Summers And Roubini Talk Negative Interest Rates, Sound Logic But Uncharted Waters

Let me say that Larry Summers certainly holds to the Democratic Party mantra of job creation through monetary policy. However, he really could care less about jobs, in my opinion, when push comes to shove. Larry Summers cares about banks. And low interest rates insures that banks remain functioning, as they skate on thin ice, like Will Rogers once said about the state of banks in the Great Depression.

You cannot have a .25 basis rate hike without putting the banks on thin ice these days. That is the Summers' message. And China just cut their funds rate .25 percent and our stock market in the United States rejoiced for a while. Talk about thin ice.

Back in 2013, Summers talked about how the natural interest rate sans a bubble economy is negative. Yes, negative. Remember, this is not some chump off the street. Larry Summers was the second choice behind Janet Yellen for Fed chairman.

The relentless decline of the 10 year treasury bond interest rate, stopped only by the Dot Com bubble and housing bubble, is decidedly down over the past 20 years.

So, raising rates in the midst of little bubble activity seems to Summers to be ludicrous. You could say housing is in another bubble. But it is a bubble for the wealthy. It does not appear that Main Street is participating in many bubbles right now except in auto sales. In fact, it is more likely that main street is a victim of bubbles that exist, at least in food, housing and until recently, oil and building commodities.

Keeping Main Street weak, through technological gains and job elimination and China slowing, could theoretically push interest rates down to negative territory and certainly, the Fed fears Main Street becoming strong without a reliance upon the credit their member banks offer. Wage inflation is a no no, although bankers really like asset inflation.

When Volcker raised interest rates to over 20 percent to stop inflation back in the '70s, the act only destroyed the S&Ls. If someone tried to stop overheating nowadays by that method, you would destroy the TBTF banks, ie. the financial system itself.

The economy simply cannot be permitted to overheat in any significant way, the key being tamping down any wage inflation which can be done whether there are bubbles or no bubbles. I think that this bully of a financial system has been Alan Greenspan's plan all along. He has created this monster, with diminishing or stagnate main street consumer demand, which Summers is trying to make sense of, with potentially dreadful consequences.

So, Summers is basically saying or implying that the economy on Main Street cannot be permitted to engage in bubbles anymore, unless negative interest rates are available as a means of stimulus after the resulting crash.  

Bloomberg agrees with Summers. There are not very many options left in a downturn.

The Fed wants to raise rates now, and lower them later while still being positive. But it is looking like that could hurt the banking systems and obviously undo the stock markets around the world.

Keeping Main Street bubble-free ensures some bank stability but profits are low. Or if you want Main Street to engage in bubbles, and Summers says they are necessary to growth, you have to allow negative interest rates in times of bust. Of course, at the point at which the negative interest rate is at  minus 100 percent, you will just give your money to the banks and never see it again.

While that prospect is ridiculous, Larry Summers, on his own blog, spoke of permanent secular stagnation.  Summers says that there is too much saving in America. He says that this excess saving slows down the economy. Of course, his goal is a cashless society, where people will have to put their money in the bank, and in order to avoid losing it to negative interest, will be forced to spend the money to stimulate the economy.

That is his way of aborting secular stagnation, or deflation. Summers is far more worried about secular stagnation than he is worried about inflation.

Summers believes that in any crisis, Fed funds rates must be cut at least three to four percentage points. That means, if there was a crisis today, Fed funds would need to be lowered to minus 3 to minus 4 percent! Without a cashless society in place, those low rates would be difficult to do in the face of inevitable bank runs.

If you think that little notion of negative 4 percent is far-fetched, Nouriel Roubini and Paul Krugman have advocated negative interest rates and/or a cashless society as a means of stimulating the economy as well. While they make valid arguments logically, I have to tell you that there is an aspect of totalitarianism in their thinking. Economics as a dismal science rarely gets more dismal than this. I think this is a potentially chilling plan going forward, as the world spirals towards deflation.

But that is where we are as the Fed looks foolish in trying to raise interest rates by a pitiful 25 basis points month after month, without achieving the goal! The actions of the Fed make Larry Summers look more reasonable and logical all the time, and that is scary. Derivatives are the cause of this, you know.  Derivatives' demand for collateral forces treasury bond prices up and treasury bond yields down.

The need for collateral has made treasury bonds into rock stars. The shortage of those bonds is a huge reason why I believe Summers wants interest rates to stay low and go lower.  It has nothing to do with jobs. According to Summers, jobs are going to be lost anyway, to technology.

No, Summers wants low rates and it has to do with hedge funds, financial clearing houses and banks. If interest rates remain low,  the people who need to buy scarce bonds as collateral will not be interfered with by some old retired guy who wants to make a little interest on bonds.

God forbid that the average Joe would hold precious clearing house collateral and have it lying around doing nothing! No, the financial system, and I think this is the crux of Larry Summers' thinking, has to make treasury bonds look really ugly to the public. Low and negative interest rates make these bonds ugly to Main Street, but they are still very pretty to people who want to make deals on Wall Street.

This must be what people are talking about when they say the financial system is divorced from the real world. There isn't anything brave about this new world. It is dreadful in its design.

