Most Popular
1. Banking Crisis is Stocks Bull Market Buying Opportunity - Nadeem_Walayat
2.The Crypto Signal for the Precious Metals Market - P_Radomski_CFA
3. One Possible Outcome to a New World Order - Raymond_Matison
4.Nvidia Blow Off Top - Flying High like the Phoenix too Close to the Sun - Nadeem_Walayat
5. Apple AAPL Stock Trend and Earnings Analysis - Nadeem_Walayat
6.AI, Stocks, and Gold Stocks – Connected After All - P_Radomski_CFA
7.Stock Market CHEAT SHEET - - Nadeem_Walayat
8.US Debt Ceiling Crisis Smoke and Mirrors Circus - Nadeem_Walayat
9.Silver Price May Explode - Avi_Gilburt
10.More US Banks Could Collapse -- A Lot More- EWI
Last 7 days
Stock Market Volatility (VIX) - 25th Mar 24
Stock Market Investor Sentiment - 25th Mar 24
The Federal Reserve Didn't Do Anything But It Had Plenty to Say - 25th Mar 24
Stock Market Breadth - 24th Mar 24
Stock Market Margin Debt Indicator - 24th Mar 24
It’s Easy to Scream Stocks Bubble! - 24th Mar 24
Stocks: What to Make of All This Insider Selling- 24th Mar 24
Money Supply Continues To Fall, Economy Worsens – Investors Don’t Care - 24th Mar 24
Get an Edge in the Crypto Market with Order Flow - 24th Mar 24
US Presidential Election Cycle and Recessions - 18th Mar 24
US Recession Already Happened in 2022! - 18th Mar 24
AI can now remember everything you say - 18th Mar 24
Bitcoin Crypto Mania 2024 - MicroStrategy MSTR Blow off Top! - 14th Mar 24
Bitcoin Gravy Train Trend Forecast 2024 - 11th Mar 24
Gold and the Long-Term Inflation Cycle - 11th Mar 24
Fed’s Next Intertest Rate Move might not align with popular consensus - 11th Mar 24
Two Reasons The Fed Manipulates Interest Rates - 11th Mar 24
US Dollar Trend 2024 - 9th Mar 2024
The Bond Trade and Interest Rates - 9th Mar 2024
Investors Don’t Believe the Gold Rally, Still Prefer General Stocks - 9th Mar 2024
Paper Gold Vs. Real Gold: It's Important to Know the Difference - 9th Mar 2024
Stocks: What This "Record Extreme" Indicator May Be Signaling - 9th Mar 2024
My 3 Favorite Trade Setups - Elliott Wave Course - 9th Mar 2024
Bitcoin Crypto Bubble Mania! - 4th Mar 2024
US Interest Rates - When WIll the Fed Pivot - 1st Mar 2024
S&P Stock Market Real Earnings Yield - 29th Feb 2024
US Unemployment is a Fake Statistic - 29th Feb 2024
U.S. financial market’s “Weimar phase” impact to your fiat and digital assets - 29th Feb 2024
What a Breakdown in Silver Mining Stocks! What an Opportunity! - 29th Feb 2024
Why AI will Soon become SA - Synthetic Intelligence - The Machine Learning Megatrend - 29th Feb 2024
Keep Calm and Carry on Buying Quantum AI Tech Stocks - 19th Feb 24

Market Oracle FREE Newsletter

How to Protect your Wealth by Investing in AI Tech Stocks

The ECB and the Negative-Interest-Rate Game

Interest-Rates / ECB Interest Rates May 28, 2015 - 02:03 PM GMT

By: Frank_Hollenbeck

Interest-Rates

The ECB is now two months into its bond buying binge but the European Central Bank (ECB) never clearly explained the goal and purpose of its own version of quantitative easing. The deflation bogeyman was never a serious threat, nor was it based on any solid theoretical foundation.

A possible justification may have been to make the 1 percent much wealthier so that their extravagant lifestyles trickled benefits down to the average working stiff. Another possible reason may have been to lower the value of the euro to benefit exporters at the expense of the rest of European consumers, the middle class, and the poor. This would be a violation of the unwritten rule that monetary policy should not be targeting the value of the currency directly.


