Welcome to the Currency War, Part 16: Interest Rates Go Negative

By: John Rubino | Thu, Jun 5, 2014
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This morning the European Central Bank tried something different. As Bloomberg reported:

Draghi Takes ECB Deposit Rate Negative in Historic Move

The European Central Bank cut its deposit rate below zero and said it would announce further measures later today as policy makers try to counter the prospect of deflation in the world's second-largest economy.

ECB President Mario Draghi reduced the deposit rate to minus 0.10 percent from zero, making the institution the world's first major central bank to use a negative rate. Policy makers also lowered the benchmark rate to 0.15 percent from 0.25 percent.

The promise of further measures today "has stoked up hopes that the ECB is going to unleash a huge bazooka on the market in the press conference," said Philip Shaw, chief economist at Investec Securities Ltd. in London. While he thinks that quantitative easing is "very unlikely" now, "it may well be that what the ECB just said is stoking up hopes that QE could be on the cards after all. "

Later in the day, Draghi fleshed out his thoughts in the aforementioned press conference. From Business Insider:

Mario Draghi Explains The Decision

In his introductory statement, Mario Draghi unveiled targeted longer term refinancing operations (TLTROs). The initial size of TLTROs is about €400 billion and all TLTROs will mature in September 2018, or in about 4 years. Two successive TLTROS will be conducted in September and December 2014. "From March 2015 to June 2016 all counter parties will be able to borrow quarterly up to three times the amount of their net lending to the euro area non-financial private sector, excluding loans to households," said Draghi.

The ECB is "intensifying preparatory work for outright purchases in the ABS [asset backed securities] market." It will also suspend its weekly securities market program (SMP) sterilization.

The Q&A has begun. Here are the key highlights:


Some thoughts

Anyone who finds this surprising hasn't been watching Europe's inflation numbers. As most of the eurozone including, recently, Germany slipped towards deflation, it was clear that the European Central Bank would have to launch a new currency war offensive, and soon. So here it is: negative interest rates on bank excess reserves (though not yet on consumer bank accounts) along with direct infusions of cash into the banking system.

This will have a modest effect on bank lending and economic activity, but it won't stop the eurozone's downward spiral because liquidity doesn't fix insolvency. In other words, if the system's collateral isn't as valuable as the debt it supports, then the system is in trouble. And coercing banks into making more loans against inadequate collateral will not help the situation.

So the next, equally inevitable stage in Europe's offensive will be some form of QE, and apparently the ECB has decided that asset backed bonds will be the instrument of choice. The idea is that by buying, say, mortgage backed bonds with newly-created euros, the ECB will be able to direct those euros back into the housing market, which will in turn get people spending again. This, by the way, is the script the US followed in the first half of the 2000s which produced the housing bubble and the subsequent crash.

But before this bubble bursts, the euro will fall due to rising supply, which is the same thing as saying that the dollar will soar. This will be deflationary for the US, producing a string of "unexpected" misses in corporate earnings, GDP and inflation, and will leave Washington with no choice but to respond with renewed debt monetization and money printing and in all probability negative interest rates of its own. And so it will go, until we figure out that depreciating fiat currencies against each other is a zero-sum game that makes the rich richer and everyone else much poorer.

One would expect gold to be the main beneficiary of crazy policies like negative interest rates, and it did pop on Draghi's news. But the ongoing manipulation of precious metals prices makes this far less of a sure thing than theory and common sense would imply. Fundamentals always win in the end, but in a world of manipulated markets the timing is completely unknowable.

 


Previous articles in this series are here

 


 

John Rubino

Author: John Rubino

John Rubino
DollarCollapse.com

John Rubino is author of Clean Money: Picking Winners in the Green Tech Boom (Wiley, December 2008), co-author, with GoldMoney's James Turk, of The Collapse of the Dollar and How to Profit From It (Doubleday, January 2008), and author of How to Profit from the Coming Real Estate Bust (Rodale, 2003). After earning a Finance MBA from New York University, he spent the 1980s on Wall Street, as a currency trader, equity analyst and junk bond analyst. During the 1990s he was a featured columnist with TheStreet.com and a frequent contributor to Individual Investor, Online Investor, and Consumers Digest, among many other publications. He now writes for CFA Magazine and edits DollarCollapse.com and GreenStockInvesting.com.

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