Ex-BIS Chief Economist William White Warns “The system is dangerously unanchored”

Here are juicy excerpts from an interview of former Bank for International Settlements chief, William White, by Finanz and Wirtschaft where the former expresses alarm bells over the Swiss SNB’s negative deposit rates and the de facto global easing policies. (all bold mine; italics interviewer) [hat tip zero hedge] 

By the way, Mr. White predicted the crisis of 2008. [note this isn't to say past is the future, rather, Mr. White's ability to foresee the future has been grounded on relatively "sound" analysis compared with the mainstream]

Will the rate cut of the SNB lower the domestic interest rate level in Switzerland even further?

WW: Maybe yes, maybe no. One argument is, if you lower the rate set by the central bank, then all the other rates will follow. My reaction is: Not so fast, my friend! The Swiss banks are now suffering losses on their reserves at the SNB. Banks could reduce interest rates on deposits to recoup these losses. But this has clear limits: People do not have to hold money at banks, they can ask for their money in notes. The banks could also recoup their losses in a different way, and this is something to be concerned about: They could raise the rates on loans. Far from encouraging lending and spending, negative interest rates at the central bank might work in the opposite direction.

So negative interest rates could actually increase the cost of borrowing?

WW:When interest rates cannot go lower anymore, when they hit the Zero Lower Bound, monetary policy might work like quantum mechanics. Take this simple example from the world of physics: Classical Newtonian mechanics only work when the mass of a body is big enough. When the mass is too small, you are in quantum mechanics. These are completely different ways of looking at the world. The Zero Lower Bound might be the quantum mechanics of monetary policy. Things just do not operate in the same fashion. If you think things do operate the same way, you might make a very dangerous mistake.

But will Swiss banks really increase loan rates now?

WW: I do not know. The banks might swallow the losses for some time. They may decide, as the SNB likes them to, to put their money in some other currency in which they do get a positive return.

By holding a one-sided peg of the Franc to the Euro, the SNB has in effect linked its monetary policy to the ECB. How will the SNB ever be able to decouple from the ECB?

The hope is that at some time the pressure on the Franc will come off, when interest rates rise elsewhere. Then the SNB could gradually reduce their exposure to the Euro. That may be a while.

Do you have an idea who will win or lose from negative interest rates?

WW: The banks will lose as they have to pay rates on their excess reserves they hold at the central bank. The public sector, the SNB, will gain. If the banks do not push down deposit rates, but increase the loan rates, the borrowers will pay the price. And when interest rates go down, savers will suffer.

The SNB has to follow the ECB in its monetary policy. Is it not dangerous when the monetary policy of one country affects another?

WW: Currently we have an international monetary non-system. Nobody has to follow any rules. Everybody does what they consider is in their own short-term best interest. The real difficulty is: What is in their short-term interest – for example, following ultra-easy monetary policy – could well backfire somewhere. It might be not in their long-term best interest. And as the easy monetary policy influences the exchange rates, it influences other countries. Almost every country in the world is in easing mode, following the Fed, and we have absolutely no idea how it will end up. We are in absolutely uncharted territory here. This worries me the most. The SNB has been doing well in what it was forced to do by this international monetary non-system. The Swiss have to do the best they can, because that is what everybody else is doing.

What are the risks of this non-system?

WW: There is no automatic adjustment of current account deficits and surpluses, they can get totally out of hand. There are effects from big countries to little ones, like Switzerland. The system is dangerously unanchored. It is every man for himself. And we do not know what the long-term consequences of this will be. And if countries get in serious trouble, think of the Russians at the moment, there is nobody at the center of the system who has the responsibility of providing liquidity to people who desperately need it. If we have a number of small countries or one big country which run into trouble, the resources of the International Monetary Fund to deal with this are very limited. The idea that all countries act in their own individual interest, that you just let the exchange rate float and the whole system will be fine: This all is a dangerous illusion.

