Fed May Need to Deploy Negative Rates Says Former Economic Advisor

 

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Photo by DonkeyHotey

There’s a war going on; one that’s taking place is between the government and your savings account and, so far, your savings account is losing. Now one expert says the government hasn’t even brought out the big guns yet.

It’s not that your savings account’s ever done anything to Uncle Sam that warrants being carried off the financial battlefield; the government just doesn’t want you sitting on a lot of your own cash. Our government, and many like it around the world, would prefer that you invest that money, or spend it. Currently the Fed is trying everything it can think of to get our cash moving but so far investors are holding tight to their cash reserves.

In a fair market people with money to lend make it available to people who want to borrow through an intermediary, like a bank. The bank pays its depositors interest in exchange for their cash, then charges the borrower interest on the loan. The bank then pays back its interest debt to depositors and pockets the difference. But the process hasn’t actually worked that way since the 1960s. Today big banks get cash from the Fed at near-zero interest, then lend that money out. Your cash is not only unneeded but, to some banks, hiring staff to take care of your needs is an annoyance.

ZIRP

ZIRP stands for Zero Interest Rate Policy and it’s the artificial economic world we’ve been living in for the last decade. The cash flowing into the banking system from the Fed created kind of an asset bubble, because borrowers getting money at lower interest can afford higher payments. That’s exactly the mechanism that’s been feeding the rise in home prices the last seven years. Cheap money warps financial markets.

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Could Interest Rates Go Less than Zero?

Now former Fed economist and policy advisor Marvin Goodfriend is speculating that continued deflationary risks will force the Fed to keep interest rates low. And it gets worse, he says; when the next recession strikes, the only tool left to our central bank will be negative interest rates—unprecedentedly low ones, in fact.

As Goodfrined sees it, essentially the Fed will be charging us for holding onto our own cash. That could mean rates as low as negative two percent, far below any we’ve seen so far, even in Japan and Europe. While two percent may not sound like much, keep in mind that’s two percent on top of the two percent you already lose to inflation. Lose two percent to inflation, then lose an additional two percent to negative interest rate and now you’re talking some serious money. Imagine the $10,000 in your savings account suddenly worth $9,600, just like that.

Markets Turned Upside Down

If cheap money warps financial markets, then negative interest rates turns them upside down and tosses them around like a toy boat in a hurricane. Negative interest rates destroy the wealth of the most fiscally responsible members of society, people who keep cash savings for emergencies, pension funds that are required by charter to hold “safe” investments like government bonds, and companies that operate profitably and responsibly.

No Exit Strategy

The Fed has now become trapped by the very asset bubble it helped to create. Take that cheap money away and our markets will collapse. If the markets do disintegrate, the Fed will likely have to turn to negative interest rates anyway, in an attempt to get the cash in the system moving again.

Opting Out

As a small investor you have an option that’s not available to pension funds. You can take part of your cash and turn it into liquid hard assets, like gold and silver coins. The gold and silver is not only safe from negative interest rates, it benefits from them. The more poorly cash gets treated in the marketplace, the better it is for gold and silver. In a world full of asset bubbles and artificially inflated markets, gold and silver can’t be cheated.

In today’s market diversification is more crucial than ever and part of a well diversified personal portfolio includes precious metals.