Infinite Negative Rates, Infinity Gold Prices. Ben Davies

Negative Interest rates have long ceased to be the thing of legends. The Scandinavian central banks have engaged in negativity for some time now. The Riksbank and Danmarks NationalBank are evidently run by Odin and Thor. So omnipotent in their gestures, cutting rates again and again. Only recently the Norse Gods have been at mischief again — this time it would seem these central bank governors really do believe in the market monetarist myth — that if one wants to maintain economic growth, one must target the Nominal GDP trajectory. Essentially Odin and Thor determine the path along which NGDP should grow by using their monetary policy tools — in other words no interest rate is too negative too this end.

Sweden, a country with 3% GDP growth y-o-y and stable price inflation, as well as a run-away housing market, up 20% on average of late since rates went negative, has seen the Riksbank cut to -0.50% from -0.35%. A tad more than market expectations let’s say. Sweden’s main export market is really the EU but the Krona hasn’t been exhibiting any strength against the euro this past year, so even in the beggar-thy-neighbour export war, this rate cut seems nonsensical. Notwithstanding negative interest rates are nonsensical in the first place. One can only conclude they are front-running the ECB. SuperMario is priming the bazookas for a radical adjustment of its rate facilities.

There are now five regions with negative interest rates, Denmark, Sweden, Switzerland, Eurozone and most recently Japan — “The Club of 5” — It won’t be long before it’s Club 10.

In July 2012, my erstwhile colleague Simon White, Head of Risk Management penned this research blog entitled:

Negative Interest Rates — Central Banks’ Next Bullet and Why It Makes Investing in Gold Essential

The ECB’s recent decision to lower the deposit rate — the rate it pays to commercial banks for excess reserves — to 0% marks a new chapter in the developed world central banks’ response to the ongoing financial crisis. The EUR dropped over 4% against the USD in the following days as international investors switched out of euro-denominated reserves. Soon after the ECB’s announcement there were reports speculating that the Fed would consider lowering the IOER (the rate it pays to banks for excess reserves, currently 0.25%), and that the Bank of England would lower its deposit rate too. Moreover, the Bank of Japan lowered the floor, from 0.10%, it pays to purchase government bonds in its so-called Rinban operations. The world of competitive devaluations is alive and well, and being played out in the arcane world of central bank deposit rates.

However, there is more to come. No sooner had the ECB made its rate cut, forecasters were pencilling in more, with the corollary that the deposit rate would soon go negative. That is, if commercial banks wanted to hold excess reserves at the ECB, they would have to pay for the privilege.

We think this will come to pass, and it won’t be long before most if not all of the major central banks are operating some form of negative interest rate system. We think this is important as it marks a sea change in the attitude of central banks to a long-running problem of the current monetary policy framework.

In essence, the tools available to central banks are asymmetric. In response to a booming economy with ever rising inflation, a central bank can use its main tool — the overnight interest rate that it sets — to eventually bring inflation under control and cool down the economy to a more sustainable pace. No matter how high the inflation rate, the bank can keep raising the interest rate in response.
 
 But, throughout this financial crisis, central banks have been fighting a different problem. The huge contraction in the shadow banking system following the subprime and Lehman busts left a yawning gap in the amount of credit available in the financial system. Unless debt were to be defaulted on en masse — something no government or central bank wants to countenance — the only solution has been for governments to step in and assume the extra debt burden. Central banks have so far assisted their respective governments by buying up government debt in quantitative easing programmes.

Central banks have been battling to resuscitate something called the ‘money multiplier’. This is, essentially, the ratio between the money created by the central bank (eg that which it created to buy government debt when it quantitatively eased) and the money created by the private sector. As the chart below shows, this collapsed after the financial crisis beginning late 2007, and has been falling for almost all of the time since.

To stimulate spending and to try to encourage the private sector to start lending again, central banks in developed countries slashed interest rates to close to zero. But this is where the asymmetry kicks in. Taking rates less than zero is non-trivial. And for one good reason: the existence of cash. Cash — which in technical terms, is an infinite maturity bearer bond which pays 0% interest — limits the ability of central banks to impose negative interest rates.

