The spread of negative bond rates throughout Europe brings to a close the “crisis is over” period. On Wednesday, Germany auctioned off 2-year bunds at a record low -0.07%. That followed Tuesday’s negative rate tender in Denmark, that country’s first since the euro crisis “ended” in 2012. Anyone who pays even the slightest attention to the fate of the euro has seen the same spread of negative rates once more throughout Switzerland, the euro’s foil through much of that period. Not only have Swiss rates turned markedly lower, interest rate swap spreads have compressed back to similar levels as those “worst” days.
Those bond yields, however, are a sideshow to the “real” European center, its vast interbank market. Unlike the United States with a bond market of equal and in some places greater size to its banks, Europe is conspicuously more “banked” as their role in that system is expanded. So where the ECB sees continued erosion in lending to anything outside of a sovereign government, it is simply determined to change that “fortune.” To wit, the ECB has tried, unsuccessfully, to re-ignite the “animal spirits” of European banks through targeting interbank rates and methods (collateral mostly).
Going back to early May 2013, the ECB has been narrowing its rate corridor in what looks definitively to me as an attempt to actively “corral” Eonia (the unsecured and private overnight interbank rate). With Eonia fixing in the very slight negative almost every day now, the ECB has “had” to narrow the rate corridor by two-thirds in that time (from 150 bps down to just 50 bps), bringing the deposit rate “floor” more deeply negative (at -20 bps) with its Main Refinancing Rate barely positive (just 5 bps).
That seems in keeping with the orthodox textbook as to cutting interest rates in order to “stimulate” lending and demand (thought to be one in the same). However, there is clearly something deeply missing from that approach as nothing that has been tried has curtailed the curtailment in lending in Europe. As it was, the companion monetarism launched this year aside the rate corridor “management”, the “T” LTRO’s, came in very low (well below all projections) in its subscriptions this week. European banks just don’t want to follow central bank “orders.”
The widening circle of negative rates as the developed world continues on its course of Japanification does nothing to confirm the textbook approach. The development of that very textbook dates back more than a century, to the period in which central banking gained itself the very management role in ironically (given what transpires now) partnering with banks. When Andrew Carnegie wrote in 1908 of gold as the North Star, he was proposing not the fullest pledge toward the gold standard as it existed then, but rather was pointing toward the coming changes that would result in the Federal Reserve System:
“Man found that gold possessed many advantages as a metal and was the one that fluctuated least in value; therefore its merits have made it the standard of value. That is all. If another metal appears that keeps truer to uniform value, it will displace gold and make itself the standard, as Lyra, under present conditions, will finally displace the present North Star.”
Unspecified in this quoted passage is what Carnegie was asserting, namely that banks “full” of gold would thus be of sound position in order to issue their own currency free from most restrictions, especially in line of a bank panic. By the time of the Panic of 1907, that had come to be something of the official doctrine of the inflationists, Populists, and everyone with any interest in detesting stable money. In linking the gold standard to bank panics, but retaining the best qualities of gold, the path was open to the eventual overturning of all traditional monetary function.
The key to the entire affair lay in the panics themselves, these periodic openings of disorder and dysfunction that even the common man was forced to be a part of. The modern business cycle, which was then only half a century or so in existence, had become a major feature of modern, industrial life. By the time Carnegie tried to assert asset-side dominance for bank rules, the US and global economy had only recently passed what was then called the Great Depression, the decade of the 1890’s that came to shape (like the 1930’s) almost everything thereafter.
One of the founders of the Federal Reserve system, Senator Robert Owen had close experience with the Panic of 1893. An entrepreneur of sorts, Senator Owen had founded a bank back in his home state of Oklahoma, only to see it nearly extinguished in that event. As a presumably sound practitioner of bank principles (I have never seen any evidence otherwise of his First National Bank of Muskogee, though that would be something of an obscure historical observation) you can understand the detestation of any process that would in a single stroke destroy “good” firms at the same moment as “bad.”
Indeed, that is what panics have been projected, the blind withdrawal of actual money from banks, both sound and insolvent, and very likely more of the former than the latter. That makes this process an easy case to make, especially to a public whereby bank panic means a close following of widespread unemployment and economic misery. It is here where the gold standard seemingly loses its entire luster, as it becomes a mechanism that stitches together systemic failure of the good and bad.
