The Negative Interest Rate Gap

By Dmitry Orlov and cross-posted from Club Orlov

Back in the early 1980s the US economy was experiencing stagflation: a stagnant economy and an inflating currency. Paul Volcker, who at the time was Chairman of the Federal Reserve, took a decisive step and raised the Federal Funds Rate, which determines the rate at which most other economic players get to borrow, to 18%, freezing out inflation. This was a bold step, not without negative consequences, but it did get inflation under control and, after a while, the US economy stopped stagnating.

Well, not quite. Wages didn’t stop stagnating; they’ve been stagnant ever since. But the fortunes of the 1% of the richest Americans have certainly improved nicely! Moreover, the US economy grew quite a bit since that time. Of course, most of this growth came at the expense of staggering structural deficits and an explosion of indebtedness at every level, but so what? Sure, the national debt went exponential and the government’s unfunded liabilities are now over $200 trillion, but that’s OK. You just have to like debt. Keep saying to yourself: “Debt is good!” Because if everyone started thinking that debt is bad, then the entire financial house of cards would implode and we would be left with nothing.


But once interest rates peaked in the early 1980s, they’ve been on a downward trend ever since, with little ups and downs now and again but an unmistakable overall downward trend. The Federal Reserve had to do this in order to, in Fed-speak, “support economic activity and job creation by making financial conditions more accommodative.” Once it started doing this, it found that it couldn’t stop. The US had entered a downward spiral—of sloth, obesity, ignorance, substance abuse, expensive and disastrous foreign military adventures, bureaucratic insanity, massive corruption at every level—and under these circumstances it needed ever-cheaper money in order to keep the financial house of cards from imploding.

And then, in late 2008, the Fed finally reached the ultimate target: the Fed Funds Rate went all the way to zero. This is known as ZIRP, for Zero Interest Rate Policy. And, unfortunately, it stayed there.

It stayed there, instead of continuing to gently drift down as before, because of a conceptual difficulty: how can an interest rate be negative? Does it become a “disinterest rate”? How can that work? After all, lenders are “interested” in lending because they get back more than they lend out (accepting some amount of risk); and depositors are “interested” in keeping money in banks because they get back more than they put in. And if these activities become “of zero interest,” why would lenders lend and depositors deposit? They wouldn’t, now, would they? They’d buy gold, or Bitcoin, or bid up real estate.

But of late other central banks around the world came up with a brilliant innovation: negative interest rates. Both Japanese and European central banks sent rates negative. That’s right, now money isn’t just free any more, but you can be paid to borrow! Good-bye ZIRP, hello NIRP! And if you are silly enough to keep your money in the bank, the bank charges you for that privilege. Of course, people are not so silly, so instead of putting their money in the bank they will buy precious metals.

And if they don’t have the money with which to buy precious metals, they can always be paid to borrow some, and buy precious metals with that. And that will cause a shortage of precious metals. Don’t worry, you and I will still be able to buy a handful of gold and silver coins, but what about the fortunes of the 1%? They need the ability to buy gold wholesale, tons of it, and if they can’t then they will throw a fit and knock the card table over, taking the financial house of cards with it and leaving us with nothing.

Yes, that’s a danger, but the world is a dangerous place, and in the meantime we have a more serious problem: deflation. Unlike the 1980s, when the US dollar was experiencing double-digit inflation, now most things are getting cheaper. Commodity prices are way down: oil, gas, copper, steel, you name it, and this is seriously hurting all kinds of businesses. Sure, education, medical care, rent and a few other things have never been more expensive, but they are all optional because, unlike the suffering business tycoons, you can just stay ignorant, sick and homeless. The important thing is that a gallon of pesticide-laced milk is still cheap, and Walmart still has everyday low prices on shoddy imported products. But there is a problem: when everything keeps getting cheaper businesses can’t make money and there are job losses. Hello, Federal Reserve!

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