Should Central Banks Go Negative Now?

Tim Wallace of The Telegraph reports, Prepare for negative interest rates in the next recession, says top economist:
Negative interest rates will be needed in the next major recession or financial crisis, and central banks should do more to prepare the ground for such policies, according to leading economist Kenneth Rogoff.

Quantitative easing is not as effective a tonic as cutting rates to below zero, he believes. Central banks around the world turned to money creation in the credit crunch to stimulate the economy when interest rates were already at rock bottom.

In a new paper published in the Journal of Economic Perspectives the professor of economics at Harvard ­University argues that central banks should start preparing now to find ways to cut rates to below zero so they are not caught out when the next ­recession strikes (click on image).

Traditionally economists have assumed that cutting rates into negative territory would risk pushing savers to take their money out of banks and stuff the cash – metaphorically or possibly literally – under their mattress. As electronic transfers become the standard way of paying for purchases, Mr Rogoff believes this is a diminishing risk.

“It makes sense not to wait until the next financial crisis to develop plans and, in any event, it is time for economists to stop pretending that implementing effective negative rates is as difficult today as it seemed in Keynes’ time,” he said.

“The growth of electronic payment systems and the increasing marginalisation of cash in legal transactions creates a much smoother path to negative rate policy today than even two decades ago.”

Countries can scrap larger denomination notes to reduce the likelihood of cash being held in substantial quantities, he suggests. This is also a potentially practical idea because cash tends now to be used largely for only small transactions. law enforcement officials may also back the idea to cut down on money laundering and tax evasion.

The key consequence from an ­economic point of view is that forcing savers to keep cash in an electronic ­format would make it easier to levy a negative interest rate.

“With today’s ultra-low policy interest rates – inching up in the United States and still slightly negative in the eurozone and Japan – it is sobering to ask what major central banks will do should another major prolonged global recession come any time soon,” he said, noting that the Fed cut rates by an average of 5.5 percentage points in the nine recessions since the mid-1950s, something which is impossible at the current low rate of interest, unless negative rates become an option.

That would be substantially better than trying to use QE or forward guidance as central bankers have attempted in recent years.

“Alternative monetary policy instruments such as forward guidance and quantitative easing offer some theoretical promise for addressing the zero bound,” he said, in the paper which is titled ‘Dealing with Monetary Paralysis at the Zero Bound’.

“But these policies have now been deployed for some years – in the case of Japan, for more than two decades – and at least so far, they have not convincingly shown an ability to decisively overcome the problems posed by the zero bound.”
Anyone who has ever taken a graduate level macroeconomics course knows exactly who Ken Rogoff is. He's one of the most respected economists teaching at Harvard and the former Chief Economist and Director of Research at the International Monetary Fund.

Rogoff also co-authored This Time Is Different: Eight Centuries of Financial Folly along with Carmen Reinhart, one of the most cited books explaining the 2008 financial crisis by presenting  a comprehensive look at the varieties of financial crises.

Now, let's put our macroeconomic hats on and think about what Ken Rogoff is proposing here. He's telling central banks to lay the groundwork and prepare for negative interest rates. In fact, he's saying "don't wait for the next financial crisis, do it now."

Moreover, he claims alternative monetary policy instruments such as forward guidance and quantitative easing have helped at the margin but ultimately, only negative interest rates will resuscitate this debt-laden deflationary economy.

Last week, I discussed Ray Dalio's warning on the dangerous divide where I went over six structural factors that lead me to believe we are headed for a prolonged period of debt deflation:
  1. The global jobs crisis: High structural unemployment, especially youth unemployment, and less and less good paying jobs with benefits.
  2. Demographic time bomb: A rapidly aging population means a lot more older people with little savings spending less.
  3. The global pension crisis: As more and more people retire in poverty, they will spend less to stimulate economic activity. Moreover, the shift out of defined-benefit plans to defined-contribution plans is exacerbating pension poverty and is deflationary. Read more about this in my comments on the $400 trillion pension time bomb and the pension storm cometh. Any way you slice it, the global pension crisis is deflationary and bond friendly.
  4. Excessive private and public debt: Rising government and consumer debt levels are constraining public finances and consumer spending.
  5. Rising inequality: Hedge fund gurus cannot appreciate this because they live in an alternate universe, but widespread and rising inequality is deflationary as it constrains aggregate demand. The pension crisis will exacerbate inequality and keep a lid on inflationary pressures for a very long time.
  6. Technological shifts: Think about Amazon, Uber, Priceline, AI, robotics, and other technological shifts that lower prices and destroy more jobs than they create.
These are the six structural factors I keep referring to when I warn investors to temper their growth forecasts and to prepare for global deflation.

I will add a seventh obvious one here, globalization, which basically means capital is free to find the best opportunities around the world but labor isn't as mobile. We often here of "offshoring" of manufacturing and increasingly service sector low paying jobs to countries like China and India but elsewhere too.

