Tuesday, February 23, 2016

Stephen Roach: Central Banking Goes Negative

In a new article appearing on the Project Syndicate web site, economist Stephen Roach talks about the move towards negative interest rates around the world. Below are some quotes from his article and then a few added comments.


"In what could well be a final act of desperation, central banks are abdicating effective control of the economies they have been entrusted to manage. First came zero interest rates, then quantitative easing, and now negative interest rates – one futile attempt begetting another. Just as the first two gambits failed to gain meaningful economic traction in chronically weak recoveries, the shift to negative rates will only compound the risks of financial instability and set the stage for the next crisis."

"The adoption of negative interest rates – initially launched in Europe in 2014 and now embraced in Japan – represents a major turning point for central banking. Previously, emphasis had been placed on boosting aggregate demand – primarily by lowering the cost of borrowing, but also by spurring wealth effects from appreciating financial assets. But now, by imposing penalties on excess reserves left on deposit with central banks, negative interest rates drive stimulus through the supply side of the credit equation – in effect, urging banks to make new loans regardless of the demand for such funds."

. . . . . . 

"The shift to negative interest rates is all the more problematic. Given persistent sluggish aggregate demand worldwide, a new set of risks is introduced by penalizing banks for not making new loans. This is the functional equivalent of promoting another surge of “zombie lending” – the uneconomic loans made to insolvent Japanese borrowers in the 1990s. Central banking, having lost its way, is in crisis. Can the world economy be far behind?"


My added comments: In a recent blog article I suggested that the move to negative interest rates is seen by most people as the central bankers waving a white flag of surrender and as an act of desperation. Here is the quote from this recent article:

" According to this CNBC article, negative interest rates employed in Europe were a failure because they instilled a lack of confidence in the system by the public. Of course they do. It's basically looked upon as officials waving a white flag of surrender. Everything else we tried failed so now we are going to punish savings and force you to spend or invest. It looks very desperate to most people."

It appears that Stephen Roach agrees in this new article. He goes a lot further than I did and says this will "only compound the risk of financial instability and set the stage for the next crisis."

By now it should be obvious to anyone who follows this blog regularly why we encourage people to stay alert and informed. It should also be clear why we talk about watching for signs of another major crisis and why people should have a plan in mind to deal with one if it happens. It's not because we are predicting such a crisis or even know when we might get one again. It's because monetary officials are behaving in ways that suggest we have to be on the alert. They issue warning after warning about the potential for asset bubbles bursting (due to their own easy money QE policies building up the bubbles in the first place). They are talking about bail-ins, eliminating cash, forcing everyone into a digital monetary system so they can control capital flows if need be (such as during a crisis, remember Greece), and imposing negative interest rates because everything else they have tried is failing to get desired results.

Here we have actually gone the extra mile to try and show that despite all the many warnings and weird proposals being floated by monetary officials that we do believe there are tools to deal with systemic problems should they arise (we listed some in this article). We think that people need to be aware of those tools along with the warnings about potential crisis. But it's getting harder and harder to make that case when we constantly see more officials talking about things like negative interest rates as Stephen Roach points out in this article (hint: Stephen Roach is not a fear merchant, he is a highly respected economist who is simply expressing what a lot of people are feeling right now including Dr. Michael Ivanovitch and former Dallas Fed President Robert McTeer). We can add on former BIS Chief Ecnomist William White whose interview we recently covered here. Minneapolis Fed President Neel Kashkari wants to break up big banks to "avoid a meltdown". We could make a much longer list.

As always, we state here that do not know if we are going to get another major crisis or not. We talk about the potential for one only because so many current and former monetary officials talk about it and because respected analysts like Jim Rickards are forecasting one. If we don't get a crisis, that's great news. However, to ignore all these respected voices and just assume we will never get another major crisis is foolish in our view here. It is the same as owning a $500,000 beach front home and watching a potential hurricane move towards it while making no effort to protect it and also owning no insurance policy on it. Taking those actions is not fear, it's just common sense.

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