„Negative“ Interest Rates and the War on Cash

The talking heads featured on the corporate mainstream media have started to disseminate the idea that cash is a barbarous relic and needs to be abolished. Central bankers have been particularly articulate, such as former IMF staffers Kenneth Rogoff and Peter Bofinger, or current Bank of England spokesman Andrew Haldane.

Among the reasons why cash suddenly needs to be abolished are the usual arguments, such as that criminals may be using cash, or that electronic money is more ‘efficient’. Some media even claim that people are annoyed in queues when someone pays with the more cumbersome cash, instead of the faster plastic money. The truth is of course the opposite, although the recent introduction of contactless debit cards in the UK, which only need to be waived at the card terminal for payment, have speeded up the payment of petty transactions compared to the usually much longer processing time for debit cards compared to cash.

Another reason given in favour of abolishing cash is the argument that this will facilitate bank bail-ins, as agreed at the Seoul G20 summit in 2010: if people can move money out of the banks into cash, it is not possible to steal their money to bail out the banks. While cynics will be open to this argument, the reality is that it does not make sense: in Cyprus, where the Seoul G20 programme was first implemented, banks were shut before deposits were confiscated. In Greece, banks were shut for a month and people had to survive on cash, which they were after a while allowed to withdraw in small amounts only. What would have happened if cash had already been abolished is that the ECB shutting down Greek banks would have been more effective in blackmailing the Greek people to give in to Troika demands.

The main reason advanced by the Bank of England for wanting to abolish cash is that it wishes to stimulate the UK economy, and to do so it wants to use interest rates. Since rates are already zero, it is now only reasonable to lower them into negative territory. However, to make such a policy effective, the possibility to move from electronic money into cash needs to be taken away. If cash is abolished, we can then enjoy the benefits of negative interest rates – or so the official narrative goes.

This story is so full of holes that it is hard to know where to start. Let’s begin by reminding ourselves that it has been the Bank of England that has since 2009 argued that interest rate policy is not a good tool to stimulate the economy, and instead it wanted to use what it (misleadingly) called ‘Quantitative Easing’. So if that is true, why now suddenly switch back from the quantity to the price of money? What is it that should make ‘price easing’ now more effective than an emphasis on quantities? Wouldn’t it be better to instead introduce true quantitative easing, which expands purchasing power in the productive economy, such as in the hands of SMEs?

Secondly, let us consider the proposal of introducing negative interest rates in an effort to stimulate the economy. As we know, the proclaimed transmission mechanism of lower rates is via cheaper borrowing costs. In countries where a negative interest rate policy has been introduced, such as Denmark or Switzerland, the empirical finding is that it is not effective in stimulating the economy. Quite the opposite.

This is because negative rates are imposed by the central bank on the banks – not the borrowing public (so please forget the idea that you will be given a mortgage, and paid an extra fee on top to do so). To be precise, they are imposed on the reserves held by banks at the central bank.

This might seem reasonable at first sight: Have not these mean banks been hoarding all the QE cash from the central bank, instead of lending it out?

No. It is a little known fact that the total quantity of reserves held by banks at the central bank is entirely determined by the central bank. Individual banks can try to reduce their reserves, but only at the expense of other banks holding more reserves. This is of course why the type of „QE“ implemented by many central banks – buying financial assets and increasing banks‘ reserves at the central bank – have only created another asset bubble, but hardly helped the real economy. Banks cannot lend out their reserves at the central bank. As we show in the book „Where does Money come from?“, banks‘ reserves at the central bank are simply credits created by the central bank for the benefit of the banks – central bank money that cannot circulate in the economy.

As a result, negative interest rates on banks‘ reserves at the central bank are simply a tax imposed on banks. So why would central banks impose new taxes on banks at this stage? The experience of Switzerland may provide answers: negative rates raise banks’ costs of doing business. The banks respond by passing on this cost to their customers. Due to the already zero deposit rates, this means banks will raise their lending rates. As they did in Switzerland. In other words, reducing interest rates into negative territory will raise borrowing costs!

If this is the result, why do central banks not simply raise interest rates? This would achieve the same result, one might think. However, there is a crucial difference: raised rates will allow banks to widen their interest margin and make their business more profitable. With negative rates, banks‘ margins will stay low and the financial situation of the banks will stay precarious and indeed become ever more precarious.

As readers know, we have been arguing that the ECB has been waging war on the ‘good’ banks in the eurozone, the several thousand small community banks, mainly in Germany, which are operated not for profit, but for co-operative members or the public good (such as the Sparkassen public savings banks or the Volksbank people’s banks). The ECB and the EU have significantly increased regulatory reporting burdens, thus personnel costs, so that many community banks are forced to merge, while having to close down many branches. This has been coupled with the ECB’s policy of flattening the yield curve (lowering short rates and also pushing down long rates via so-called ‘quantitative easing’). As a result banks that mainly engage in traditional banking, i.e. lending to firms for investment, have come under major pressure, while this type of ‘QE’ has produced profits for those large financial institutions engaged mainly in financial speculation and its funding.

The policy of negative interest rates is thus consistent with the agenda to drive small banks out of business and consolidate banking sectors in industrialised countries, increasing concentration and control in the banking sector.

It also serves to provide a (false) further justification for abolishing cash. And this fits into the Bank of England’s surprising recent discovery that the money supply is created by banks through their action of granting loans: by supporting monetary reformers, the Bank of England may further increase its own power and accelerate the drive to concentrate the banking system if bank credit creation was abolished and there was only one true bank left – the Bank of England. This would not only get us back to the old monopoly situation imposed in 1694 when the Bank of England was founded as a for-profit enterprise by private profiteers. It would also further the project to increase control over and monitoring of the population: with both cash and bank credit alternatives abolished, all transactions, money creation and allocation would be implemented by the Bank of England.

With all money being electronic money, one can already predict the questions ‚raised‘ by the PR departments of central banks and keenly picked up by the mainstream media: How could one increase the security and safety of this digital money. What if one loses one’s direct debit card? No doubt, some bright Bank of England spark, or else any of the talking heads in the media, will then suggest we should adopt the techniques long practiced with our pets, namely of implanting microchips under the skin as our money of the future. Whether this spells progress readers needs to decide for themselves.


First published in the October 2015 Liquidity Watch report by Prof. Richard A. Werner


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