I interpret Mr.White’s point as one of saying that 

-central bankers have indulged in a grand gambit with the monetary system from which they have been pushing these monetary tools to the limits (“we are in absolutely uncharted territory here”), 

-the average citizens are guinea pigs (in the case of the SNB's negative deposit rates; banks, borrowers and savers lose as the public sector gains--arbitrary confiscation that benefits a few at the cost of many), 

-that such gambit has signified an act of desperation (“forced to do”) predicated on path dependency and the bandwagon effect (“because that is what everybody else is doing”) and 

-that central banks have entirely been clueless of the risks and ramifications of their actions, where the policy trend have been focused on short term fixes (“The system is dangerously unanchored. It is every man for himself. And we do not know what the long-term consequences of this will be”)

Stocks may be at record levels for NOW, but at what costs in the future?

Swiss Central Bank Imposes Negative Deposit Rates!

The Keynesian euthanasia of the rentier policies of abolishing interest rates has been intensifying.

Today, the Swiss National Bank joins the ECB (June 2014) and Sweden (2009) to implement negative deposit rates supposedly intended to discourage capital flows.

From Bloomberg:

The Swiss National Bank (SNBN) imposed the country’s first negative deposit rate since the 1970s as the Russian financial crisis and the threat of further euro-zone stimulus heaped pressure on the franc.

A charge of 0.25 percent on sight deposits, the cash-like holdings of commercial banks at the central bank, will apply as of Jan. 22, the Zurich-based central bank said in a statement today. That’s the same day as the European Central Bank’s first decision of 2015.

The SNB move follows Russia’s surprise interest-rate increase this week and hints at the investment pressures that resulted after that decision failed to stem a run on the ruble. Swiss officials acted as the turmoil, along with the imminent threat of quantitative easing from the ECB, kept the franc too close to its 1.20 per euro ceiling for comfort.

As one would notice, the SNB’s has supposedly been responding to unintended consequences from previous interventions

And since every interventions create unintended economic and financial dislocations, these has prompted policymakers to apply even more interventions which furthers the imbalances. Thus one intervention begets another. The ramification of which is a massive accumulation of distortions, or malinvestments pillared on the destruction of savings or capital consumption that eventually results to a crisis

As great Austrian economist Ludwig von Mises warned in his magnum opus the Human Action (bold mine)

The age-old disapprobation of interest has been fully revived by modern interventionism. It clings to the dogma that it is one of the foremost duties of good government to lower the rate of interest as far as possible or to abolish it altogether. All present-day governments are fanatically committed to an easy money policy. As has been mentioned already, the British Government has asserted that credit expansion has performed "the miracle...of turning a stone into bread." A Chairman of the Federal Reserve Bank of New York has declared that "final freedom from the domestic money market exists for every sovereign national state where there exists an institution which functions in the manner of a modern central bank, and whose currency is not convertible into gold or into some other commodity." Many governments, universities, and institutes of economic research lavishly subsidize publications whose main purpose is to praise the blessings of unbridled credit expansion and to slander all opponents as illintentioned advocates of the selfish interests of usurers.

The wavelike movement affecting the economic system, the recurrence of periods of boom which are followed by periods of depression, is the unavoidable outcome of the attempts, repeated again and again, to lower the gross market rate of interest by means of credit expansion. There is no means of avoiding the final collapse of a boom brought about by credit expansion. The alternative is only whether the crisis should come sooner as the result of a voluntary abandonment of further credit expansion, or later as a final and total catastrophe of the currency system involved.

And why does it seem that we are in a crisis for central banks to resort to unprecedented emergency measures?

Naturally Wall Street love such invisible transfers—policies which confiscate arbitrarily; and, while the process impoverishes many, it actually enriches some—as they are one of the key beneficiaries.

And so today’s continuing party.

Deposit Confiscation via Negative Interest Rates: German Bank Sets Trend

When Keynes wrote then that “Lenin is said to have declared that the best way to destroy the capitalist system was to debauch the currency. By a continuing process of inflation, governments can confiscate, secretly and unobserved, an important part of the wealth of their citizens. By this method they not only confiscate, but they confiscate arbitrarily; and, while the process impoverishes many, it actually enriches some", confiscation via inflation then has been imposed tacitly or "secretly and unobserved".

