Does ZIRP -> NIRP = DERP?

Monday 11 April 2016

Persistently low negative interest rates could be a serious own goal for central banks - and a boost for digital cash.

You can’t understand the attraction and adoption of bitcoin without having some grasp of the wider global economy. Every time China’s stock market sneezes, for example, bitcoin jumps. Every time one or other country imposes capital controls, boom. Conversely, when things quieten down on the global markets, bitcoin often does too. The need for bitcoin, in an existential sense, is inversely correlated with the health of the traditional financial system.

Read also: Helicopter money incoming? 

It can’t have escaped many people that the global economy has problems. We’ve weathered the worst financial storm in a lifetime, but we’re not out of the woods yet (to mix metaphors). The fact that we have had historically low interest rates for years should be indication enough of that.

And it’s getting worse. Central banks in major economies around the world have gone from low interest rates to a Zero Interest Rate Policy (ZIRP). It hasn’t worked. Inflation and economic growth are still stubbornly low. So some have taken a step further, right into the world of Looking Glass economics, and imposed a Negative Interest Rate Policy (NIRP).

Derp cash

NIRP is a DERP. Derp Money courtesy of these guys

It makes sense in theory - and theory is very firmly where we are operating at the moment, because the whole NIRP thing is an untested experiment with the financial system. Central banks believe that if you lower interests rates into the negative, so that individuals and businesses actually have to pay to keep money in their accounts, those customers will instead be incentivised to spend the money, raising aggregate demand, boosting prices and generating economic activity. Inflation and economic growth result where there would otherwise be stagnation and deflation. The Eurozone is testing this hypothesis actively right now.

Here’s the problem: theory is not practice. Recently, the Bank for International Settlements (BIS) has come out and suggested that negative rates might not be desirable: in fact, they might be a colossal own goal. And when the central bankers’ central bank says something like that, you’d better listen.

Why is it a problem? Firstly, because people will withdraw money and keep it under their mattresses (a recent rise in the number of safes sold in Japan indicates this is not a theoretical issue). That, of course, is deflationary: the exact opposite of the intended effect. Secondly, because it will hit banks’ profitability. It could also have serious implications for other financial businesses like insurance companies and pension funds. And that’s bad for savers, pensioners, and governments who get lower tax receipts. Another reason is that it ignores the necessity for people to save money, again like pensioners. And if returns on their investments are going to be lower, they're going to have to save more to compensate.

It comes down to this: if you make banks unattractive places to keep money, people will keep their money somewhere else. Even if you ban physical cash people will find other stores of value: gold, precious metals and… you guessed it, bitcoin.

We haven’t got there yet, though that may well be because commercial banks have so far generally insulated retail depositors and businesses from sub-zero interest rates. But if things keep heading in the same direction, it’s only a matter of time.

TL;DR: ZIRP -> NIRP = a big fat DERP.


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