The origin of negative interest rate of central banks lies in the neutral rate identified by Knut Wicksell almost a century ago. Negative interest rates meant that the rate of interest required to bring an economy back to full employment with a stable inflation, which could be even negative. The real job creators in any free market economy are not only producers but also consumers. Hence, both producers and consumers have to prosper for a robust economic growth.
On macroeconomic level, there is a huge income inequality in global economy because of the reluctance of their central banks to follow a monetary policy which would usher a true free market economy. The Fed has also printed several trillion dollars in its ambitious Quantitative Easing (QE) program after 2008 stock market crash. As a result, the economy stabilized in 2009 and began to grow in 2010. However, real wages of Americans fell, while the corporate profits sky-rocketed. How did that happen? Because, the entire increase in government spending from rising budget deficit went into the coffers of already wealthy producers. This is how Goldman Sachs alone could give bonuses of over $20 billion to its executives in 2009, while millions of ordinary Americans were still being laid off from their jobs. While the consumer debt actually fell, the government spending and hence its debt actually rose so much that executives received hefty extra compensation.
Due to absence of a free market economy where wages keep pace with productivity, the central banks have to print dollars just to sustain deficits in respective economies. The trade deficits of the US are a result of offshoring of manufacturing Low Labor Cost (LLCs) Asian countries to increase the corporate profits of US based MNCs. With a lost domestic manufacturing in developed economies to countries in Asia, the citizens in developed countries are relegated to low paying service sector jobs. Hence, the real wages of majority of citizens in the U.S. have actually decreased with rising trade deficits. These trade deficits however have benefited the external share holders of corporations who have reaped huge profits from the rising share prices resulting from a practice of offshoring.
The growing economic disparity has also reduced the ability of low wage earning citizens to pay a fair share of their taxes. Additionally, the tax cuts that are offered to corporations have added further to national budget deficits. Now, the growing trade and budget deficits can be sustained only by means of printing more currency. With their monetary policies, the central banks like Federal Reserve (Fed) or European Central Bank (ECB) prints more money to bring down the rate of interest, and lower interest rates induces people to increase their borrowing or it increases consumer debt. As the wages fall with rising productivity resulting from technological progress, the wage-productivity gap keeps rising so fast that even the government has to raise its own spending and debt constantly to sustain an economic demand from the growing gap between wages and productivity. In this way, even the national debt keeps rising because of increased government spending.
Hence, Central banks keep printing more and more money and all the printed money keeps entering into the pockets of already wealthy individuals and corporations but such policies do not help boost domestic consumer purchasing power in economy. Hence, the real economic demand keeps stagnating and even falling in some cases. Since, wages contribute to economic demand and productivity contributes to an economic supply, wage-productivity gap contributes to demand-supply gap.
The Fed’s benchmark interest rates are already close to zero percent and just to keep the value of the dollar high in order to be able to export more goods to the U.S., the ECB entered into negative interest territory in June 2014. This unprecedented step of imposing a negative interest rate on banks for their deposits is in effect charging lenders to park money with the banks. Additionally, the monetary policies of central banks let wages trail productivity resulting in a lack of economic demand. This causes all the money that is not put into the bank accounts to not get invested into the economy due to a poor economic demand. In fact, negative interest rates are causing money to get stashed underneath mattresses, thereby steadily shrinking of the consumer credit in the economy.
When Fed hiked its benchmark interest rate by only 0.25 percent in early 2016, there was a net inflow of funds from developing economies into the U.S. This move has strengthened USD as compared to its other trading partners. The Asian trading partners like Japan are also following an unconventional monetary policy and Japanese central banks are moving into a negative interest rate territory just to maintain a net trade surplus with the U.S. Hence, any reluctance by the Fed to hike its benchmark interest rate is undone by a decision of US trading partners to enter into a negative interest rate territory.
A rising value of US dollar from all these policies is not good for the US economy as U.S. is unable to export its goods to other countries due to high value of USD. Hence, US trade deficits are steadily rising and could rise further if the Fed hikes its interest rates further in 2016. Rising USD combined with falling US exports are crashing the profits of US MNCs. All of this causes an inability of the U.S. to be able to balance its budget in order to retain its AAA rating. The corporate bonds can no longer retain an excellent credit rating when corporate profits keep crashing because of falling consumer demand in the economy.
A net inflow of capital from developing economies into the U.S. has also triggered a panic in the developing economies as they are dependent on the capital arriving from developed economies. The US based MNCs have neglected consumer demand in US economy, in search of a better RoI from Asian economies and this is crashing MNC profits in both developing as well as developed economies. Everything depends on the ability of the U.S. to service its sovereign debt which would no longer retain its AAA rating as corporate profits start crashing. The end result of all this would be exactly like what has happened with the housing market crash of 2008, but this time the crisis will be much more severe than the housing market meltdown. Once the U.S. defaults on its debt, the global economy would collapse like a ‘Fire Cracker’.
This article is a sequel to Apek Mulay’s two published articles on LinkedIn viz:
- Negative interest rates of central banks could burst debt bubble like a fire cracker? (https://www.linkedin.com/pulse/20140605212609-11893233-negative-interest-rates-of-central-banks-could-burst-debt-bubble-like-a-fire-cracker?trk=mp-reader-card) published on 5th June 2014 when Negative Interest rates went into effect in Europe.
- Negative Interest Rates of Banks – Part 2 (https://www.linkedin.com/pulse/negative-interest-rates-banks-part-2-apekshit-mulay-apek-?trk=mp-reader-card)
Author’ Bio –
Apek Mulay is Business and Technology Consultant at Mulay’s Consultancy Services. He is also a senior analyst and macroeconomist in US Semiconductor Industry. He is author of book Mass Capitalism: A Blueprint for Economic Revival. Mulay has also authored another book Sustaining Moore’s Law: Uncertainty leading to a Certainty of IoT Revolution with Morgan & Claypool publishers. He pursued undergraduate studies in Electronics Engineering (EE) at the University of Mumbai in India and has completed master’s degree in EE at Texas Tech University, Lubbock. Mulay authored a patent “Surface Imaging with Materials Identified by Colors” during his employment in Advanced CMOS technology development team at Texas Instruments Inc. He has also chaired technical sessions at International Symposium for Testing and Failure Analysis (ISTFA) for consecutive years. USCIS approved his US permanent residency under the category of foreign nationals with extraordinary abilities in science and technologies even though he did not pursue a PhD degree in engineering or economics. He has been cited as an ‘Engineer-cum-Economist’ by superstar economist Professor Ravi Batra in his 2015 Volume ‘End Unemployment Now: How to Eliminate Poverty, Debt and Joblessness despite Congress’. He has appeared on National Radio shows, made Cover Story for Industry Magazines, authors articles for newspapers as well as several reputed blogs & industry publications, as well as has been invited on several Television shows ( because of his accurate macroeconomic forecasts ) for his ideas about Mass Capitalism. He is also an investing partner in an ecommerce business Calcuttahandicraft.in which he started to envision his ideas about Mass Capitalism. www.ApekMulay.com.