Not anymore. Government’s confiscation has become an upfront policy tool. [isn't it a wonder, considering record stocks, isn't today supposedly a boom, but why have policymakers been panicking?]

Prior to the last month’s QE, the ECB launched their negative deposit rates last June. Well ECB’s policies have now been transmitted to the banking system. Last November 1, a German bank embarked on imposing negative rates on consumer deposits.

From Sovereign Man’s Simon Black

On November 1st, the first European bank has passed along these negative interest rates to its retail customers.

So if you maintain a balance of more than 500,000 euros at Deutsche Skatbank of Germany, you now have the privilege of paying 0.25% per year… to the bank.

We’ve already seen this at the institutional level: commercial banks in Europe are paying the ECB negative interest on certain balances.

And large investors are paying European governments negative interest on certain bonds.

Now we’re seeing this effect bleed over into retail banking.

It’s starting with higher net worth individuals (the average guy doesn’t have half a million euros laying around in the bank). But the trend here is pretty clear– financial repression is coming soon to a bank near you.

It almost seems like an episode from the Twilight Zone… or some bizarre parallel universe. That’s the investment environment we’re in now.

Bottom line: if you’re responsible with your money and set some aside for the future, you will be penalized. If you blow your savings and go into debt, you will be rewarded.

If we ask the question “cui bono”, the answer is pretty obvious: heavily indebted governments benefit substantially from zero (or negative) rates.

Case in point: the British government just announced that they would pay down some of their debt that they racked up nine decades ago.

In 1927, then Chancellor of the Exchequer Winston Churchill issued a series of bonds to consolidate and refinance much of the debt that Britain had racked up from World War I and before.

This debt is still outstanding to this day. And the British government is just starting to pay it down– about $350 million worth.

Think about it– $350 million was a lot of money in 1927. Thanks to decades of inflation, it’s practically a rounding error on government balance sheets today.

This is why they’re all so desperate to create inflation… and why they’ll stop at nothing to make it happen. (It remains to be seen whether they’ll be successful, but they are willing to go down swinging…)

What’s even more extraordinary is how they’re trying to convince everyone why inflation is necessary… and why negative rates are a good thing.

On the ECB’s own website, they say that negative interest rates will “benefit savers in the end because they support growth and thus create a climate in which interest rates can gradually return to higher levels.”

I’m not sure a more intellectually dishonest statement could be made; they’re essentially telling people that the path to prosperity is paved in debt and consumption, as opposed to savings and production.

These people either have no idea how economies grow and prosper, they’re outright liars, or they’re completely delusional.

Negative rates will serve as a precursor to the widespread adaption of deposit confiscation via haircuts or wealth taxes especially when the global crisis emerges. 

Yet the desperate desire by governments to "create inflation" means only to survive or maintain the status quo for the political establishment (troika welfare-warfare state, politically connected too big to fail banks and central banking) charged to their respective citizens by inflating debt away. 

All those supposed growth thing are no more than propaganda smokescreens. This means that the promotion of wanton consumption financed by destroying savings through indiscriminate debt acquisition represents a fundamental recipe towards depression as resources continue to be misallocated. 

Thus the thrust by governments to generate inflation is to balloon systemic risk on overleveraged systems.

Nonetheless, the article above reveals of signs of desperation by governments to confiscate resources in the facade of debt financed consumption that should allegedly serve as elixir to real economic activities. 

As the great Austrian economist, Ludwig von Mises presciently warned,

Credit expansion is the governments' foremost tool in their struggle against the market economy. In their hands it is the magic wand designed to conjure away the scarcity of capital goods, to lower the rate of interest or to abolish it altogether, to finance lavish government spending, to expropriate the capitalists, to contrive everlasting booms, and to make everybody prosperous…

It is a fact that today measures aimed at lowering the rate of interest are generally considered highly desirable and that credit expansion is viewed as the efficacious means for the attainment of this end. It is this prepossession that impels all governments to fight the gold standard. All political parties and all pressure groups are firmly committed to an easy money policy.

