Central Banks and Negative Interest Rates: It's Going Down For Real!

Central Bank Failure

Since the Brexit vote, panicking Central Banks have flooded the world with more money in attempt to stabilize the financial system. Over thirteen trillion dollars of bonds around the world are yielding negative interest rates, which means nearly 30% of all worldwide government debt is at negative rates.

This is a historical first. I believe that the policy of the money kings of the global central banks is starting to fail. Over the last ten years, the United States has averaged 1.8% GDP growth, the worst in US history. The only success the Federal Reserve and other Central Bankers can point to is an artificially high stock market. Underneath the glow of record highs lies a ticking time bomb of over-extended consumers, decreased industrial production, European-banking problems, Brexit, a massive debt bubble in China, ISIS, deflation and a contentious US presidential election.

If there is a recession in the United States, the Federal Reserve will have a very difficult time cutting rates.  It is this reason that a Fed rate hike could be in the cards.  It would at least give The Fed some room to maneuver back down if recession strikes. The Fed should have raised rates over two years ago.  At zero rates leading into a recession, The Fed only really has three options: fiscal spending, deregulation or currency depreciation.   

Fiscal spending has been an emphasized topic from both US Presidential candidates, particularly infrastructure spending in the United States. Both candidates agree that the United States has lacked infrastructure spending and is in need of a big build-out. This will be one of the big themes in the stock market over the next couple of years. One positive aspect about potential infrastructure spending is that current record low interest rates allow for cheap borrowing. I believe we should require infrastructure bonds to be established as mortgage bonds that pay down the debt at the end. This will eliminate the open-ended borrowing where debt spirals even higher. Instead the projects will be paid off in thirty years just like a home.

The final way for a central bank to control inflation at zero interest rates is currency depreciation. I am expecting a major currency problem in the next 6-18 months that will likely lead to higher inflation. Evidence of the transition from deflation to inflation appears as central banks overplay their hand and currencies begin to fall. Over time, this will be good for gold and hard assets.

Aspin Speech
Long time readers of the MaxOut Savings Report know that I believe Stanley Fischer, the Vice Chairman of the Federal Reserve, is the most respected member of the Fed. Over the weekend, Fischer delivered an influential speech at the Aspin Institute laying out some important points on US economic standing. First, he made the case that over the last two years the United States has weathered a number of economic shocks. The events in China, a 20% rise in dollar value, and the Brexit vote have had little effect on the US economy and the labor market. I believe this could translate to a more hands off Fed. The next time the stock market falls, don’t expect the Fed to rush in and talk it up.

Regarding negative interest rates Fischer stated that it is “something that the Fed has no plans to introduce”. That was a clear statement.

Stanley Fischer also commented on the “exceptionally slow labor productivity growth….Business productivity growth is reported to have declined for the last three quarters, its worst performance since 1979”. Negative productivity is potentially a result of incorrect measurement or poor business investment. Stanley stated the key to boosting the productivity growth and long run potential of the economy is likely found in effective fiscal and “more-effective regulatory policy.” This statement hints the Federal Reserve is concerned that government regulation has become over reaching and is now negatively affecting economic growth.

Regulatory Policy is an area that the United States can make tremendous headway. The beauty of deregulating the economy is in the resulting increase in growth and hiring. Deregulation and regulation efficiency are low cost compared to big ticket deficits such as tax cuts and infrastructure spending. Remember deregulation will grow the economy at no cost!

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