“Suppose the economic outlook, which I don’t expect, but if it were to deteriorate in a significant way so that we thought we needed to provide more support to the economy then potentially anything, including negative interest rates, would be on the table.”
That was Federal Reserve Chairman Janet Yellen testifying to the House Financial Services Committee on Nov. 4, 2015 to a question by Rep. Tom Emmer (R-Minn.), saying that if the economy turns south, everything is on the table.
Including negative interest rates.
Consider, since that time, the S&P 500 is down abouot 9.6 percent. Jim Stack, president of Stack Financial Management and Investech Research warns the total bear market could have the S&P correcting downward by as much as 34 percent.
The Dow Jones Industrial Average is down 9 percent.
Oil has dropped another 37 percent to about $30 a barrel.
The Bureau of Economic Analysis confirmed the U.S. economy has not grown above an inflation-adjusted 3 percent in 10 years. It may threaten recession in 2016.
The Baltic Dry Index — a proxy for global trade conditions —has been testing all-time lows.
U.S. 10-year treasuries have dropped 0.47 percentage points from 2.22 percent to 1.75 percent — a 21 percent decline in the overall rate.
And just this month, joining the European Central Bank, Denmark and Sweden with negative interest rates at the central bank level is the Bank of Japan, which just went negative, too.
Now, the Japanese 10-year treasury is testing 0 percent, a threshold it already crossed once on Feb. 9, just days after the Bank of Japan’s announcement. On Friday, it was at 0.013 percent.
In short, since Yellen spoke, the economic outlook has been deteriorating. And that means anything, including negative interest rates, must be actively considered, but what about the consequences?
The implication of negative rates, not just on excess reserves, but also the discount window, is that banks will get paid to borrow from the Fed.
Should the deposit rate go negative, depositors will be charged to save money.
Should the mortgage rate go negative, homeowners will be paid to go into debt.
Should U.S. Treasuries go negative, the federal government would be paid revenue to borrow more money.
Just pause there a moment. Because, the implication of the government actually getting paid interest to add to the national debt, now $19 trillion, is quite astounding.
For example, if the federal government were to refinance the national debt at, say, -5 percent, it would earn $950 billion in interest — every single year. It would balance the budget.
While that might sound great on the surface, it would actually be a net tax on the financial system and global investors, whose only option would be to borrow at even lower negative rates from central banks like the Fed to keep the cash flow going.
Then, the scarcity of new treasuries — remember, at that point the budget is balanced — would create artificial demand for the pre-existing, rapidly dwindling supply of positive-yielding bonds.
In the meantime, real-world investors, retirement funds and the smart money that do not have access to central bank borrowing windows and depend on positive yields to survive might start dumping the dollar on foreign exchange markets. Why?
As the world’s reserve currency, the dollar has a special status as the primary means for settling international trade.
Well, when you want less of something, you tax it. And taxing investors for holding dollars via negative interest rates creates a disincentive for holding them for very long — or at all.
Yellen outlined in her testimony that negative would be a “measure to support the economy and to encourage additional lending and to move down yields on interest-bearing assets to stimulate risk-taking [and] investment spending.”
But the real risk is that instead of stimulating aggregate demand, negative rates actually encourage investors and foreigners to get out of dollar-denominated assets like U.S. treasuries. It would encourage institutions to start trading with something that actually has a positive yield, instead of paying for the privilege of merely engaging in commerce.
In short, negative interest rates by the Fed could provoke a run on the dollar. Perhaps it is an outside risk, but a risk nonetheless.
Perhaps members of Congress like Rep. Emmer ought to intervene and take negative rates off the table for the Fed — before we get there. As Yellen noted, “Rule out is something we tend not to do.” That means it might actually happen.
Robert Romano is the senior editor of Americans for Limited Government.
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