Unfortunately politically incited quasi booms always morphs into an economic bust, again the great Mises

But the boom cannot continue indefinitely. There are two alternatives. Either the banks continue the credit expansion without restriction and thus cause constantly mounting price increases and an ever-growing orgy of speculation, which, as in all other cases of unlimited inflation, ends in a “crack-up boom” and in a collapse of the money and credit system. Or the banks stop before this point is reached, voluntarily renounce further credit expansion and thus bring about the crisis. The depression follows in both instances.

How we live in very interesting times

The ECB Takes Keynesianism to the Limits via Negative Deposit rates

I find it quite ridiculous for the mainstream to claim that the Eurozone has been experiencing a ‘recovery’ when the financial-banking industry continues to push the European Central Bank (ECB) to further ease.

Apparently, as previously noted, recent record setting stock markets in developed economies has largely been in anticipation of the ECB and Mario Draghi’s accommodation to such pressures.

Today the ECB obliged.

From Bloomberg:

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.

Notice that central banks have all been pushing monetary policies—from intensifying use of QE, ZIRP and now Negative Interest Rates—to the limits.

They have waged an all out war against savings via the abolishment of interest rates as advocated by the high priest of inflationism, John Maynard Keynes (bold mine)

Now, though this state of affairs would be quite compatible with some measure of individualism, yet it would mean the euthanasia of the rentier, and, consequently, the euthanasia of the cumulative oppressive power of the capitalist to exploit the scarcity-value of capital. Interest today rewards no genuine sacrifice, any more than does the rent of land. The owner of capital can obtain interest because capital is scarce, just as the owner of land can obtain rent because land is scarce. But whilst there may be intrinsic reasons for the scarcity of land, there are no intrinsic reasons for the scarcity of capital. An intrinsic reason for such scarcity, in the sense of a genuine sacrifice which could only be called forth by the offer of a reward in the shape of interest, would not exist, in the long run, except in the event of the individual propensity to consume proving to be of such a character that net saving in conditions of full employment comes to an end before capital has become sufficiently abundant. But even so, it will still be possible for communal saving through the agency of the State to be maintained at a level which will allow the growth of capital up to the point where it ceases to be scarce.

In short, the euthanasia of the rentier lowers interest rate with the aim that no one will find savings profitable such that everyone will simply spend. Mario Draghi and the ECB would make JM Keynes proud.

Yet this is really a camouflage for perpetual debt accumulation.

Aside from Negative Deposit Rates, the ECB has placed in the pipeline more on easing measures. From the Zero Hedge (bold original)

The much anticipated additional measures have been revealed:

-DRAGHI UNVEILS PACKAGE OF TARGETED LTROS, WORK TO PREPARE QE

-DRAGHI SAYS INITIAL SIZE OF TARGETED LTRO PLAN IS 400BLN EUROS

-ECB EXTENDS FIXED RATE FULL ALLOTMENT, SUSPENDS SMP STERILIZING

-DRAGHI SAYS PACKAGE INCLUDES PREPARATIONS FOR ABS PURCHASES

In other words, even more actions along what was expected: keep in mind the last time the ECB did €1 trillion in LTROs it did exactly nothing to boost inflation or the "real economy." Furthermore, the ABS purchases aren't activated: just being "prepared." However, what was not revealed was the biggest wildcard: European QE, which as we said repeatedly, won't happen until Europe's deflation is far worse, if ever.

