We are now entering a phase of financial experimentation that few people ever thought we could reach. We are rapidly accelerating toward the outer limits of what’s achievable in a fiat currency world.
Central banks responded to the financial crisis by driving interest rates to zero. This may or may not have assisted the banks, which are their primary concern. But it amounts to a tacit war on savers, many of whom have reacted to a zero-interest rate environment by seeking returns elsewhere. This has helped to inflate the price of equities, bonds and property to decidedly risky levels.
Beyond the zero-bound
However, monetary policy is now stuck at what central bankers call the “zero-bound”. Reducing interest rates to below zero is difficult. It’s not entirely impossible – as many bond markets in the eurozone have shown – but the existence of cash puts some limits on how effective negative interest rates can be.
As Willem Buiter, global chief economist at Citibank, points out, it makes no sense for rational savers to keep money on deposit earning negative interest. Instead, they can choose to hoard physical cash and maintain their purchasing power.
So what can central bankers do if they are determined to take rates further into negative territory? Buiter offers three “solutions”:
1. Abolish currency
2. Tax currency
3. Remove the fixed exchange rate between currency and central bank reserves
You may wonder who would want these solutions. Clearly not savers. It is difficult to respond to Buiter’s suggestions without treating them like some kind of sick joke. But then it’s clear which constituency an economist at a major bank represents. It’s certainly not the people. In one of the understatements of the century, Buiter observes: “Abolishing currency will constitute a noticeable change in many people’s lives and change often tends to be resisted”.
To respond to an economic crisis by advocating the abolition of money in its most tangible form is like responding to the threat of a house fire by burning down your property in advance. It is a sign of just how far we have come since the grim last days of Lehman Brothers. Anyone with assets is now fair game for increasingly desperate bankers and their apologists, such as Buiter.
Get ready for the flight to cash
The financial historian Russell Napier pre-empted Buiter’s fatuous research by warning of the flight to cash. In a note last month, he wrote: “[In the eurozone] the banknote is becoming an increasingly attractive investment and any move to banknotes away from deposits creates a run on the banking system.
This has not happened. Yet. However, with the vast bulk of European Central Bank purchases of assets still to come, the move to negative nominal interest rates has just begun. At some stage a shift to banknotes will begin and the limits to monetary policy will become much clearer”.
Napier is being diplomatic. What he politely calls “a shift to banknotes” is a bank run. That will clearly have consequences too: “The sputtering torch of reflation will have to be passed to governments, and extreme government measures, such as outlawing cash holdings, are already under discussion.
Investors should look to the imposition of a Tobin tax on capital inflows in Sweden, Switzerland or Denmark as a key indicator that central bank action will have to be bolstered by direct government intervention in markets”.
Time to say ‘enough!’
The dangers do not end with harebrained schemes like these. They say that generals invariably end up fighting the last war, and the last banking crisis certainly led policymakers to obsess about the risks to banks. As a result, a growing conflagration in the insurance sector has been overlooked – if not actually triggered by their radical monetary policies.
Napier points out that the Bundesbank, the German central bank, has already warned of the growing risk of insolvency in the German insurance sector. Given that insurers must now park most of their capital in zero- or negative-yielding bonds, “this solvency issue is now live for many of the world’s largest financial institutions”.
Unchecked, central bankers are leading us into greater problems. Yet further outrages can be halted. That point will come when enough people become maddened at the games being played by officials and cry: “Enough!” The nation goes to the polls in three weeks’ time.
Before that happens, write to your MP and ask whether they support the abolition of currency, and if so, why. Their answers (or more likely bafflement at the question even being raised) are likely to be illuminating.
• Tim Price is director of investment at PFP Wealth Management. He writes The Price Report newsletter with Doug Pritchard.
Category: Market updates