That became the doctrine of currency elasticity and not just in the United States. Through growing public anguish, these elite financialists sought to gain full control over monetary affairs in order to create a system whereby gold might be preserved for public taste but also to dispel these tendencies for systemic disorder. The appeal of currency elasticity, or what we call today liquidity, was that “objective” mechanisms might be put in place to determine the difference between good and bad banks, and thereby allow a “reserve” system to reject systemic pressure in favor of only those solvent.
Curiously absent from most descriptions of this historical process, and even its modern incarnations, is how that sets the public’s interest against itself. Essentially, with true money as property, banks have no choice but to follow the rules of property and act simply as custodian with deposit claims gaining the highest priority. That puts the onus upon banks to try to measure “good order” as it relates to fractional lending of that property, which is the very discrepancy of bank panics as they were – people care little about a bank’s losses, only if those losses might lead to a situation whereby the bank is deficient in its custodial duties and fails to return such property.
This overturning of historical bedrock principle has been referred to even to this day by quoting Senator Owen in one of his more famous phrases. Although I have not yet seen it in Chairman Janet Yellen’s speeches, then-Chairman Bernanke spoke of it on more than one occasion, noting, “it is the duty of the United States to provide a means by which periodic panics which shake the American Republic and do it enormous injury shall be stopped.”
That is not the full quote, however, as Senator Owen had much more to say on the subject though it has never gained that same notoriety (as it should).
“It is the duty of the United States to protect the commercial life of its citizens against this senseless, unreasoning, destructive fear that seizes the depositor when he has been sufficiently hypnotized by the metropolitan press with its indiscreet suggestions.”
Here we have the defining principle of the modern monetary age, whereby the role of villain in the process of banking panics is played by the public and nothing else (except maybe the incitement of the “metropolitan press”). And so the entire evolution of banking from that point forward, aided in no small part by the Federal Reserve’s existence, was to separate the banks from their depositors. The degree to which that has been accomplished,especially since the 1960’s and 1980’s, is staggering.
The vast array of monetary programs and incidences are all instituted toward that purpose, so that banks can be insulated from “the people”, those laypersons far too simple and ignorant to understand the details of high finance. Therefore, monetary purpose lays down in that track, a close partnership between government, through central banks, and banks themselves. The very existence of heavy monetarism is traced to that detail, where banks are backstopped by central banks in order that they continue unabated by the hand of public emotion – to keep credit and debt flowing, and thus, as theory contains, the very economy itself.
The problem of the current period, then, presents an existential counterpoint to that founding theory. It is not just that European bond and interbank rates have turned negative in 2014, but that those negative rates continue a string of dynamic action that upends such theory totally. Tracing the means of dysfunction in monetary terms back even to 2007 shows that it wasn’t the public enthralled by emotion and panic so much as banks themselves. The Panic of 2008 was the first (major) instance of a panic among and between only banks; the public and depositors were almost totally uninvolved outside a few outlier instances (like IndyMac and Northern Rock).
The major failures, especially Lehman Brothers, Bear Stearns and the GSE behemoths, turned not on public indulgence but rather interbank fear. The very contempt that monetary policy has held for more than a century, in total favor of an elite banking regime I might add, was exhibited in the very place that it was not supposed to ever have penetrated. The very rationale for taking money as property (through Executive Order 6102, as authorized by Congressional action of the Emergency Banking Relief Act of 1933) was that it could not be “trusted” in the hands of the public; far better to remain under dominion of banks and the central bankers. Monetary socialism was born under the exact premise that it was the public’s action that created economic dysfunction, and that bank/central bank partnership, encoded by law and political interweaving, would answer all affairs for all time.
What we observe of 2008, however, is even worse than that as the system had turned in on itself without any relation to the public, as was designed. The entire absence of true money actually contributed to the framework deficiency as nobody, in the banking and central banking realm, had any real idea what belonged where. There are far too many examples of that to exhibit here, so I’ll just refer to one instance.
