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Around the world, central bankers are using unconventional strategies in an attempt to stimulate their economies.
First came quantitative easing, or QE. With QE, central banks buy bonds from commercial banks, which has the effect of raising the price of bonds and lowering their yield. It also increases the money supply, giving commercial banks more money to lend. The idea is that the resulting lower interest rates and more money in the system available for borrowing will boost economic growth and also increase inflation (or at least stave off deflation).
Opinions on the effectiveness of QE are across the board, from advocates who believe it saved us from depression to critics who say it has distorted asset prices and just postponed the inevitable collapse. The reality is somewhere in the middle. A global depression was averted. However, seven years after the credit crisis, healthy global economic growth is still elusive.
Now, central bankers in several countries are reaching in the toolbox and selecting another unusual tactic in their quest to enhance growth–negative interest rates.
Japan’s central bank became the latest to drop rates below zero. The -0.10 percent rates will apply only to new balances (reserves) that commercial banks park at the central bank. Existing reserves will continue to earn 0.1 percent. So far, the negative rates apply only to commercial banks that are customers of central banks. At the consumer level, banks likely will resist cutting deposit rates and alienating their customers, who already are wary of no earnings on savings.
Negative consumer deposit rates would foster unusual behavior, provoking people to either withdraw their savings and put it under the mattress or spend it (the preferred behavior by central banks wishing to boost growth). On the other hand, mass consumer withdrawals would reduce deposits at banks and curtail their ability to lend.
Japan’s move to negative rates means that nations producing almost 25 percent of world output now have a central bank with a negative interest rate. Other countries where central banks are using negative rates include Switzerland (-0.75 percent), Sweden (-0.35 percent) and Denmark (-0.65 percent). In December, the European Central Bank, which oversees 19 countries in the Eurozone, cut its deposit rate to -0.3 percent. Observers believe Canada could be next.
If you think negative interest rates are strange, financial scholars are bandying about even more bizarre ideas for stimulating economies. Consider these methods offered up by two Harvard economists: Ken Rogoff suggests banning cash. This would allow banks to charge negative rates on electronic deposits at banks. Because consumers couldn’t withdraw paper cash, they would instead resort to spending, thereby stimulating the economy.
Greg Mankiw offered that the Fed could announce a lottery and draw a number from zero to nine whereby all paper currency notes ending in the selected digit would become worthless for a period of time. This would make the expected return of holding cash -10 percent, effectively turning the interest rate negative and prompting consumers to spend.
The negative interest rate experiment will be watched closely by global monetarists. These strategies provide interesting discussion for U.S. investors, but their full attention should be on the businesses they own and the opportunities that recent market volatility is providing.•
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Skarbeck is managing partner of Indianapolis-based Aldebaran Capital LLC, a money-managementfirm. He can be reached at 818-7827 or ken@aldebarancapital.com.
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