Dan White: Negative interest rates a desperate act
The ECB must switch on the printing presses to prevent Europe from falling into a deflationary trap
Published 24/11/2013 | 20:30
NEWS that the ECB is contemplating imposing negative interest rates on banks who deposit cash with it shows just how desperate the eurozone economic crisis has now become. Unless the ECB starts printing money soon, then the European financial system risks grinding to a halt.
We all knew that things were bad in the eurozone. The shock cut in official eurozone interest rates to a record low of just 0.25 per cent at the beginning of this month was a signal the ECB was very worried.
However, just how worried only became clear last week when Bloomberg carried a story claiming the ECB was contemplating cutting the interest rate which it pays banks that deposit excess cash with it from 0 per cent to minus 0.1 per cent.
The report came as the ECB council, which sets official eurozone interest rates, was holding its regular mid-month meeting in Frankfurt. An ECB spokesperson refused to comment on the rumours, which served to reinforce market opinion that they were probably accurate.
The single currency quickly lost 0.6 per cent of its value on the foreign exchange markets; there was a corresponding rise in eurozone stocks, with the Stoxx 600 index of European shares jumping by 0.4 per cent.
While ECB president Mario Draghi moved to soothe ruffled German feathers, it is clear he and most of his fellow ECB council members are desperately worried.
They should be. Annual inflation in the eurozone dropped to just 0.7 per cent in the 12 months to October – less than half of the ECB's 2 per cent target; third-quarter growth slowed to just 0.1 per cent, while unemployment rose to 12.2 per cent. There is almost certainly even more bad news coming down the tracks.
Eurozone money supply, normally a good leading indicator of future economic performance, grew by just 2.2 per cent in the year to September, while private sector bank lending shrank by 1.9 per cent over the same period.
Unless you happen to be a German central banker, it is now blindingly obvious the EU risks falling into a Japanese-style deflationary trap. While falling prices might seem like a good thing to a population reared on tales of the supposed evils of inflation, be careful what you wish for.
Japan spent over two decades stuck in a deflationary trap after the bubble economy burst in 1990, only finally emerging when prime minister Shinzo Abe broke with protocol and basically ordered the Bank of Japan to print more money after his victory in last year's general election.
While Japan was ultimately sufficiently wealthy and cohesive to emerge from a prolonged bout of deflation more or less unscathed, other countries have not been so lucky. The deflation unleashed by the Great Depression swept away most of Europe's democracies in the early 1930s and ultimately paved the way for the Second World War. There are worrying signs that history is beginning to repeat itself on the European mainland with recent polls showing Marine Le Pen, the leader of the neo-fascist National Front, well-positioned to win the next French presidential election, which thankfully doesn't take place until the spring of 2017.
In Greece, the hard-left Syriza party and the neo-nazi Golden Dawn won a combined 34 per cent of the vote in last year's general election. Quite clearly austerity is eroding support for mainstream political parties in many eurozone countries. Would deflation tip many of Europe's fragile democracies over the edge?
The fact that the ECB is even contemplating such an unprecedented move as imposing negative interest rates on banks shows just how worried it has become.
Unfortunately, while negative interest rates might deter banks from 'parking' their surplus cash with the ECB in the short term, such a desperate expedient threatens to make an already bad situation even worse.
While banks might wear negative interest rates for a limited period, it would almost certainly be a different story for savers. Ordinary depositors would hardly accept the banks dipping into their savings.
Far more likely is massive deposit withdrawals as cash was emptied from bank accounts and stuffed under mattresses. This in turn would undermine the stability of the banks as they ran out of cash.
So if negative interest rates are such a bad idea, what can the ECB do to avert a potential economic and political catastrophe?
There is of course one other option available: the printing press. Like the other major central banks, the ECB must be prepared to print as much money as is required, AKA quantitative easing, to kick-start the eurozone economy. Perhaps Mr Draghi should remind the Germans that the printing press was a German invention.
It is only by doing so that the eurozone can be spared deflation and the terrible consequences that will come in its wake.