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

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:

• There will be additional reporting requirement to ensure lending goes to real economy. For all practical purposes the ECB has reached the lower bound of rate policy, Draghi says.

• “The main reason to commit to sterilization by my predecessor first and by myself later was based on the effects that this additional liquidity might have on inflation,” says Draghi. “This decision takes place in a background characterized by low inflation, weak recovery and weak monetary and credit dynamics, that’s the reason for suspending this commitment.”

• “Being able to have unanimity on such a complex set of instruments means a very very extraordinary degree of consensus,” says Draghi. “What is in this TLTRO that makes it different? The cost obviously, it is very low, the term maturity is four years, and the termination that this money not be spent on sovereigns and on sectors that are already experienced or have just come out of a bubbly situation, that’s what in it.”

• We don’t see deflation says Draghi.

• “There is a deep misunderstanding here. The rates we’ve changed are for the banks, not for the people,” says Draghi. It’s wrong to think we want to “expropriate savers. …The concerns of savers should be taken very seriously.” Draghi however adds that the decision to lower rates for households is the decision of banks, not the ECB.

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

20 thoughts on "Welcome to the Currency War, Part 16: Interest Rates Go Negative"

  1. How does on deal with a vampire? Start by not offering to give him your blood. The bankers, who loan $100 for every $5 on deposit now propose to charge you for letting them do this: tell the bank manager you are withdrawing x amount of cash each month strictly as a protective measure, or better yet, threaten to transfer your account to a credit union. That should at least make the vampire go pale

  2. This is a stealth bailout for any EU sovereign government that borrows in euros. Negative interest rates keep their borrowing costs artificially low. The IMF and its troika smile when their refinancing tasks are easier.

  3. ECB, et al, have tried to milk cows with a cattle prod. That hasn’t worked.
    Now they’ve decided to use an electric prod! More juice! That’s the ticket!

  4. You write, 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.

    A deflating Euro is already turning US based corporations lower, the formerly soaring Refiners, VLO, MPC, PSX, HFC, are now trading lower, on the lower Euro.

    Currency deflation coming from the hands of the currency traders selling the Euro against the Yen, and from the Mario Draghi ECB June 5, 2014 mandate, are global destabilizing things, which export economic deflation and create economic deflation worldwide.

    Negative interest rates on bank excess reserves caused Germany’s Deutsche Bank, DB, to immediately trade 2.6% lower on the Mario Draghi ECB June 5, 2014 announcement.

    The Japan-like “pernicious negative spiral” of deflation will intensify as investors are forced to deleverage out of EUR/JPY funded currency carry trades in Eurozone Companies such as France’s debt trade Telecom Provider Orange, ORAN.
    A lower Euro, FXE, is coming but it will not help boost exports as all currencies will be falling together into the Pit of Financial Abandon.

    Up until today, the ECB has done as much as the northern Europeans would let it. Mr. Draghi has figured out how to get them to do even more. The negative interest rate announced by Mario Draghi in effect regionalized the Eurozone’s banks and has established a defacto banking union. Throughout the world, via regionalism, banks will be absorbed into the regional government and become known as Government Banks or Gov Banks for short.

  5. another great article. “Fundamentals always win in the end, but in a world of manipulated markets the timing is completely unknowable.” there it is.

  6. This is a full retreat with the bankers & corporate oligarchs twisting & turning & looking for a way out of the trap.There is no way out,the only question is when.I can see at least 2 good reasons why this is so!
    1)These austerity policies & high inflation will decimate the middle classes in the western world.The working middle classes are the primary consumers that buy the products produced by the companies owned by the establishment’s monied class,the bankers & corporate oligarchs.If the middle class consumers are impoverished & cannot buy products the economy will crash & that will ruin the elites.In a nutshell,the rich & powerful cannot survive without the middle class.Whether they like the idea or not!If the middle class dies,which is what is now happening,the rich & powerful will also go under!
    2) In Europe they call it Austerity,in America it financial repression.Either way what it means is pauperization of the working middle class.It will be destroyed.Thanks to modern communications & social media the MSM & it’s game of misinformation & deception has been largely bypassed.For the first time in history the general public is aware of what is in store for it.The people in America & Europe will not stand by & watch their living standards disappear just to save the establishment elites.First there will be elections to remove the politicians who will be held responsible for hard times.Their replacements will not do better because the situation will be impossible to fix by political means.With no improvements from the politicians the mobs will hit the streets & chaos will ensue until such time as a dictator shows up & promises order & stability.This will certainly happen in Europe but I hope we can sneak through this in relative freedom in America!

    1. All currencies are falling. The BRICs bank will initiate gold backed yuan/RMB, ruble, etc. Bye-bye dollar. The Germans have already cut their deals for a gold backed Nordic euro.

  7. I get the feeling that barring some unexpected and uncontrollable “black swan” event this back and forth nonsense from all the major central banks could go on for years. I am beyond tired of all this. I can only hope that the longer this goes on the worse it’s going to be for the monetary authorities, bankers and politicians when the mobs get their hands on them.

    1. “…nonsense from all the major central banks could go on for years.”
      I hate to say it, but it is starting to look that way. Maybe they have figured out some way of printing just enough fiat to balance out the deflationary forces?

      The sheeple don’t seem to mind ‘leaving’ the labor force, lol, as long as they get their disability and food stamps. The thing that will trip them up is when they make a policy mistake and let too much fiat bleed through, resulting in $6/gal gasoline, and similar increases in other consumer goods.

      Notice how they’re all squawking about $10/hr minimum wage? That is to lay the framework for the next big move up in cpi inflation. Akll the chatter about ‘deflation’ is just a smoke screen. They’re creating fiat by the trillions, not reducing the money supply.

  8. Now let me get this straight, Draghi’s action was an attempt to weaken the euro which would have, in turn, strengthen the dollar which typically causes stocks to slide. In fact the euro rallied, the dollar slid, PMs popped and the stock markets went to new all time highs. France closed up 1+%, Germany waffled and England slid. Yep, it all makes perfectly good sense.

    How many of us, me included, recently called a top ? Now with ECB on track to start some serious easing and the Bank of China also threatening some form of easing, we can assume that the dollar is gonna strengthen which will force the Fed to do start easing (again). All the extra printed money has got to go somewhere, probably into stocks. I can’t help but feel the correction has been postponed for some indefinite period of time. The crash apparently was rescheduled and will come right after the Red Socks win the Stanley Cup.

    Welcome to the new abnormal.

    1. FWIW …The immediate reaction is just classic buy the rumor sell the fact. Negative rates had been telegraphed and since they didn’t announce QE outright at this meeting, there were no surprises, hence no further Euro weakness or dollar strength.
      But yeah, it’s all completely insane,

  9. Nothing spells central bank FAILURE like negative interest rates. Talk about not wanting to pay the piper!

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