Importantly, the main point I'm emphasizing here is all these factors exacerbate inequality and therefore exacerbate deflation.

And as I've stated many times in this blog, institutional and retail investors need to prepare for a prolonged period of debt deflation because it will eviscerate risk assets across public and private markets for a very long time.

I'm not joking here, I'm dead serious which is why I can look at the portfolio of Japan's GPIF or Norway's Government Pension Fund Global and tell you they both have a giant beta problem and are ill-prepared for the deflationary tsunami I'm warning of.

To be fair, with exception of HOOPP and OTPP which have a relatively high allocation to government bonds, most public and private pensions are ill-prepared for the deflationary tsunami I've been warning of. When it hits them and they erroneously think it's a cyclical correction and then see it's more secular in nature, it will hurt them for many years.

Anyway, I don't want to dwell on this too long because people roll their eyes when I warn of deflation but I remind them that my duration calls have been right on the money and tell them not to be surprised when the yield on the 10-year US Treasury note plunges below 1% and possibly much lower in the years ahead.

Forget Kim Jong-un who has already launched more missiles this year than his father did in his lifetime. The reason I'm recommending US long bonds (TLT) as the ultimate diversifier has nothing to do with North Korea.

My number one macro concern remains a slowing US economy at a time when the rest of the world is still in the grips of deflation. If deflation comes to America, Kim Jong-un will be a walk in the park.

This morning you saw the dip buyers move in after a night of unrest. All the large CTAs are buying stocks on every dip, and thus far this strategy has worked just fine for them.

But when the big "D" hits us, dip buyers and risk-takers like volatility sellers will get killed and they won't know where to turn.

This is why I strongly feel Alan Greenspan and others are out to lunch when they claim there is a bond bubble. They simply don't get the baffling mystery of inflation deflation.

Moreover, those asking when will the tech bubble burst are equally out to lunch. They're asking the wrong question. It's not when the tech bubble will burst, it's when will deflation come to America and obliterate all risks assets across public and private markets for a very, very long time.

Capiche? I'm glad TPG's David Bonderman made a $425 million windfall yesterday when Gilead (GILD) acquired Kite Pharmaceuticals (KITE) for $11.9 billion.

I'm not worried about the David Bondermans or the Ray Dalios of this world, they have amassed a fortune over the decades through their financial acumen and let's be honest, by squeezing public and private pensions dry on fees.

"But Leo, that's capitalism, you need to pay up for performance. Even Mark Wiseman told you that he'd love to hire David Bonderman but he can't afford to so he invests in his funds."

Oh PUHLEASE!!! As I stated unequivocally and quite eloquently in my comment on the pension prescription back in May, it's high time these elite hedge funds and private equity funds get down from their high pedestal and be part of the pension solution by drastically cutting their fees.

I know, this won't incentivize them to take more intelligent risks, but I'd rather see pensions allocate more to these alternative managers in return for drastic cuts in fees than the status quo which is doing absolutely nothing in terms of helping chronically underfunded pensions get back to fully-funded status.

All this brings me to Ken Rogoff's proposal for negative rates. Any time I evaluate a macro policy, I ask some basic questions:
  1. Will it promote aggregate demand? 
  2. Will it significantly reduce inequality?
  3. Will it spur more business investment and help productivity?
  4. How will it impact risk-taking behavior?
  5. How will it impact pensions? Will it exacerbate pension deficits?
That last one is a bit easy to answer. As rates plunge to negative territory, pension deficits will soar and many chronically underfunded pensions will not be able to meet their pension payments.

This means less money for pensioners which means less money for the economy, which isn't good for aggregate demand and is deflationary.

What about stocks and other risk assets? This is far from clear because if central banks actively look to go negative, it could send a jolt through markets but if it works in spurring economic activity, the correction will be followed by a sustained rally.

I don't know, negative rates aren't going to stop aging demographics, globalization, or technological change and they will decimate pensions, so I'm not sure if Rogoff's proposal has any merit from a policy perspective.

I could be wrong but I think we should prepare for QE infinity, not negative rates. If they occur, it will be a symptom of a deflationary crisis unlike anything we've ever seen before.

Once again, I don't have a monopoly of wisdom on this or other issues I cover on my blog. I'm sharing my thoughts and if you have anything to add, feel free to email me at

Also worth reminding all of you reading this blog to please support my efforts by donating/ subscribing on the top right-hand side under my picture (web version on your smart phone). I truly appreciate all of you who have shown and continue to show your financial support.

Below, Kenneth Rogoff, Economics Professor at Harvard University, speaks on the future of cash & India's demonetisation drive (Parts 1 & 2).

Rogoff also spoke to Blomberg in India stating rates shouldn't be hiked and dismissed the rationale of quantitative easing by the US Federal Reserve.