With intensifying concerns regarding the soundness and stability of the international monetary and financial system, calls for reforming it have been on the rise.
By T Sabri Öncü, an economist based in Istanbul, Turkey, and cross-posted from Economics and Politics Weekly.
Oldrich Vasicek is an old friend. When I started my “quant” career in bonds in January 1994 in Walnut Creek, California, Oldrich was there. A recently graduated PhD in mathematics, I received my first real-life finance education from him.
Vasicek (1977), a statistician by trait, is famous for developing the first theory of term structure of default risk-free interests rates in 1977. But, despite this, he had been unfortunate until lately because his theory allowed for negative nominal interest rates. Many modellers considered this as a flaw because negative nominal interest rates were unimaginable then.
And recently, the entire term structures or in non-academic parlance yield curves of Denmark (on 24 July 2019), Switzerland (on 29 July 2019), Germany (on 5 August 2019) and the Netherlands (on 5 August 2019) went below zero. On 15 August 2019, Finland’s entire yield curve also went below zero, but the next day, the longest maturity rate was above zero. I presumed it would go below zero again and, as expected, it went below zero on 28 August for another day. Belgium and Sweden seem to appear next in line, although which one will win the competition remains uncertain.
Negative Interest Rates
Let us forget about the theories and look at the history of nominal interest rates starting from about 5,000 years ago (who knows, maybe earlier?) when lending for interest started (Hudson 2018). Although negative interest rates had occurred on some rare occasions in the past, such as on some gold deposits during the gold rush of 1848–55 in California as protection costs, the start of the “formal” history of negative interest rates goes back to the 1970s.
Given that Super Imperialism was kicked off in 1971 (Hudson 2003), it does not come as a surprise that the first “formal” negative interest rates had been imposed on bank deposits of foreigners in Switzerland from 1972 to 1978 to discourage capital inflows to ease the appreciation of the Swiss franc. But, what is Super Imperialism and what happened in 1971?
Super Imperialism is a term coined by Michael Hudson (1972, 2003) in his celebrated book, Super Imperialism. The Pluto (publisher of the 2003 edition of the book) press release on 25 November 2002 describes the concept as follows:
Past studies of imperialism have focused on how corporations invest in other countries, extracting profits and interest. This phenomenon occurs largely via private sector investors and exporters. But today’s novel form of international financial imperialism occurs among governments themselves, and specifically between the US Government and the central banks of nations running balance-of-payments surpluses.
The larger their surpluses grow, the more dollars they are obliged to put into US Treasury securities. Hence, the book’s title, Super Imperialism.
If you agree with this description, then the kick-off date of Super Imperialism was 15 August 1971, although the transition had taken place over about five years through the monetary crisis of 1968–73 and Super Imperialism formally started in 1973.
On the kick-off day, the then United States (US) President Richard Nixon gave his now-famous speech in which he announced his New Economic Policy in an address to the nation on “The Challenge of a Peacetime Economy.” He said:
We must create more and better jobs; we must stop the rise in the cost of living; we must protect the dollar from the attacks of international money speculators.
Among many policy tools to achieve these goals, he suspended the dollar’s convertibility into gold…