks and corporations to do just that—fail. This overhang of inefficient capital allocation was never allowed to clear since the Japanese real estate bubble burst a couple decades ago. No band aid or quick fix Keynesian sugar high will fix this problem. As a recent financial talkin head put it, “The Bank of Japan can always be relied upon to do the exact wrong thing.” Japan needs to quit spending money, fix its banking system, and pay down its debt. Only then, maybe, will its economy being to grow.
In the U.S. and Europe, we have similar problems and issues. Debt levels are reaching historic levels and growth has been hampered by central bank policies, the opposite effect of what was intended, to the consternation of the Fed and others. The only thing that will get the economic engines of the West humming again will be to bite the bullet, stop spending money we don’t have, and pay down our debt levels. We can’t spend, print, or borrow our way out of this problem. Only good old fashioned fiscal and monetary sound policies will do the trick.
Yes, there will be pain in the short run. We could dip into a recession. However, just as with Paul Volker’s attack on inflation in the 1980’s, once the problem is solved, Western economies will come roaring back, setting the stage for a sound economic future for our children.
Negative interest rates are not the answer to the problems in Japan, Switzerland or the United States or Canada. The answer is getting our financial house in order. Then, and only then, can the world’s economy recover.
L. Todd Wood is a former emerging market debt trader with 18 years of Wall Street and international experience. He is also an author of historical fiction thriller novels. His first of several books, Currency, deals with the consequences of overwhelming sovereign debt. He is a contributor to many media outlets and is a foreign correspondent for Newsmax TV. LToddWood.com
