By Matthew Lynn at MarketWatch
LONDON (MarketWatch) — Central banks have slashed interest rates to nothing. They have printed money on a vast scale. Where that has not quite worked, and if we are being honest that is most places, they now have a new tool. Negative interest rates. Across a third of the global economy, money you put in the bank does not only generate nothing in the way of a return. You actually get charged for keeping it there.
That is already producing strange, Alice-in-Wonderland economics, where nothing is quite what it seems. Governments want you to delay paying taxes as long as possible, the mortgage company pays you to stay in the house, and cash becomes so sought after there is even talk of abolishing it.
But the real problem with negative rates may be something quite different.
\As a fascinating new paper from the St. Louis Fed argues, they are in fact a form of tax. They impose a levy on the banking system that has to be paid by someone — and that someone is probably us. That may explain why central banks and governments are so keen on them. Hugely indebted governments are always in the market for a new tax, especially one that their voters probably won’t notice. But it also explains why they don’t really work — because most of the economics in trouble, especially in Europe, are already suffocating under an impossible high tax burden.
Negative interest rates have, like a fast-mutating virus, started to spread across the world.
The Swiss first tried them out all the way back in the 1970s. In June 1972 it imposed a penalty rate of 2% a quarter on foreigners parking money in Swiss francs amid the turmoil of the early part of that decade, but the experiment only lasted a couple of years. In the modern era, the European Central Bank kicked off the trend in June 2014 with a negative rate on selected deposits.
Since then, they have spread to Sweden, Denmark, Switzerland (again), and more recently Japan, while the ECB has cut even deeper into negative territory. They already cover about a third of the global economy, and there is no reason why they should not reach further. The Fed might be raising rates this year, but it is the only major central bank to do so, and if, or rather when, there is another major downturn, it may have no choice but to impose negative rates as well.
To central banks, that is a way of fighting deflation, even though there is little evidence that mildly falling prices do much damage — heck, some of us even like it when stuff gets cheaper. But there may well be a hidden agenda.
In fact, negative rates are a form of stealth tax. In a paper this month, the St. Louis Fed published a paper arguing that negative rates were a form of tax. Why? Because they effectively impose a levy on bank reserves, in the sense that instead of just parking reserves with the central bank at zero cost, or with some modest rate of interest, they now have to pay for the privilege.
And just like any levy imposed on companies, that has to be passed along somehow — in higher charges for customers, or lower wages, or lower dividends. Wherever the bill ends up, someone eventually has to pay. “At the end of the day, negative interest rates are taxes in sheep’s clothing,” it concludes.
Very true. The bill can come in different forms. If banks take a hit to profits, share prices will fall, and investors will have less money. If they pass on the costs to depositors — and some Swiss banks have started charging customers for holding cash with them — they will have less money to spend elsewhere. Alternatively, if they pass it on to borrowers, in the form of higher charges for loans, that will depress spending, and hit the economy as well. The central bank, which is owned by the government, will end up with more money, and everyone else with less. The deeper into negative territory rates go, the bigger that impact will be.
You can already see some of the impact of that in Europe. As rates have turned negative, bank share prices have cratered. Take a giant such as Deutsche Bank, once the mightiest financial institution on the continent. Its shares are down from 40 euros in 2013 to less than 15 euros now – so weak have the shares been that the bank has had to put out statements saying it is not about to go pop. The Eurostoxx financial index SXFINE, +1.00% has lost a third of its value in the last year. They are all suffering badly — as you might expect when a tax is imposed.
The trouble is, another tax is the last thing the eurozone economy needs. Most countries are already suffering under a state that has grown out of control — in both France and Belgium for example, the government now takes in more than half of gross domestic product every year. Tax cuts rather than rises are more likely to stimulate growth.
Indeed, you can also argue that quantitative easing, the first of the extraordinary measures used to fight the 2008 crash, was another form of tax. It has imposed a huge burden on savers, and has made pension funds virtually impossible to operate, imposing a huge hidden cost, while also dramatically reducing the cost of servicing vast levels of government debt.
But negative rates take that a step further. The emergency measures taken by central banks since the crash of 2008 may have been an attempt to rescue a global economy in danger of collapse. But increasingly, they also look like a way of increasing taxes — which may also explain why they haven’t worked very well.