A recent Wall Street Journal piece titled “Are Negative Rates Backfiring? Here’s Some Early Evidence,” cites worries among economists that consumers and businesses are saving instead of spending, raising a conundrum that flies in the face of economic conventional wisdom.
How can it be that, in spite of central banks across the world paying debtors to borrow, individuals across Europe and Japan are saving more and companies in Europe, the Middle East, Africa and Japan continue to hold significant levels of cash on their balance sheets?
Aren’t central banks able to “goose” financial assets by making government bonds less attractive with paltry interest rates, making riskier investments with higher yields the only investing game in town?
As the Journal puts it:
Low interest rates should encourage consumers and businesses to spend by depressing returns on savings and safe assets such as government bonds. Such spending should create demand for goods, help lift sagging inflation and boost economic growth.
Negative rates aren’t fundamentally different…Negative rates mean large commercial banks have to pay to park their money at central banks, which encourages them to lend it out instead. Banks spread those costs in various ways. For the individual or most corporate customers, the effect is to push interest rates paid on deposits, while still positive, even closer to zero.
Challenging this conventional wisdom is free marketeer of Forbes and Real Clear Markets, John Tamny, who argues in Who Needs the Fed? that such logic is patently false.
Here is Tamny’s salvo against the sages at central banks the world over, who believe that economies can be “stimulated” through enlightened central planning by way of price controls through manipulated interest rates:
[M]any…embraced the idea that the Fed’s [U.S. Federal Reserve’s] QE [quantitative easing] policies created lots of dollars in search of return, and then the central bank’s pursuit of a zero interest rate caused yield-hungry investors to park their easy money in the stock market over lower-yielding bonds. Apparently, government manipulation of markets works after all. Or maybe not.
Indeed, the accepted wisdom about the bull market raised many simple objections. First, the Fed’s imposition of artificially low interest rates on the way to supposedly easy credit would have to have been one of the few instances in global economic history of price controls actually leading to abundance over scarcity.
Second, if the pursuit of yield was what was actually luring investors into rapidly rising shares, logic dictates that Treasuries and corporate bonds would have been declining in value, a reflection of investor flight away from that which was prosaic and yielding little. The problem there was that yields on Treasuries and corporate bonds remained low throughout the program.
Third, and assuming the supposed flight of easy money into equities, one investor’s purchase of shares is another investor’s sale. An investor rush into equities with allegedly easy Fed money by definition signals a perhaps wiser investor exit from those same equities. There are no buyers without sellers, except in the unreal world inhabited by members of the Fed. Supposedly, these charitably average individuals, who have “a 100 percent error rate in predicting and reacting to important economic turns,” according to John Allison, and who act as though there are buyers without sellers, let alone that there are borrowers without savers (what else could explain their decision to lower the Fed’s rate to zero?), can engineer rallies. Basic common sense says that they could not have done what the consensus said they did, because in the real world, there are buyers and sellers.
Let’s bring von Mises back into the discussion of how markets work:
Even prices that are established under the influence of speculation result from the cooperation of two parties, the bulls and the bears. Each of the two parties is always equal to the other in strength and in the extent of its commitments. Each has an equal responsibility for the determination of prices.
As we learned in often-bloody fashion in the twentieth century, governmental attempts to plan markets always end in failure.
Fourth, markets never price in the present; they price in the future. With the quantitative easing side of the Fed’s intervention over by October 2014, and its end well telegraphed before then, wouldn’t investors have long before rushed out of the very markets that this easing allegedly caused them to rush into? Yet, the stock-market rally continued well into 2015.
The common answer to the above is that markets were so overly manipulated that equity prices reflected their being the only game in town for investors who wanted some semblance of return. But to believe this, one would have to believe that central bankers suddenly figured out how to engineer bull markets.
The problem with such an assertion, particularly one that says low rates push investors into stocks, is that the latter has been policy from the Bank of Japan since the 1990s. Low interest rates across the yield curve have long been the norm for Japan’s central bank, as has quantitative easing (Japan’s economy has suffered 10 doses of QE from the Bank of Japan). Yet, the Nikkei 225 is still half of what it was in the late 1980s.
Moving to China, its stock markets started to buckle in August 2015. Worried about stocks falling further, the Chinese government spent tens of billions of yuan trying to prop the market up. It failed. Logically.
Importantly, a major market decline, like what occurred in Japan, and a collapse, like in China, is what one would generally expect from central bank manipulation of rates and credit, and in China, stock market indices. As we learned in often-bloody fashion in the twentieth century, governmental attempts to plan markets always end in failure. Because they do, and because markets discount the future, one would have to believe that economists at the Fed were intensely market savvy such that their interventions were actually doing some good; that, or they know how to trick investors about the good of intervention in ways that central banks up to now haven’t known.