All these represent no more than subsidies, as I previously commented: 

governments around the world have been forcing a 'reverse Robin Hood' redistribution of plundering the Main Street in favor of the Wall Streets of the world through a variety of financial repression policies such as blowing bubbles, bank deposit haircut, negative deposit rates and more…  

Yet there is no such thing as a free lunch. Every action has a consequence. Unproductive spending and malinvestments will backfire. As the great Austrian economist Ludwig von Mises presciently warned (bold mine)

The age-old disapprobation of interest has been fully revived by modern interventionism. It clings to the dogma that it is one of the foremost duties of good government to lower the rate of interest as far as possible or to abolish it altogether. All present-day governments are fanatically committed to an easy money policy. As has been mentioned already, the British Government has asserted that credit expansion has performed "the miracle...of turning a stone into bread." A Chairman of the Federal Reserve Bank of New York has declared that "final freedom from the domestic money market exists for every sovereign national state where there exists an institution which functions in the manner of a modern central bank, and whose currency is not convertible into gold or into some other commodity." Many governments, universities, and institutes of economic research lavishly subsidize publications whose main purpose is to praise the blessings of unbridled credit expansion and to slander all opponents as illintentioned advocates of the selfish interests of usurers.

The wavelike movement affecting the economic system, the recurrence of periods of boom which are followed by periods of depression, is the unavoidable outcome of the attempts, repeated again and again, to lower the gross market rate of interest by means of credit expansion. There is no means of avoiding the final collapse of a boom brought about by credit expansion. The alternative is only whether the crisis should come sooner as the result of a voluntary abandonment of further credit expansion, or later as a final and total catastrophe of the currency system involved.

It is sad to see that that the average citizens of the world have been treated like guinea pigs by monetary authorities, for an age old experiment that not only transfers resources from society to the the political class and their cronies but importantly has been DESTINED for failure: quasi booms morph into horrific busts.

When real savings have been substantially diminished relative to misallocated capital, then expect and prepare for a global economic depression in a not so distant future.

ECB Cuts Rates, Mulls Negative Deposit Rates

Central banks are reinforcing their assumed roles as superheroes for the global political economy.

Justifying a weak regional economy, the ECB has once again pared down interest rates…

From Bloomberg:

The European Central Bank cut its key interest rate to a record low as the 17-nation euro region struggles to emerge from recession.

Policy makers meeting in Bratislava today lowered the main refinancing rate to 0.5 percent from 0.75 percent, a move predicted by 45 of 70 economists in a Bloomberg News survey. The ECB kept the deposit rate at zero and reduced the marginal lending rate to 1 percent from 1.5 percent to preserve a symmetrical rate corridor. President Mario Draghi holds a press conference in the Slovakian capital at 2:30 p.m.

Since Draghi said last month that he stood ready to act if Europe’s economic outlook worsened, inflation plunged, economic confidence slumped and unemployment rose. Today’s cut, the first since July last year, takes the ECB closer to exhausting its conventional policy tools, raising the prospect of a negative deposit rate or new non-standard measures.

I have been expecting bolder and more aggressive experiments or tinkering with the financial system from central bankers. Central bankers will push using central banking (inflationism) tools to the limits.

The ECB has mulled on negative deposit rates since 2012, then I wrote:

Central banks have only one thing in mind: That is to expand to credit (inflationism) to supposedly boost aggregate demand which is reality serves as an academic cover for the true purpose—finance extravagant governments.

Unfortunately the world isn’t that simple. People refuse to take on more credit for several reasons: They have been drowning in debt, they have been tarnished by bad or blemished credit scores, they could be suffering from lower income or unemployment is high due to the recession, business environment has been hampered by politics banking institutions have been clogged and for many other reasons which reduces their incentives to do so.

What negative deposit rates will likely do is to destabilize allocation of resources and spawn more malinvestments and fuel frenetic speculation that leads to boom-bust cycles and worsen the situation

At the press conference following the announcement of the cutting of rates, the Financial Times’ Person of the year ECB’s Chief Mario Draghi has remarkable comments on the negative deposit rate and on the direction of ECB policies which deserves some comments. (bold mine)

On negative deposit rates:

We said in the past we are technically ready. There are several unintended consequences that may stem from this measure. We will address and cope with these consequences if we decide to act. And we will again look at this with an open mind and stand ready to act if needed.

Unintended consequences, which are likely to be systemic, will be suffered, not only by the taxpayers, but by the regional economy that may affect the world. This is because centralization of risk taking, which assumes simplicity and homogeneity, goes against the reality of a complex world.

