After listening to the exchange between Rick Santelli and Harvard University Professor Former IMF Chief Economist Ken Rogoff on CNBC I felt the need to break down just the last portion (the 3minute to 4 minute mark) of the interview which can be found here: https://goldsilver.com/blog/fmr-imf-chief-economist-rogoff-on-manipulation-of-capitol/
Professor Rogoff states that “if you do it right negative interest rates could be a powerful instrument in a financial crisis.”
First, in a capitalist society with free markets everything has a price and interest rates are the price of money. They reflect the cost to borrow. Also, in a capitalist society with free markets the key to free markets working and to money being allocated properly (meaning that money is used productively) is something called price discovery. Price discovery is where buyers and sellers come together to determine a fair price. Now, if the Federal Reserve can manipulate (hold interest rates near zero and eventually take them below zero) we see several different things happen. Money is allocated to companies, projects, and people that are totally unproductive and demand for products is pulled from the future into the present. For example, when the interest rate on car loans is 0% people that were not going to buy a new car for several more years purchase a new car now. Companies use the free money to buy back stock or to fund projects that never would have been feasible if interest rates were normalized. Think of all the oil and gas companies that have been funded from cheap money (do a Google search for “oil companies going under”). Free or near free money distorts and twists an economy. Think of the .com boom and bust, the housing boom and bust, the oil/gas boom and bust going on right now.
The next thing we see happen is prices get completely out of whack with reality (we no longer have a true price discovery mechanism). Let’s look at the .com boom/bust. Prices for stocks that were not making any money, and had no potential to make money, went to the moon. In the housing boom/bust the prices of houses sky rocketed in many parts of the country. Now, while the boom is in progress everyone seems happy, but the problem is the prices are not driven by fundamentals but by free or nearly free money. Builders build more homes than are really needed because everyone can get a mortgage. Eventually the prices crash causing many to lose their money (some to lose their life savings) and many to lose their homes.
At the same time that money is being offered for free causing distortions in the economy those that are trying to save for their future are being heavily penalized by near-zero interest rates. Pensions are starved of a normal yield causing them to be underfunded. So, home prices go up and crash, people lose their homes while at the same time the savers (the vast majority of the population) are making almost nothing on their savings. In fact when inflation is factored in they are losing money. If inflation is 1.75 percent a year and your savings bond pays you .25% a year you are effectively losing 1.50% per year of purchasing power. As a consumer, purchasing power is what we should be focused on. Now, losing 1.50% in a single year may not seem like much but over 5, 10, 15 and 20 years it adds up significantly. Remember all those financial sites that showed you the power of compounding your money at 6, 7 or 8% a year? Well, compounding magic does not work so well at .25% a year or when you go negative. Circling back to the major pension funds, this is the problem they are running into. They were counting on a 6 – 8% return and are not able to achieve that in a near-zero rate environment.
Now that we have established how near zero rates distort the economy and crush the savers and pension funds, we need to ask who benefits from near zero rates or possibly negative interest rates. The answer is that the government and the financial industry benefit the most because they are the biggest borrowers. The government benefits because they do not have the revenue to pay for all of the social programs they offer. The financial industry benefits because when you use borrowed money you are using leverage and leverage increases returns dramatically both on the upside and the downside. On the upside the financial industry keeps all of the money and on the down side they come to the government and the Federal Reserve seeking to be bailed out. So, while near zero interest rates help the government and the financial industry they cause money to be allocated unproductively, prices to rise to unsustainable levels, industries to produce more than is really needed, and savers and pension funds to be crushed.
Taking this whole argument one step further, if after almost 10 years of near-zero interest rates the economy has still not recovered and many distortions have been created, how would more of the same, negative interest rates, help? If businesses used this same line of logic they would quickly go out of business. Let’s take a business that offers a widget at slightly above cost that no one wants. They decide that if they offer the widget at cost that will certainly increase sales. Only the problem isn’t the price but the widget. Now, the business continues with this line of reasoning and decides that what they really need to do is to offer their widget for 10% under the cost of producing the widget to increase sales. The thinking being that they will make up the difference on the increase sales volume, the problem being that it is not the price but the product. This appears to be the line of reasoning that the Federal Reserve, Professor Rogoff and others are using. They just have to get the price of their product lower and everything will turn around.
Lastly, Professor Rogoff mentions his new book “The Curse of Cash”. Interestingly, I assume from a cursory review of his book that he really believes banning cash will help fight crime, drugs and illegal activity while allowing a policy (of lowering interest rates) that has not worked for the last 10 years to magically work now. Apparently, he hasn’t looked at how banning convicted felons from having weapons has not really stopped them from possessing weapons or drastically reduced crime in general. But, more importantly, he, like the Federal Reserve, never stops to consider it is their policy that causes many of the problems we are experiencing in the economy today, not the money we use or the freedom to use different forms of money (cash, credit cards, gold, silver, barter). I suspect Professor Rogoff feels if we could just force/coerce everyone into a financial system that is centrally controlled and that they have no way out of, our monetary experts could work their magic and force people to buy/spend their money before it was reduced to nothing by negative interest rates. This then would cause demand to increase, companies to hire more workers, to buy more materials and machines, to make more capital expenditures and the economy to boom. The problems is it hasn’t worked thus far, but maybe, like the business above if we just continue to try the same failed policy for a longer period of time and in greater degrees, certainly it will work. It actually is very similar to the medical insurance solution we currently have (ACA). If we just force everyone to buy a policy (go cashless) that covers things they will never need and fine them (negative interest rates) if they do not participate, everything will work out perfectly.
The powers that be want to move us to a cashless economy because we as individuals really don’t know what is best for ourselves and it has huge benefits to them but it will limit our choices and crush our ability to save. If you haven’t read my article on “A Cashless Society” please take a minute and give it a read https://steemit.com/money/@freemarkets/a-cashless-society
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Thanks - Jim