Of course, when the rule maker breaks his own rules, it reduces the importance of all rules. The commitment not to print to finance government spending has gone to the same graveyard as the 60 percent debt-to-GDP rule or the under-3 percent budget deficit rule. Meanwhile, the ECB’s current actions are making a mockery of the alleged independence of central banking.

Central Banks Are Buying Up Government Debt

Under normal conditions, economists take it for granted that interest rates cannot drop below zero. Instead of paying someone to borrow your money, you could just as easily stuff the money in your mattress. So why is so much of European government debt actively trading at negative rates? Why would you take money out of your mattress and pay 1,060 euros for something that will only get 1,000 euros in a year?

The answer is simple: buying government debt can make sense if you have no intention of holding the debt to maturity and think you can find a “greater fool” who will buy the debt from you. That greater fool is often the European Central Bank which, like many other central banks around the globe, is buying up government debt to keep debt-financed programs alive for another day.

And now, faced with very low or even negative interest rates on government debt, governments have been rushing to issue even more debt before announcing, in all likelihood, more vote-getting government expenditures. So, let’s not be fooled by the ECB’s charade that its actions are not indirectly financing new government expenditures.

Why Aren’t Banks Lending More?

What about bank lending? Isn’t the ECB’s quantitative easing and negative-interest-rate policy spurring a Europe wide surge in borrowing? After all, negative interest rates are supposed to have the effect of discouraging saving and encouraging movement away from presumably safe government debt into other types of borrowing.

You can lead a horse to water, but you cannot make him drink, so the fact that interest rates are at rock bottom levels is not necessarily enough to spur a frenzy of borrowing by businesses in the face of an uncertain economic future.

Banks also face new hurdles. Not surprisingly, the ECB’s current actions are, in reality, being somewhat defeated by its previous monetary policy. Banks, as financial intermediaries, make money between deposit rates and lending rates. They borrow short term and lend long term.

By setting negative rates on reserves, however, and by inducing negative interest rates on government bonds, the ECB has created a significant compression in yields. This has reduced bank profits. Banks must now charge customers for deposits. Large customers such as hedge funds and mutual funds have been withdrawing funds, further drawing down bank profits.

For example, several large pension funds in Switzerland have recently rediscovered the advantages of the mattress. As Pater Tenebrarum noted,

One fund manager showed that for every CHF 10 million in pension money, his fund would save CHF 25,000 — in spite of the costs involved in vault rent, cash transportation and other expenses.

Furthermore, Basel III forces banks to hold more risk-free assets. Banks have been forced to load up on government debt at negative rates. This also has been squeezing profits. Does anyone really expect European banks to lend more in such an economic environment?

What’s the Endgame?

The real objective of the ECB’s current money printing is essentially to kick the can down the road. It won’t solve Europe’s deep-seated structural problems. It will only postpone the inevitable and will also make the final reckoning much, much worse. Printing intrinsically worthless paper will not solve Europe’s fundamental problem of supply being misaligned with demand — a misalignment created by government’s incessant interference with the workings of the price system.

With this new phase of monetary expansion, Europe is slowly walking down the same slippery slope toward hyperinflation that is the inevitable endgame of all fiat currency systems.

In this, Germany missed an opportunity to set the ship straight. It should have made it crystal clear that any purchase of government bonds by the ECB (which violates European law) would have meant Germany’s leaving the currency union and reestablishing the deutschmark under German control. But then again, the German government is not the German people. Such quantitative easing makes it much easier to finance government spending, and the resulting inflation will lower the real value of the government’s existing debt. Of course, this is all for short-term benefits to the government, with long-term costs to everyone else.

Frank Hollenbeck, PhD, teaches at the International University of Geneva. See Frank Hollenbeck's article archives.

You can subscribe to future articles by Frank Hollenbeck via this RSS feed..

© 2015 Copyright Frank Hollenbeck - All Rights Reserved Disclaimer: The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. Information and analysis above are derived from sources and utilising methods believed to be reliable, but we cannot accept responsibility for any losses you may incur as a result of this analysis. Individuals should consult with their personal financial advisors.


© 2005-2022 http://www.MarketOracle.co.uk - The Market Oracle is a FREE Daily Financial Markets Analysis & Forecasting online publication.


Post Comment

Only logged in users are allowed to post comments. Register/ Log in