NIRP…ZIRP…what is this Alphabet Soup?

NIRP – Negative Interest Rate Policy. ZIRP – Zero Interest Rate Policy.

For around fourty years, bonds have been in a huge bull market with rates falling further and further. For as long as I can remember, the basic formula of lending money has been a simple one; “I lend you money and after an agreed upon time, you pay it back with interest”. The formula was simple and elegant; a person needing money can access it, and in return for giving up my ability to spend my own money, I receive more back in the future than I have today.

Of course, rates can’t fall forever, and eventually, yields hit zero. Essentially, this means that a lender gives a borrower money and eventually receives back exactly what they gave. Not so bad, right? The only problem is a little thing called inflation, which is the rate by which the cost of goods and services go up every year. If the lender receives back exactly what they gave, it’s actually worth less by the time they get it back and so they’ve given up part of their spending power to give money to someone that doesn’t have it. It’s a tax, by any other name.

It’s hard to believe, but as long ago as 2014, the European Central Bank decided that even this novel idea didn’t go far enough and decided to implement negative rates. Now, a lender gives the ECB money and after an agreed upon time is guaranteed to receive less than they gave them.

When the policy was first introduced, I can’t remember many people really making much of a fuss; in fact, I was actually shocked it had been so long since the policy was introduced. Of course, once one Central Bank introduced negative rates, the others followed suite, and today, governments across Europe effectively ‘get paid’ by borrowers for spending money that they don’t have. Doesn’t that seem like a great idea…

In tandem with this, Central Banks also began printing money to buy assets. The idea was another corker; print cash and exchange it on the open market for things like government bonds. At first, it was only government bonds and the idea was to force banks and institutions to start lending by swapping assets on the balance sheet with cash that could be loaned to borrowers. Then, they extended to investment grade bonds. Then equities. Then junk bonds.

One starts to ask the question; at what point does this become socialism by any other name? If the Central Bank buys and owns everything then a single entity owns all businesses and commercial enterprises…exactly the same as a centrally planned government under socialism.

These policies have also had the wonderful effect of inflating asset prices; why lend money through bonds at negative rates? Banks pay practically no interest now, so there’s no point keeping your cash there to generate a return. Home prices have gone through the roof in most countries but rents haven’t kept up so the net effect has been landlords operating at losses to own properties. Just where can savers put their money to beat inflation?

The answer; the stock market. It’s become a TINA trade; There Is No Alternative. Practically every other method of storing wealth is actually guaranteed to lose you money over time. They only problem today is that the entire global economy has come to a standstill thanks to COVID-19, so where are companies going to make their profits? What is a company that cannot trade actually worth?

Where next?

I wouldn’t count myself among the world’s greatest economic analysts, or even close to it. I’ve got an A-Level in Economics and an interest in the financial markets. So take what I write next with a pinch of salt; I imagine many ‘real’ economists will be crying with laughter at my attempt to make sense of this…but as traditional economics got us into this ruddy mess, I don’t think I mind that too much.

When I was at school, it seemed self-evident to me that the world couldn’t ‘grow’ forever. Consumption couldn’t keep increasing forever without consequences, but that’s what everyone older than me seemed to assume was the natural state of things.

Personally, I think the world finally caught up with my early observation. Growth and productivity have stalled because inequality has increased. Why bother working a 60 hour week so your boss can be paid ten times your salary? Why bother working two jobs so Richard Branson can buy another island? Why bother working to ‘save’ money if the government will just give you cash handouts by taking it off other people? Why bother working when you can horde excess capital and get other people to work for you?

The more people ask these questions, the lower productivity falls. The lower productivity falls, the worse the economic system becomes; more people work less. Our system has been built on debt; the more people borrow, the more they spend, and the more they spend, the more income other people have. The only problem is that spending borrowed money decreases future income thanks to interest. The more debt in the system, the more of a drag future generations have on their economy.

Central Banks have responded in the only way they knew how; by try to force more debt into the system to encourage spending. But when you penalise savers and incentive borrowing over spending your own money, then you increase fragility in the system. When do you feel more secure? When you can afford all your goods and services in cash, or when you need to borrow to fund them?

Personally, I want to see a two tier system; high interest rates for borrowers, lower interest rates for savers; the net effect would still be to encourage spending but would decrease debt. Over time, the ‘drag’ on the economic system would decrease and the economy would revitalise. You could then start to raise interest rates for savers to pull back the risk of inflation instead of trying to inflate your way out of a debt crisis.

Since the days of my economics A-Level, I’ve been told that inflation is a good thing, but I really, honestly cannot see why. I don’t think that deflation is necessarily a good thing either, but surely long-term price stability should be the goal.

Will this happen? I won’t say definitely not; we’re in a mad, mad world. But I won’t be holding my breath…