Desperately seeking alternatives to negative rates

Right about now would be the time to be considering alternatives to negative interest rates. First off, let’s take stimulus spending off the table, at least in the United States. A fiscal boost may well be warranted, but so are peace, love and understanding and this is a presidential election year. Global markets have entered something resembling a tailspin, with the impetus most likely being the introduction of negative rates in Japan and further moves below zero in Europe. Financials have been particularly hard-hit, sending many bank shares deep into bear market territory and leaving shares of Credit Suisse at levels not seen in 27 years. Fed Chair Janet Yellen told Congress on Thursday that regarding negative rates, “I wouldn’t take those off the table,” though she also allowed that the legal position was unclear. Investor bets now place only a 3 percent chance of the Fed raising interest rates this year, and at times earlier in the day were showing a cut to be more likely than a hike. Japan can hardly be happy with the reaction to its own step into negative rates: the yen has strengthened and Tokyo stocks, particularly financials, have fallen. So extreme has the move been in the yen that financial markets are now jittery in anticipation of an intervention by the Bank of Japan to drive down the yen. Sweden on Thursday, in cutting rates yet again, this time to -0.50 percent, said it may seek to intervene in currency markets, hardly a testament that the cut will work. The basic problem with negative interest rate policy is that it gelds the banking system, undermining and in instances destroying institutions’ ability to make money from borrowing short and lending long. Negative rates are also crazily negative for institutions with long-term obligations, like pension funds. Because pension funds do something not dissimilar to borrowing short and lending long, falling interest rates make their future liabilities larger. Britain’s Pension Protection Fund said earlier this week that plunging UK rates had ballooned the deficit of its member funds by 37 percent in January alone. William White, a well-known economist and policy maker, argues that economic managers are suffering under the delusion that the economy is like a machine they can manipulate and tightly control. “What we do know is that the health of many financial institutions is now under threat,” says White, who works for the Organization for Economic Co-operation and Development. “Bank profits, needed for capital accumulation, are being reduced by low credit and term spreads. Pension funds and insurance companies are threatened even more. Everywhere, there is the temptation to ‘gamble for resurrection,’ again with unknown consequences. The global economy could now be even more vulnerable than it was in 2007” Disparate alternatives White argues for a humble and fundamental re-think of the wisdom of easy money policies that seem to encourage the accretion of debt and the rise of asset prices. Both of these trends may well be reaching their limits, at least if you look at equity markets and bank bond prices. Don’t be fooled by the spike in gold. It isn’t asking for easier money, but for a stable store of value in the face of dislocation in financial intermediation. Others are advocating hugely disparate other policies. Macro hedge fund manager Eric Lonergan is one of those advocating direct cash transfers from central banks to individuals, an idea sometimes called “QE for the people.” Cash transfers would presumably be more likely to be re-circulated in the real economy than money laid out by central banks for financial assets in QE, and thus might push inflation higher and obviate the need for negative rates. Scott Mather, of fund manager Pimco, also took aim at negative rates in a recent client letter, blaming them for volatility and the tightening of financial conditions. Mather suggests having central banks buy equities or lower-quality bonds as a means to boost financial markets. He also suggests raising central bank inflation targets, a sort of shock and awe means of getting inflation going by acting as if you don’t care if it takes off. Certainly the Bank of Japan has for some time been buying equities, and thus far the impact of this has not proven to be what an economy in demographic decline requires. As for looser inflation targeting or direct cash transfers, the odds seem stacked against either, especially in the United States. We may be left in the position of doing the same thing over and over again and hoping for different results.