Fed shuffles from ZIRP to NIRP

Inflation is fading; the economies of Asia, South America and Europe are collapsing; the people have tasked the central banks with fixing all things economic. Yet, reports by Fed economists show that the recent rounds of money printing through QE and low interest rates for six haven’t had the intended effect. They have certainly failed in Japan and the Big EZ (Euro Zone). What can they do to turn the world’s economies around? The answer from mainstream economists at the world’s central banks is more of the same. But if continuing to do the same thing while expecting different results is a sign of insanity?
The situation reminds me of an episode in the Bible when the Israelis had embraced the worship of Baal and pushed the worshippers of Yahweh into hiding. Yahweh’s prophet, Elijah, came along, built an altar and put some dead bulls on it for a sacrifice. Then he told the Baal prophets to pray to Baal to send fire to consume the sacrifice. Baal’s prophets prayed for hours without results and became frantic. They began screaming and beating themselves to get Baal’s attention and finally began slashing themselves with knives. Elijah joked that maybe Baal was on vacation.

The failures of polices of mainstream economists in Japan and Europe hasn’t dampened their enthusiasm for those policies at all. Since they haven’t worked, they simply need to double down, like the gambler’s Nightingale fallacy. That fallacy tells gamblers that if they have lost they need to double the size of the next bet in order to recover those losses. It fails every time.

Since the Fed’s zero interest rate policy (ZIRP) has failed miserably, mainstream economists are lining up to promote a negative interest rate policy (NIRP). Of course, being academics they don’t want the unwashed massed to think they just pulled NIRP out of their hats like a magician. They have to find a rationalization for the policy and many are hitting on the idea that the “natural” rate of interest has gone negative and that justifies negative market rates.

Julien Noizet takes on the natural rate argument in his latest blog at. Interest in the natural rate of interest began over a century ago with a Swedish economist named Wicksell. He was concerned with what might be an interest rate in an economy without money, which demands the follow up question, why would interest exist without money? The issue quickly becomes complicated, but the Austrian economist Ludwig Mises simplified it. But the simplest explanation of interest came from John Calvin who wrote that interest on money is no different from rent. If someone wants to live in your house for six months, and you have to live somewhere else for that period, are you going to let them live there for free, or pay them to live in your house? Most people wouldn’t, unless they are family.

The same principal applies to money. Why would a rational person let a stranger take their money and use it a year without compensation for the lack of use of his money? Even worse, would a rational person pay someone else to use his money to earn a profit? Not likely. So the idea that the natural rate of interest can go negative is pure nonsense and it doesn’t matter how many econometric models mainstream economists run to try to prove it.

Regardless of the foolishness of the idea of a negative natural interest rates, mainstream economists are telling us that they will convince central bankers around the world to force market rates to go negative. What does that mean to investors?

Liberty Street Economics, the Federal Federal Reserve Bank of New York blog, told us what to expect from negative interest rates back in 2012 with their post, "If Interest Rates Go Negative . . . Or, Be Careful What You Wish For. (HT: Zero Hedge):

If rates go negative, we should also expect to see financial innovations that emulate cash in more convenient forms. One obvious candidate is a special-purpose bank that offers conventional checking accounts (for a fee) and pledges to hold no asset other than cash (which it immobilizes in a very large vault)...

Beyond cash and special-purpose banks, a variety of interest-avoidance strategies might emerge in connection with payments and collections. For example, a taxpayer might choose to make large excess payments on her quarterly estimated federal income tax filings, with the idea of recovering the excess payments the following April. Similarly, a credit card holder might choose to make a large advance payment and then run down his balance with subsequent expenditures, reversing the usual practice of making purchases first and payments later.

Of course, someone will have to hang onto cash and I'm guessing it will be banks holding excess reserves and taking a scalping from the Fed.  I'm also guessing that special purpose banks similar to what Liberty Street mentioned will rise up but will hold gold instead of currency. When a customer writes a check against their gold stash, the bank will sell gold for currency and make the payment.

The lesson in all of this is the hubris of mainstream economists who think the Fed can command and control the behavior of people.