A still-unappreciated piece of the puzzle in the days leading up to Bear Stearns’ demise was the role of monoline insurers in not just providing liquidity (in the modern sense) but stability. Liquidity today is misunderstood as something like what it was when Robert Owen and Andrew Carnegie debated in favor of the asset side. Indeed, the modern asset side system, enshrined in Basel rules, is that “capital” and thus “risk” are to be determined by what a bank holds rather than the liabilities a bank owes (shifting depositors to the lower ends of the priorities).
A full part of what allowed “money” expansion in the 1990’s and 2000’s was manipulation about capital regimes and asset side determinations. In that role, financial institutions that provided risk absorption services, those that “write” protection, for example, actually were providing more than hedging services as that amounts to the modern conception of liquidity. Among the largest classes of liquidity and risk providers were monoline insurers, who were very disposed in the 2000’s to take “easy money” of writing credit default swaps.
A central flaw in the credit system under securitization was that credit default swaps formed far more than hedging instruments, which were widely used by financial participants holding large credit positions (again, emphasis on regulatory leverage), but the backbone of the pricing system through the Gaussian copula (and derivatives of that statistical inference). In that narrow sense, the elite banking system had captured for itself an infinite feedback loop of potential destruction.
As the word subprime spread in usage and alarm, interbank markets finally and suddenly began to take notice of this monoline proclivity toward acting as a balance sheet risk absorber. The “funny” thing was, as interbank markets backed away from the monolines, their ability to act as a liquidity provider (through essentially renting out their balance sheet capacity) was further impaired by the very asset-side focus on the modern bank system. What that did was imperil not just ongoing systemic capacity for “liquidity” but also the very credit default swaps that were used not just as hedges elsewhere but systemic pricing benchmarks for trillions of dollars in credit instruments.
So liquidity was tied directly to pricing that was tied directly to liquidity and back to pricing, and so on forever. In that important sense, and this cannot be overstated, the lack of any valuation anchor like true money made it impossible to sort out and find some kind of central point of focus. That was why the Fed and other central banks foundered in their responses, because it was utterly impossible to pinpoint exactly the problem, especially as everything was the problem. In the anachronistic notion of bank panics, at least the central axis of it was clear – liquidity was the ability of banks to meet their custodial obligations, good or bad.
When viewing the monetary comedy of Eonia pressing below the zero lower bound and the ECB “forced” to chase it in the vain hopes of somehow incentivizing banks toward lending, you realize that nothing has changed from 2007 and 2008. To generalize about that panic is to notice that this bank/central bank system devoid of a role for public input actually turned in on itself – that was what negative interest rates then were really about. The system was fighting itself to find some way out of an impenetrable entanglement.
And so it is today, as central banks not just in Europe but all over the place find themselves deeply at odds with the very banks that are supposed to be so closely aligned as to be nearly indistinguishable. That is a direct violation of the founding theory of the Federal Reserve itself and the nature of banking as it came to exist thereafter; including the activism that central banks took as duty in the years after all vestiges of the gold standard were completely erased. Such persistence of negative interest rates, or what is looking like global Japanification, betrays the very elemental premise of all orthodox monetary theory.
Further, there is no longer any observable justification for removing property from the financial system. As it were, if banks are susceptible to panic, even for different reasons coursing through the exact same manifestations (emotion), then the elimination of public property (real money) has only served to end the chief function of gold as central arbiter of imbalance. By not having a central money anchor, imbalances have grown to immense proportions, not just in terms of debt saturation but the degree to which financialism has upended proportionality as a tool for the real economy.
And here we have the answer to the “great” orthodox “mystery” of secular stagnation, or whatever it might be called in years ahead if we never divert from Japan’s laid track. I don’t want to commit the common logical fallacy whereby invalidating one aspect does not necessarily annul an entire argument or philosophical bend, but since monetary theory ties together almost all its modern facets around this central point the wide legitimacy of it all should at least be in question. Ridding the economy of actually free markets, under property regimes, and socializing money into ephemeral concepts of “liquidity” and ledger “currency” was supposed to end depression itself (now one of the most prominent orthodox economists refers to the current period as the “Lesser Depression”).
Removing depositors from bank existence was supposed to provide stability, as central banks in particular would gain “flexibility” from placing themselves and their banks atop the monetary pyramid. The net gain for all of that “flexibility” was told as improved economic function. That has been disproven and continues to be by observed events now stretching decades.