Central bankers have been revealed as having no qualms using the economy as guinea pigs for their grand designs.

And for whose benefit?

Mr. Draghi on the direction of ECB policies:

I would use the word frustrated, yes. We view improvements in financial markets. We think financial markets are the only and the necessary channel for the transmission of monetary policy. You don’t go around with helicopter money, throwing money. In Europe, you go through banks. You don’t have capital markets as you have in the U.S. We have to go via the banking system. That is why in my press conference I try to give you a very detailed reading of different indicators because it shows how closely we are trying to examine and analyze reality to see whether these impulses that we’ve been transmitting to the economy get translated into better welfare, lower unemployment, better economic activity.

So there you have it folks, no helicopter money, ECB’s policies will mainly be directed at the rescues of the crony banking system.

Thus the consideration of negative deposit rates or of the charging financial institutions for the money they deposited with the central bank which once again will penalize savers.

Today’s derring-do rock star central bankers hardly understands why centralization will mostly fail to accomplish its goals.

As the great Nobel laureate Austrian economist Friedrich von Hayek warned of Fatal Conceit by political authorities 

The curious task of economics is to demonstrate to men how little they really know about what they imagine they can design. To the naive mind that can conceive of order only as the product of deliberate arrangement, it may seem absurd that in complex conditions order, and adaptation to the unknown, can be achieved more effectively by decentralizing decisions and that a division of authority will actually extend the possibility of overall order. Yet that decentralization actually leads to more information being taken into account

Denmark Cuts Interest Rates to Negative

Capital flight from the Eurozone has been giving Denmark’s central bank a headache.

So they experiment with negative rates—instead of the central bank (borrower) paying money to depositors (lenders), it’s now depositors (lenders) who pay the central bank (borrower) for safekeeping.

From Bloomberg, (bold emphasis mine)

Denmark’s central bank cut its main borrowing costs to record lows and brought the rate it offers on certificates of deposit below zero, as policy makers test uncharted territory to fight a capital influx.

The benchmark lending rate was cut to 0.2 percent from 0.45 percent, while the deposit rate was reduced to minus 0.2 percent from 0.05 percent, Copenhagen-based Nationalbanken said in a statement today. The move followed a quarter of a percentage point cut in the European Central Bank’s main rate to 0.75 percent. Nationalbanken doesn’t hold scheduled meetings and only adjusts rates to defend the krone’s peg to the euro.

“There’s no experience of how negative deposit rates will affect the financial markets and the krone,” Jacob Graven, chief economist at Sydbank A/S, said in a phone interview today before the decision was announced. “It’s a sign of the strong Danish economy. This is good. The opposite situation would be far worse, if the central bank would have to hike rates to defend the krone. We have a luxury problem.”

Denmark has stepped up its battle to prevent the krone from strengthening beyond its currency band as the nation’s haven status attracts investors. Danske Bank A/S (DANSKE), the country’s biggest lender, said last week it now has a risk scenario that envisages Denmark abandoning the peg should the cost of fighting currency appreciation grow too high. The bank doesn’t view this as a likely outcome, it said.

‘Absurd Scenario’

Negative rates were “until recently an absurd scenario,” said Christian H. Heinig, an economist at Realkredit Danmark A/S, the mortgage unit of Danske Bank. “Mortgage loan rates are already at record lows, and today’s rate announcement won’t have more than a limited effect here.”

The rate cut sent the krone to its weakest level since April 16 at 7.4427 against the euro. The currency was trading at 7.4396 as of 4:26 p.m. local time, compared with 7.4367 yesterday, according to prices available on Bloomberg.

Denmark has an agreement with the ECB to let the krone swing no more than 2.25 percent from central rate of 7.46038, though it maintains a tighter band in practice. Denmark’s foreign reserves climbed to a record high in June after the central bank tapped the currency market to weaken the krone. Reserves rose by 9.2 billion kroner last month to 511.6 billion kroner ($85 billion), the central bank said on July 3.

Of course there will an impact, even if they haven’t been visible to the economy now.