If, for instance, the ECB were to impose negative interest rates on excess reserves, then commercial banks could always swap these reserves into currency or actual vault cash and therefore not be penalised at all (after all earning 0% interest is better than a negative rate). There may be practical impediments to this, such as insurance, and taking physical delivery of actual cash. Alternatively, banks could move their reserves from the excess reserve account at the central bank and switch them to the current account (analogous to a regular bank account holder switching their funds from their savings account to their current account). This has already happened to some extent at the ECB. Yet, in a negative interest rate environment, it is likely the central bank would impose a ceiling on the amount that can be held in the current account.
 
 Nevertheless, the existence of currency makes it difficult for central banks to achieve their goals when interest rates are at or close to their lower bound (this is known as the ‘liquidity trap’). Which is why, in the future, policymakers may look at ways to circumvent this ‘anomaly’
. For instance, one way may be to eliminate cash altogether and use only an electronic form of currency. More and more transactions take place electronically, so this is not far-fetched. With electronic cash, central banks would be able to impose negative interest rates on currency as easily as they set positive ones.

So the one refuge savers still have — ie they can always hold cash, even if it earns 0% interest (and in real terms, it already earns a negative return) — may be the next totem to fall in response to the financial crisis. The monetary authorities would move closer to asserting absolute control over money.
 

 As we said above, esoteric, negative interest rates that central banks set in their activities with commercial banks may be the first, unsettling steps in this process of the complete appropriation of peoples’ choices in how they save — and when and how they spend — their money. Indeed, Sweden has already tried negative rates, and Denmark has them currently. These countries are harbingers of what is to come.
 
 
In this new paradigm, gold becomes even more desirable. It pays 0% interest, and the only way to force this negative is to tax the holding of it. Make no mistake this may happen, but there will always be a jurisdiction that will not agree — or need to agree — with taxing the purest form wealth there is. Gold owners can always shift their holdings to such places.
 
 Owning gold is the best way to hedge yourself from the complete autonomy monetary policymakers are incrementally asserting over all forms of money. Negative interest rates are merely an entrée in this process. Gold is ever more transparently becoming the last refuge in a world headed to monetary dominance.

So there you have it. We are often asked why we do not write as much as we use to. Well just like nobody wants negative rates nobody really wants to hear negative news anymore. We set our roadmap from 2007 to 2014, saying the balance of payments crisis of the Bretton Woods II monetary system will envelop the world in deflation and negative interest rates. We wrote at the time to subscribers that the time to own gold without hesitation was now. If you had large equity exposure you needed to divest of all your holdings and go to cash, T-bills and gold.

With regard negative interest rates, individual bank account holders may not necessarily feel the burden of these, as the negative rate is in theory solely based on facility rates. For as we articulated back in 2012, negative rates are imposed by the central banks on the domestic commercial banks for the excess reserves they hold at their respective central banks.

Negative interest rates though are effectively a charge for use of accounts. They may not necessarily become ubiquitous but it is happening. In Australia, the Americas, South Africa and Asia, the banks charge for checking accounts and it wasn’t so long ago that this was common practice by banks worldwide.

We suspect many banks in countries faced with charging customer interest rates on deposits will also tend to make up for the cost borne on them by charging higher rates on other products. For example mortgage rates in Switzerland’s banks have been set higher on 10 to 15 year fixed-rates at 2.0% and 2.5% respectively.

In Germany Deutsche SKatbank, one of the smaller Land banks has already imposed 0.25% charge on accounts with over €500,000 on deposit. Commerzbank has said it will inflict these “punishment interest” rates on larger corporations.

So charges are occurring and once bank customers begin to see it widespread they will accept it as the norm. Andrew Haldane of the Bank of England mooted the potential of a cashless society i.e. banning cash. This was precisely because he fears that if negative interest rates are implemented and thus de facto charges on deposit accounts occur in the UK, this would force people to remove cash from the banks and hoard it. He must have been reading our research blog.

A charge on gold storage and spend doesn’t seem onerous in this light. If you think the chance of infinity gold prices is stupid then you must think negative interest rates are equally asinine….

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Originally published at hindesightletters.com.