Truth is, Wall Street folks will pay banks for the privilege of owning treasury bonds for use as collateral. They don't care if there are negative interest rates. The more negative, the better, as that means they won't have to worry about not having enough bonds with which to do business. 

Roubini, as I said above, is in the negative interest rate camp. No big deal to him, since you accept zero interest at the bank and that is an effective negative rate as inflation runs higher. Roubini says you will also get used to accepting having money pulled out of your account for interest payments when real negative rates become a reality.

I always thought Roubini had a Rasputin quality about him. 

That need for negative interest rates to provide economic stimulus is the only significant reason for a cashless society, to keep you from hiding your money under the mattress and not spending it. All other reasons are just secondary.

But Roubini talks about the mattress as well. He talks about robberies increasing once thieves know society is putting money under mattresses and in walls, and also he speaks about the destruction of said money by rodents. I kid you not.

Roubini and Larry Summers are not madmen,but certainly there is a sense of desperation and risk of negative consequences coming out in their thinking. One could think that their thinking puts us on the edge of the abyss of economic thought. But it is Roubini who wants you to just accept negative rates voluntarily. I bet he can afford a rodent-proof safe.

As I said, I don't believe these economists want Main Street to participate in more bubbles until the negative interest rate regime is in place. After all, they can't control the behavior of the masses in a bubble-then-crash setting. They can't control the masses if interest rates rise and the masses gobble up all their precious treasury bonds, the new gold of the derivatives clearing houses.

They don't want people walking away from their loans again, because they fear the government will be adverse to future bailouts. Truth is, it will be easier to accomplish bail-ins if money is held captive in the cashless society.

Better to have negative interest rates, so that people will want to spend their money, say the economists. But Roubini's idea has a fatal flaw: many will still hide their money and not spend it. That is, after all, the prudent way to live, or at least always has been until this derivatives monster was created.

Summers, alas, has the plan that will work, force you to spend or lose money in your forced savings account. But the St. Louis Fed disagrees, saying that negative interest rates are not a tool that should be used by central banks:

The above examples of negative central bank policy rates are newsworthy because they are unusual. Some analysts have argued that such examples suggest that central banks should consider setting negative policy rates, including negative rates on deposits held at the central bank. Such proposals are foolish for a number of reasons. First, a policy rate likely would be set to a negative value only when economic conditions are so weak that the central bank has previously reduced its policy rate to zero. Identifying creditworthy borrowers during such periods is unusually challenging. How strongly should banks during such a period be encouraged to expand lending? Second, negative central bank interest rates may be interpreted as a tax on banks—a tax that is highest during periods of quantitative easing (QE)Central banks typically implement QE policies via large-scale asset purchases. Sellers of these assets are paid in newly created central bank deposits, which, in due course, arrive in the accounts of commercial banks at the central bank. It is an axiom of central banking that the banking system itself cannot reduce the aggregate amount of its central bank deposits no matter how many loans are made because the funds loaned by one bank eventually are redeposited at another. Is it reasonable for the central bank to impose a tax on deposits held at the central bank when the central bank itself determines the amount of such deposits held by banks and the banking system? Perhaps these and other considerations caused European Central Bank President Mario Draghi in a recent press conference to label negative deposit rates "uncharted waters" and dismiss any possibility that the ECB would consider it.

In summary, in normal economic times, both nominal and real interest rates are positive. But in unusual times, negative nominal and real yields are not unusual. Both often reflect investors' flight to safety. The existence of negative yields, however, provides no support for the argument that central banks should consider negative policy rates as a monetary policy tool.


Remember I said that Summers only cares about the banks. He would surely expect the banks to pass on negative Fed Funds rate to customers, making the negative savings rate even more negative than the Funds Rate. He would sacrifice the savings of Main Street Americans to keep the banking system afloat in a deflationary environment. Stimulus would come from savers, and while it makes logical sense, it is a real theft, a tax imposed by a financial system that is not our government, but is international and not beholden to, nor patriotic toward, any national government.

Negative interest rates could vary from nation to nation, but would be a New World Order private tax, collected by the  globalists and their banks, not from government. Talk about taxation without representation. Keep in mind that the St. Louis Fed said that rates are negative in unusual times, while Summers has said that rates are negative when there are no bubbles. Summers is saying that negative rates are a new normal, if you will.

How Americans react to this potential totalitarianism of finance will certainly be interesting to watch going forward. Perhaps if Summers is thwarted in his grand plan, the next downturn could see stimulus just handed out to regular people, with the caveat that it could not be used to pay down debt, only to spend towards a little prosperity for the economy. Summers' plan is totally reasonable, in a crazy sort of way, if his assumptions are correct about our "unusual times".

You would think consumer spending and dollar turnover would create a multiplier effect, if Main Street had any extra dollars, that is. But giving Main Street extra dollars risks overheating the economy, which I have already said cannot be stopped by conventional means. Volcker-type interest rate hikes would destroy the TBTF banks, not just S&Ls.

I am not sure the consumer's pocketbook can survive the potential triple Fed mandate of wage stagnation, asset inflation, and negative interest rates all happening at the same time. It sounds as if Larry Summers wants this, and if unusual times are the new normal, he is saying there is no other choice in the future.

I am not an investment counselor nor am I an attorney so my views are not to be considered investment advice.

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