By Dmity Orlov and cross-posted from Club Orlov
Previously, I have written about the progression from positive interest rates to zero interest rates (since 2008) and finally to negative interest rates. And I asked my readers a simple question: How will negative interest rates blow up the financial system? And apparently none of you knew the answer. Now, I must confess that to start with I didn’t know the answer either, which is why I asked the question, and my first attempts at finding it were somewhat tentative. But now, having thought about it, I do seem to have found the answer, and it is that…
But first let us back up a bit and answer several preliminary questions:
1. Why did zero interest rates become necessary?
2. Why are negative interest rates now necessary? and,
3. Why are negative interest rates a really excellent idea?*
* if you ignore certain unintended consequences (which is what everyone does all the time, so let’s not worry about them just yet).
1. Interest rates went to zero because economic growth went to zero. If you are just now wondering why that happened, just google “Limits to Growth” by clicking this link. (A public notice about the scheduled end of growth has been on display at your global planning office for four decades now. It is not anyone else’s fault if people of this planet don’t take an interest in their global affairs. I mean, seriously…)
Interest rates and rates of growth are related: a positive interest rate is little more than a bet that the future is going to be bigger and more prosperous, enabling people to pay off the debts with interest. This is an obvious point: if your income increases, it becomes easier to repay your debts; if it stagnates, it becomes harder; if it shrinks, it eventually becomes impossible.
Yes, you can nitpick and split hairs, and claim that there was still some growth, but in the developed economies most of this growth has been in financial shenanigans, fueled by an explosion in debt, and most of the benefits of this last bit of growth accrued to the wealthiest 1%, and did next to nothing for anyone else. Did this growth help support a large, stable and prosperous middle class? No, it didn’t.
In fact, wages in the US, which was once the world’s largest economy, have been stagnant for generations. In response, the Federal Reserve has been continuously reducing interest rates, until they hit zero in 2008. And there they have stayed ever since. But now, it turns out, that’s not good enough. If the Federal Reserve wants to keep the party going, they have to do more, because…