In this day and age, we are bombarded by articles about the various ways mankind is destroying this planet, through increasing pollution, emissions of carbon dioxide and urbanisation. In addition, a crescent view is growing that the widespread developments in artificial intelligence (AI) that have been happening, and are set to continue, will bring about mass unemployment, with the gap between the haves and have-nots spreading tremendously, causing the alienation of a majority of the population from the fruits of the technological progress. Moreover, some even believe the entire human species is in jeopardy of being totally wiped out.
The aim of this post is not to discredit these assumptions. Despite these themes being interesting premisses for Hollywood movies (like The Day After Tomorrow or Kingsman, on climate change, and 2001: Space Odissey or The Terminator franchise, on AI), in my opinion, they are unfounded. In any case, for those who believe that nonsense, they should be rejoicing over the fact that the developed nations in the world are on the verge of implementing negative interest rates. In spite of the Euro Area (deposit facility), Japan, Denmark and Switzerland being currently imposing the infamous Negative Interest Rate Policy (NIRP), plus Sweden having experimented with it for awhile, they will soon be joined by the other western countries as these are already at zero or very close to it. Taking a look at the interest rate, savings and time preference section, you know the interest rates are a function of savings and these, in turn, are derived from the time preference. Interest rates are positive because people have positive time preferences. This stems from their preference to satisfy their needs in the present rather than in the future, which leads people to demand a higher return on savings than the opportunity cost of savings (cost of foregoing present consumption). In lay terms, people only save if they assess that by doing so they can improve their lives and well being in the future. Hence, a positive time prefence is a requisite for civilisations to develop. Furthermore, a negative interest rate would only be materialised in a free market - without central bank manipulations -, if individuals had a negative time preference. This means they would not mind, and in fact want, the cost of savings to be higher than the return on savings. In other words, only present consumption matters, so much so that if they put money set aside the amount has to decline over time, so that they have less resources in the future, halting or even depleting the capital structure and, consequently, reverting prosperity. It goes without saying that people have positive time preferences. Despite all of those Chicken Littles who believe we are destroying ourselves, they still do not want to burn their hard-earned pay. Thus, this is only possible through central banking devilry. Additionally, were the interest rates on deposits to be negative, everybody would instead hold cash outside of the banking system. Accordingly, in order to force people to keep their currency in the banks, central banks are going to ban or hinder the use of paper money, i.e. cash. The move towards a cashless society has been gaining momentum, with institutions having been developing infrastructures for digital currencies. Besides cryptocurrencies, there are other initiatives in the pipeline. China has been developing its own digital yuan and in the future, as Jim Rickards proclaims, Russia and the rest of the "Axis of Gold" could have their joint digital currency backed by gold, the PutinCoin or XiCoin as he calls it. In the private sector there has been other projects referred to as stablecoins. The most prevalent ones are Facebook's Libra, JP Morgan's JPM Coin and Fnality International' Utility Settlement Coin (USC). Stablecoins are digital currencies pegged to a central bank currency, like the dollar, or a basket of currencies. Fnality International is a consortium comprised of some of the world's biggest banks. Its objective is to deliver a distributed ledger technology (DLT) based global payment system, one that can facilitate peer-to-peer markets. The crux of USC is that it has been sold to people as a model for a decentralised digital future. We are told that JPM Coin and other stablecoins will offer an alternative method for transacting through distributed ledger technology, one that moves away from the centralised ground of today – ground that is monopolised by central banks. Another objective of Fnality International is to connect decentralised market infrastructures to a corresponding central bank, which presumably would result in transactions being settled in central bank currency, through DLT ready payment systems. The USC and the other stablecoins will also have to conform to international anti-money laundering and know-your-customer regulations. Hardly an example of a decentralised utopia. More importantly, the IMF has been studying the most practical way to make NIRP possible. In an IMF working paper entitled Monetary Policy with Negative Interest Rates: Decoupling Cash from Electronic Money, the framework and rationale of (almost) banning cash is layed out. Its plan is to have a dual local currency system: cash and digital. The rationale is for central banks to be able to break on through the zero lower bound (ZLB). With such a system in place, a central bank would be able to use conventional monetary policy tools without the constraints of the ZLB to stabilize the economy. In a world of low neutral real interest rates - e.g. inflation rate of -5% would be matched with a -5% interest rate -, it would help reduce the length of business cycle downturns and, hence, the duration of low interest rate periods. Interestingly, cash would be maintained, for five reasons: cash is still widely used and banning it could lead to disruptions in retail; poorer and older people are less likely to use electronic payment methods; cash is preferred by those who put privacy above everything else; in case of malfunctions on the electronic means of payment, cash is the only option; and if cash is abolished the decision would be hard to revert. In terms of the design, the digital currency would pay the policy rate of interest, and cash would have an exchange rate, the conversion rate, against the digital. This conversion rate is key to the proposal. When setting a negative interest rate on the digital, the central bank would let the conversion rate of cash in terms of digital depreciate at the same rate as the negative interest rate on the digital. The value of cash would thereby fall in terms of the digital currency. In following this scheme, the banks would be able to pass on negative interest rates to their depositors, without causing a flight to cash. The funny (peculiar) aspect of this is the notion that the keynesians at the IMF believe that NIRP, in such a system, would effectivelly counter recessions, making the economy to expand again. However, as I explained above, only positive interest rates foment societal progress by reflecting individuals' desire to better their well being. In short, people save because they want something better in the future. Inversely, negative rates will incentivise individuals to spend their income now, precluding them from saving to improve their welfare. To conclude, although NIRP is aimed at being a tool to achieve the keynesians' wet dream of leveling the business cycle and having permanently booming economies, the outcome is the complete opposite. Individuals would stop thinking of ways to improve their future situation because they would be focus only on the present situation, freezing prosperity. After awhile, everyone would become aware of the failure of this policy, demanding for a reset of the monetary system, which I exposed in the previous post. For the time being, the move towards digital will keep on advancing, with stablecoins probably taking the lead and central banks following suit or adopting them. On some other day I will discuss the dynamics that the NIRP is going to produce in the economy, but as you can imagine the implications of this policy are dreadful.
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AuthorDaniel Gomes Luís Archives
March 2024
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