Friday, March 04, 2016

The Negative Rate Disaster

The Negative Rate Disaster
By Geoffrey Pike | Friday, March 4, 2016
I’ll make you a deal: You can give me your money, and then I’ll give you back most of it next month. Or you can give it to me for 10 years, and I will give all of it back to you in a decade as long as you make small, periodic payments to me.

Who in their right mind would take this deal? Apparently there are some people in Europe and Japan who are doing this. This is the world of negative interest rates.

It was just over a month ago that the Bank of Japan (BOJ) announced its new policy of negative interest rates. Specifically, the central bank is imposing a negative rate of 0.1% on excess reserves held by banks. This is supposed to get the banks to lend money in order to jumpstart the economy.
This idea of negative rates goes against everything we have learned about money. An interest rate is supposed to be a reflection on the price of money in relation to time preference.

If you ask someone if he would prefer a dollar today or a dollar a year from now, most people are going to take the dollar today. Even if you may not spend it until a year from now, at least you have the option.

If you were offered one hundred apples to eat, you might prefer to have one a day for the next 100 days instead of getting them all at once, assuming that they would be fresh each day. That is because apples will go rotten. If you get 100 of them in one day, you better quickly sell them or find people to give them away to.

But money is not the same as apples. Money does not go rotten (setting aside what central bank inflation may do). You can save money. You can buy goods and services with it today, or you can wait for another time in the future to buy. This is the luxury of an advanced civilization with the use of money and a high division of labor.

Imagine a world a long time ago where people bartered goods and services. Imagine a baker with many loaves of bread having to find various people to trade with. It would be a nightmare without a common medium of exchange. It is much easier to sell the bread for some form of money that is widely acceptable. Then the baker can buy whatever he wants at the time of his choosing.

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