Is the Federal Reserve preparing U.S. banks for negative interest rates?

As central banks all over the world start to implement or contemplate the concept of negative interest rates (SEE: Will negative interest rates dominate monetary policy in 2016?), the Federal Reserve may be preparing United States banks for potential negative interest rates.

As part of its annual stress test this year, the U.S. central bank will attempt to test the resilience and pliability of major financial institutions. One of these will consist of the rate on the three-month U.S. Treasury bill hitting below the zero mark for an extended period of time. During this test, the unemployment rate rises to 10 percent.

In this latest stress test, banks will be required to handle three-month bill rates touching subzero in the second quarter of 2016, and then reaching minus 0.5 percent, which would last until the first quarter of 2019.

“The severely adverse scenario is characterized by a severe global recession, accompanied by a period of heightened corporate financial stress and negative yields for short-term U.S. Treasury securities,” the central bank said in an announcement of the stress tests. The Fed was sure to add that “this scenario does not represent a forecast of the Federal Reserve.”

This isn’t the first time that the three-month bill has dipped below zero. Since the Great Recession, the three-month bill has gone under zero several times, and one of the latest occurred in September when the Fed delayed its rate hike. Also, on Oct. 2, the three-month bill touched minus 0.5 percent.

The Fed is Open to Subzero Rates

Officials at the Fed have iterated many times that they are not in the vicinity of slashing rates to below zero – their regular denials is just a tad too intense. New York Fed President William Dudley confirmed last month that monetary policy makers weren’t really considering negative rates.

“But I suppose if the economy were to unexpectedly weaken dramatically, and we decided that we needed to use a full array of monetary policy tools to provide stimulus, it’s something that we would contemplate as a potential action,” he said on Jan. 15.

With that being said, the Fed has noted that it’s quite open to subzero rates in the event of another economic calamity.

Fed Chair Janet Yellen said late last year that negative interest rates are on the table should a financial crisis transpire.

“Potentially anything – including negative interest rates – would be on the table. But we would have to study carefully how they would work here in the U.S. context,” Yellen told a House of Representatives committee in November.

Moreover, Fed Vice Chairman Stanley Fischer told a meeting of the Council on Foreign Relations (CFR) that negative interest rates are working better than he anticipated in countries that have instituted them.

A handful of central banks have embraced the concept of negative rates in the last couple of years. The Bank of Japan (BOJ), the European Central Bank (ECB), the Swiss National Bank (SNB), the Riksbank in Sweden and the Dansmark National Bank in Denmark have all dipped to below the zero mark. And it hasn’t done much for their economies in terms of establishing growth.

The Damages of Negative Rates

Of course, this leads to an array of unintended consequences. One of them is the consumer himself. Since he receives pittance (if anything at all) on his savings, he searches for yield in any financial instrument, including high-risk investments. He becomes a gambler, addicted to the need for yield. Before he knows it, his savings are lost because the bank wouldn’t even give him a paltry one percent on his deposits to fight price inflation.

Not only is the consumer desperate, but so is the central bank.

Subzero interest rates suggest that central banks are out of ideas and tools to incite economic growth. Money printing hasn’t worked. Buying bonds hasn’t worked. Government stimulus hasn’t worked. Near interest rates haven’t worked. The only thing left is subzero, and that won’t work, either.

Here is what Paul-Martin Foss writes on the Mises Institute:

“What we can’t forget is that the real rate of interest can never be negative. The real, or natural, rate of interest is a function of the preference for present goods over future goods. A bird in the hand is worth two in the bush, in other words. A negative natural rate of interest would mean that someone prefers less in the future to more in the present. Given the choice between $20 today and $10 tomorrow, you would prefer the $10 tomorrow. That is a complete absurdity that would never happen in reality. But when you realize that most of the assumptions made by mainstream economists in creating their models are absurd, unrealistic, and nonsensical, you can understand at least a little why those practitioners of voodoo mathematics think that negative interest rates are a potential policy tool.”

Do you have a microwave, mattress, a Paul Krugman book? That’s where you’ll be parking your money for a while once negative rates arrive.

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Comments

  1. Rabelrouser says:

    Keep no more money in the bank than you are ready to lose.
    With the dollar weakening, and the commodities rising, I would say thats where you should invest.
    Tangible items that hold wealth: Food, barter items, “precious metals”, heck, even toilet paper,. those items that can create an alternative economy.

  2. At current interest rates, .05 percent at my credit union there is no reason to keep any money in the bank. I am making 25% (Saving 25%) on all extra money, by paying down credit card debt by $500 each month. Saving over $800 in interest payments. in 12 months. When I get my credit card debt paid off in 18 months, saving over $2,000 in interest payments. I will be keeping any extra cash at home in a fireproof safe. Then if it crashes, I will have access to money to buy stuff that I need, without worrying if the bank is open and I can get my money back. .

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