I’ve noted how Denmark’s 2 year bonds turned negative earlier here.

Such destabilizing capital flows are likely to spawn boom bust cycles.

And perhaps this may have began to manifest through Denmark’s equity markets.

Denmark’s major equity benchmark the Copenhagen 20 has been one of top world performers (18% year to date) and trails the Philippine Phisix by only a few percentage points.

No, this isn't about liquidity traps.

But this is the loony kindda o’ stuff you see only with the paper money system.

Will the ECB Impose Negative Deposit Rates?

This Bloomberg report thinks so.

European Central Bank President Mario Draghi is contemplating taking interest rates into a twilight zone shunned by the Federal Reserve.

While cutting ECB rates may boost confidence, stimulate lending and foster growth, it could also involve reducing the bank’s deposit rate to zero or even lower. Once an obstacle for policy makers because it risks hurting the money markets they’re trying to revive, cutting the deposit rate from 0.25 percent is no longer a taboo, two euro-area central bank officials said on June 15.

“The European recession is worsening, the ECB has to do more,” said Julian Callow, chief European economist at Barclays Capital in London, who forecasts rates will be cut at the ECB’s next policy meeting on July 5. “A negative deposit rate is something they need to consider but taking it to zero as a first step is more likely.”

Should Draghi elect to cut the deposit rate to zero or lower, he’ll be entering territory few policy makers have dared to venture. Sweden’s Riksbank in July 2009 became the world’s first central bank to charge financial institutions for the money they deposited with it overnight. The Fed rejected cutting its deposit rate from 0.25 percent last year. With Europe’s debt crisis damping inflation pressures and curbing growth, the ECB may feel the benefits outweigh the negatives.

‘Psychological Effect’

“A rate cut could have an important psychological effect in the current environment,” said Christoph Kind, head of asset allocation at Frankfurt Trust, which manages about $20 billion. “Negative interest rates aren’t an irrational concept. I’m not sure, though, whether in the case of the ECB it will have the desired effect.”

The ECB uses three interest rates to steer borrowing costs in financial markets. The main refinancing rate determines how much banks pay for ECB loans, while the deposit and marginal rates provide a floor and ceiling for the interest banks charge each other overnight.

If the deposit rate was cut to zero or lower, it would discourage banks from parking excess liquidity with the ECB overnight, potentially prompting them to lend the cash instead. Almost 800 billion euros ($1 trillion) is being deposited with the ECB each day.

On the other hand, a deposit rate cut could hurt banks’ profitability by lowering money-market rates, potentially hampering credit supply to companies and households and reducing banks’ incentive to lend to other financial institutions.

Central banks have only one thing in mind: That is to expand to credit (inflationism) to supposedly boost aggregate demand which is reality serves as an academic cover for the true purpose—finance extravagant governments.

Unfortunately the world isn’t that simple. People refuse to take on more credit for several reasons: They have been drowning in debt, they have been tarnished by bad or blemished credit scores, they could be suffering from lower income or unemployment is high due to the recession, business environment has been hampered by politics banking institutions have been clogged and for many other reasons which reduces their incentives to do so.

What negative deposit rates will likely do is to destabilize allocation of resources and spawn more malinvestments and fuel frenetic speculation that leads to boom-bust cycles and worsen the situation

As the great Ludwig von Mises once warned,

But today credit expansion is exclusively a government practice. As far as private banks and bankers are instrumental in issuing fiduciary media, their role is merely ancillary and concerns only technicalities. The governments alone direct the course of affairs. They have attained full supremacy in all matters concerning the size of circulation credit. While the size of the credit expansion that private banks and bankers are able to engineer on an unhampered market is strictly limited, the governments aim at the greatest possible amount of credit expansion. Credit expansion is the governments' foremost tool in their struggle against the market economy. In their hands it is the magic wand designed to conjure away the scarcity of capital goods, to lower the rate of interest or to abolish it altogether, to finance lavish government spending, to expropriate the capitalists, to contrive everlasting booms, and to make everybody prosperous.

The ECB seems to be grasping at straws.