Submitted by Tyler Durden
Over the weekend there was a flurry of commentary around the increasing use of NIRP by central banks, and the program’s declining effectiveness. Predictably the IMF – whose Christine Lagarde recently said “When The World Goes Downhill, We Thrive“, came out in support, while investors Larry Fink and Bill Gross came out hammering the program.
On one side of the argument, and to the surprise of no one, the IMF was quick to defend negative rates. In a blog post on Sunday, the organization listed the reasons they favor NIRP. Despite the fact that they admit individuals may just increase their cash position, they base their argument on the fact that lending will increase and portfolios will rebalance from fixed income into riskier assets such as equities, corporate bonds, or property.
The portfolio balance channel appears to have operated normally at negative rates. Wholesale interest rates have fallen with central bank deposit rates. Money market trading activities appeared to have declined, but it is not clear whether these effects reflect negative rates per se, or the substantial surplus liquidity associated with quantitative easing that reduces the demand for trading. Lower risk-free wholesale rates have tended to encourage investors to switch from low yield government securities to riskier assets such as equities, corporate bonds, or property. In addition, lower wholesale interest rates have reduced the cost of funds for those borrowers such as large corporates who can directly finance in commercial paper and corporate bond markets.
On the other side are Blackrock’s Larry Fink and Bill Gross, both of whom came out hammering NIRP, pointing out that it would decrease spending, lead to disastrous consequences for insurance companies and pension funds, and generally crush the middle class.
Larry Fink’s take, as the Financial Times reports, is that savers aren’t going to be able to get the returns they need to prepare for retirement, so as fixed income rates go negative they would divert those funds into savings instead.
This reality has profound implications for economic growth: consumers saving for retirement need to reduce spending…A monetary policy intended to spark growth, then, in fact, risks reducing consumer spending.
Bill Gross agrees with that sentiment. In an interview with Barrons, Gross touches on the fact that savers would be going to cash, but also brings up the fact that insurance and pension models would blow up, and along with it, the ability of states to fund their liabilities, or insurance companies to honor their commitments.
So where does that leave our economy?
In the developed financial economies, as a bloc, lowering interest rates to near zero has produced negative consequences. The best examples of this include the business models of insurance companies and pension funds. Insurers have long-term liabilities and base their death benefits, and even health benefits, on earning a certain rate of interest on their premium dollars. When that rate is zero or close to it, their model is destroyed.
To use another example, California bases its current and future pension payments to civil workers on an estimated future return of 8% or so from bonds and stocks. But when bonds return 1% or 2%, or nothing in Germany’s case, what happens? We’ve seen the difficulties that Puerto Rico, Detroit, and Illinois have faced paying their debts.
Now consider mom and pop and other people who read Barron’s. They are saving for retirement and to put their kids through college. They might have depended on a historic 8%-like return from stocks and bonds. Well, sorry. When interest rates get to zero—and that isn’t the endpoint; they could go negative—savers are destroyed. And savers are the bedrock of capitalism. Savers allow investment, and investment produces growth.
Of course central banks will do what they please, as they know best of course. Many countries have already enacted NIRP, and some speculate that the US will follow in short order, although that remains to be seen.