Interest Rates Turn Negative

We are fast approaching the point where banks are going to start charging depositors the right to deposit money in their own bank accounts. Let me explain

Money Losing Its Value

The economic growth over the last few years has barely moved, even though in 2008 the government flooded the markets with money and stimulus spending. The U.S economy should be doing much better; but it isn’t.

In a nutshell, what the Administration and the Federal Reserve tried to do was print a ton of money and have that huge influx of money raise the prices of everything. They believed that by doing so the banks, as well as the consumers, would be better off. ¬†Because the banks were underwater on their real estate loans during this time, the governments plan was to inflate the prices of everything, including housing which would make the loans look better. So, if a bank had a loan on their books for $1,000,000 but the property was only worth $800,000, the banks were showing a loss of $200,00. In the Fed’s printing of money scheme, the hope was that the same property, for example, would inflate to $1,300,000 while still having the original loan of $800,000. Like magic, the banks would now be making money!

So, even though the banks’ balance sheets have improved, economic activity remains stagnant. The reason nobody wants to talk about is very simple: people are not spending money. Neither companies nor individuals are parting with their money. This results in the velocity of money¬† (the speed at which money circulates through the economy) being quite low.

When an economy and market are healthy, people will invest and spend. Consumers are willing to spend and invest more because they know they will be able to benefit from that spending. They are confident that their business prospects will be better in the future. But since individual and businesses know the economy is morbid, they are holding on to every dollar.

After all the changes since 2008, and the amount of money creation by the Fed, there is still very low turnover in money. Increased regulations in the banking sector as a result of the Dodd-Frank law, combined with the passage of Obamacare, has increased the regulatory burden for everyone and added to this problem.

These regulations, along with the thousands of others already on the book, are making it harder and harder for the economy to move forward. One way to think of the economy is to think of it analagous to a massive machine with many gears. Prices and economic activity move the gears in an efficient manner. But onerous regulations and rules are like pouring gallons of thick syrup onto the gears. The machine still works… but with drastically reduced efficiency and at a much slower rate. As that activity slows, the flow of money slows down as well.

This slowdown in the movement of money as well as the increased regulatory environment, is not only happening here but in the global economy as well. Interest rates have plunged across the globe, as banks have been flooded with cash from the creation of dollars. The banks, not wanting that money have begun to offer negative interest rates. For example Sweden has negative interest rates. In Sweden, when you deposit $100 into your the account, one year later you will have $99 dollars in that same account. They’re not paying you to save…they’re charging you to save!

Global governments are facing the same problem. Banks flooded with cash, consumers who won’t spend and poor economic activity. The “solution” rapidly approaching is to start charging consumers for their deposits so they are forced to take their money out of the banks.The hope behind this idea is that if they push all of this cash into the consumers’ hands they will start to spend it. An increase in the velocity of money will follow. Many economists fear this approach will result in explosive inflation.

The scenario laid out is that once consumers start to realize that inflation is rising, they will start to convert their dollars into hard assets such as homes, durable goods for example. They will figure out that its better to own an asset that is increasing in value rather than a dollar that is depreciating in value. The solution of changing dollars for hard assets will be their only protection against rapidly increasing prices.

Given the expansion of the size and power of governments throughout the world there is a corresponding need for them to control all aspects of our lives. From the printing of trillions of dollars to the heavy hand of government regulations, we are getting close to a tipping point that could have dire consequences.

The reduction of government regulations and a return to sound fiscal policies would do wonders for everyone everywhere. However it seems the likelihood of such a common sense approach slips further and further away each day as politicians’ egos seem to have inflated well in advance of currency.

Steve

sleeclark@gmail.com