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Now is The Winter of Our Discontent. NZ Reserve Bank Signals Impending Negative Interest Rates

Craig Hutchinson (context, nuance, free speech, privacy)Aug 15, 2020, 2:49:48 AM

A sign of desperation

... when central banks run out of policy options to stimulate their nations' economies [they] turn to the desperate measure of negative interest rates. Central banks impose [this] when they fear their national economies are slipping into a deflationary spiral ...{1}

The Reserve Bank's (RBNZ) recent (12 August) monetary policy statement confirms their intent to shortly implement NIRP - a quaint sounding acronym for a negative interest rate policy - in the form of a negative Official Cash Rate (OCR). This is a last gasp (and certainly futile) attempt to use monetary policy to stimulate New Zealand's critically damaged economy. The 12 August statement is the latest in a series of warnings going back to March when a negative OCR topped the list of their so-called alternative policy tools to combat the pending economic crisis. By August 6 the RBNZ reported they were "completing work with financial institutions" to prepare for a negative OCR. Their latest policy statement is just the alarm starting to scream and flash bright red.

The RBNZ is obviously worried about the slowing velocity of money, and rightly so from their perspective - low money velocity is directly related to debt-deflation {2}. And debt-deflation is a central banker's worst nightmare because under our current debt-funded, consumption-based, infinite growth economic paradigm, debt-deflation means unshakeable deep economic contraction, which leads to the unspeakable big 'D'. Depression.

The RBNZ knows this policy is highly risky and will result in "a significant increase in financial exposure" to the government, which is why they sought, and received, an indemnity against losses that would otherwise be contrary to their legal remit. In truth NIRP is not actually an alternative policy tool; it's an extremist version of the only monetary policy tool they know - monetarism. NIRP is only proposed as a last desperate attempt to create more private debt in order to kick start spending by an already deeply indebted private sector. They hope to get some inflation into the economy. All I can say is 'good luck with that'. Just look at Japan's 30 odd years of trying. And Japan began in a much healthier global economic climate.

What does a negative OCR mean?

With a negative OCR, instead of receiving interest on savings, you will likely pay interest on savings, albeit probably hidden away as extra fees

The OCR is the interest rate the government charges banks to borrow money and it influences the interest rate you pay on debt and receive on savings. In theory, a higher OCR results in both higher borrowing- and deposit-rates. The converse is also true: a lower OCR should lead to lower rates for both. So when the OCR drops below zero, expect to start paying for the privilege of letting the bank use your money.

What it won't mean is banks paying lenders to borrow. It does mean that banks get paid by the government to borrow money which they then on-lend for a profit. Though the actual mechanism remains uncertain at this time, it will likely result in a small positive interest rate charged for loans, and higher structural fees to make up the lost interest income - after all the private banks sole aim is to protect their profits.

What about existing debt. Won't my interest rate drop?

No. Or more accurately, not at all (or by much) for some debt, and not quickly for others. Existing loans are covered by preexisting contracts and unless they can be renegotiated it is unlikely many loans will see an interest rate drop. Mortgages, which are renegotiated over their multi-decade terms, will possibly see a reduction, but this will take years to flow through as people's current terms expire over time. Credit cards may reduce from the current usurious rates to slightly lower, still usurious, rates. Car loans and other for-consumption debt isn't normally renegotiated and that's unlikely to change.

[Added 19 August: Economist Steve Keen says NIRP will result in increased interest rates for existing debt. See his analysis here.]

So who will this benefit? A very select few.

NIRP may benefit that tiny sector of the population that can actually get new debt, though I wouldn't be surprised to see a requirement for a certificate of mental health before new loans are issued - who in their right mind would consider taking on more debt at the moment (this includes S&M business, which would normally be excepted from this sort of statement because they use debt to generate income; I ask them 'where are your customers coming from? The people who won't be eligible for this new debt?'). Still, the key phrase here is 'new debt'.

This idea is to encourage new debt and get people spending this new debt on consumption. The risk is people instead use the new debt to bid up asset prices (e.g. property). Eitherway, it seems the government believes that New Zealanders, who are among the most indebted people (currently private debt is about 180% of GDP) in the world , will benefit from more debt. If they can get it. A one-last-gasp effort to try and breath some life into the zombie New Zealand economy. But here's the thing. As economist Michael Hudson says:

Debts that can't be paid, won't be paid

No bank will create debt unless they are reasonably certain of getting repaid. There are two scenarios whereby banks can achieve this certainty. The traditional method, where the loan is secured against an existing asset and the lender can likely repay it. That's a big 'and' in the current economic climate. In this scenario most people won't actually be eligible for new debt even if they wanted it. The second scenario sees the banks receiving a guarantee from the government; in this case the banks will happily lend to any and all, knowing future generations of New Zealanders will repay the loan if (when) the lender defaults. Both scenarios are a bad idea because both scenarios will double down on what is already the major problem and risk in the New Zealand economy. Private debt.

What about savings?

The negative rate will probably manifest itself as a fee. Not that it actually matters how it appears. NIRP is intended to discourage people from saving and it will work. Because why would anyone want to keep money in the bank when they are being charged for the privilege - especially when this is over and above the shrinkflation-by-stealth already experienced in the guise of fees. In effect savers will be paying a storage fee to the bank for the privilege of them borrowing your money.

How will this play out?

Some will act as rabbits in the headlights and watch the effects steamroll their savings. Others will stuff their savings under a mattress and hope there's no inflation (which as I said is the actual aim of NIRP). These hoarders (a pejorative term for savers that people will soon become familiar with*) are probably safe in the short term though I don't recommend it as it comes with other risks (e.g. theft). Still others will 'invest' in the stockmarket; a risky proposition when all stockmarkets are over heated with little relationship between the share price and earnings (P/E). I won't be doing that unless I know the business well. Some sensible souls will invest in assets which can help them at least protect value and possibly generate income - land for example, if bought at a good price and no debt.

And some will invest in physical precious metals, which have generally retained value for centuries until recently; it's been a wild ride for both gold and silver over the last 50 years, though this could be changing. There is a lot of talk in the bullion market about the long awaited bull market finally starting, with talk of prices doubling and then some, especially silver which has started from such a low point. Silver has risen over 60% since early June, but there are still plenty of commentators who believe silver is just starting. The massive fiat money creation currently happening is usually part of those commentaries.

What I can't see is people going out and spending new debt for consumption - conditions are just too uncertain. It's a crazy policy.

Possible solutions coming ... .

* Didn't have to wait long. Three days after writing, this appeared at interest.co.nz "a lower OCR would encourage cash hoarding and break down the transmission of monetary policy". This may be the first public utterance of 'hoarding' as a pejorative this depression.

Keep Calm and Carry On

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{1} https://www.investopedia.com/articles/investing/070915/how-negative-interest-rates-work.asp

{2} This will be contested by neoclassical economists, the same people who have hoodwinked two generations of uncritical politicians. Nearly everything they believe is built on the broad shoulders of intellectual fantasy - as economist Prof. Steve Keen says (Debunking Economics, p. 18, 2nd Ed., 2011) "Virtually every concept that is taught as gospel in the text books has been proved to be unsound in the original literature." (my italics). Keen is unloved by the neoclassicals; it's not hard to see why. Unfortunately for them he was one of the tiny number of economists who forecast the 2008 Global Financial Crisis and published on it before events. Even worse, he was able to explain why - using models that actually worked! An example relevant in this context is they (neoclassicals) believed money velocity is constant. They're now finding out it's not. Yet it's a critical assumption in their models (which are wrong anyway). So we shouldn't worry what they say. Except they're the ones who control the financial levers - no matter what the politicians like to believe.