The idea of seeing negative U.S. interest rates has gone from far-fetched to quite likely. Everyone's trying to figure out what this means for them individually, as well as for the stock market and the U.S. economy writ large.
I believe the Federal Reserve has made a big policy error in recent years through bank bailouts, the extended period of near-0% interest rates and quantitative easing instead of simply letting the free market take its course.
Most Fed critics are upset that the central bank raised the fed funds rate by a quarter point in December, arguing that the hike undermined market psychology. But this short-term view misses the bigger picture of the Fed's earlier policy errors.
At this point, I think years of bailouts, gamesmanship and a failure to let markets "wash themselves out" mean the only alternative to a currency-devaluation war now is a complete reset of global financial systems.
It's probably inevitable that we'll see a breakup of "Too Big To Fail" financial firms at some point, with the U.S. Justice Department enforcing antitrust laws to bust up global conglomerates. The Internal Revenue Service will probably also eventually crack down on corporate tax-loophole engineering.
Painful as such a complete reset might be in the short term, I believe it's the only thing that will get our system back on track for the long haul.
Minnesota Fed President Neel Kashkari recently proposed some ways we could reset our economy and markets. In prepared remarks to the Brookings Institution, he said:
"I believe we must begin this work now and give serious consideration to a range of options, including the following:
-- Breaking up large banks into smaller, less connected, less important entities.
-- Turning large banks into public utilities by forcing them to hold so much capital that they virtually can't fail (with regulation akin to that of a nuclear power plant).
-- Taxing leverage throughout the financial system to reduce systemic risks wherever they lie."
Now, I've long been hard on Kashkari and the various bureaucratic roles that he's held. He first moved from Goldman Sachs (GS) to the U.S. Treasury Department under then-Treasury Secretary Hank Paulson, then headed the Troubled Asset Relief Program before going to the Minneapolis Fed.
But I want to give Mr. Kashkari credit for even suggesting these things. Whether he proposed these reforms so the Fed could later say it considered and rejected them is debatable, but at least I'm happy to see some recognition that our system hasn't been meaningfully reformed since the 2008 crash.
Always remember that the Fed is a private organization that's owned by the same "Too Big To Fail" banks that it's supposed to regulate. As such, I believe we'll only see negative interest rates if big financial firms like Goldman, JPMorgan Chase (JPM) and Wells Fargo (WFC) think that's in their best interest.
That doesn't seem to be the case right now, as the "Too Big To Fail" firms are pleading with the Fed and other central banks around the world (at least publicly) not to use negative interest rates. Of course, having your economists argue against negative interest rates in public would give more plausibility to the banks later claiming that any benefits they get from such policies were against the firms' will.
For now, the logic goes that banks will see their profits squeezed in a negative-interest-rate environment. But I'm not sure I buy that, as there's nothing to stop banks from raising interest rates on mortgages and credit cards while getting essentially paid through negative interest rates to take Fed money. For example, Swiss and Danish banks have hiked mortgage rates since their countries introduced negative rates.
U.S. banks could also use a negative fed funds rate to justify moving to negative interest rates on customers' deposits. Of course, charging people to "store" their money at a bank would prompt some people to move funds into actual cash (i.e. paper money).
But governments and central banks could have a tool to fight that -- the removal of large-denomination bills from circulation. As my Real Money colleague Antonia Oprita recently noted, we've already seen European Central Bank President Mario Draghi tell the European Parliament that there's "increasing conviction in world public opinion" that criminals use the 500-euro banknote.
Andrew Haldane, the Bank of England's chief economist, has even said that "a more radical proposal would be to remove the zero-lower-bound constraint entirely by abolishing paper currency (in England)."
And here in America, none other than former U.S. Treasury Secretary Larry Summers is proposing that we take $100 bills out of circulation.
The Bottom Line
Banks are notorious for focusing on near-term profits, speculating in markets and maximizing bonuses when times are good. So, I can certainly see how bankers might actually want negative interest rates.
I'll talk in a future column about how negative interest rates would impact the stock market, and why we should remain cautious until the Fed finishes up what I believe is now a new easing cycle.
