Will the Fed drop interest rates below zero?

The rates were dropped to zero in mid-March. The Fed is set to meet again next week. Bloomberg has now published an opinion piece calling for the Fed to go negative on interest rates.

https://www.bloomberg.com/opinion/articles/2020-04-24/coronavirus-economy-the-fed-should-go-negative-next-week

Unprecedented situations require unprecedented actions. That’s why the U.S. Federal Reserve should fight a rapidly deepening recession by taking interest rates below zero for the first time ever.

When Fed officials hold their regular policy-making meeting next week, all the lights on their dashboard will be flashing red. The unemployment rate is expected to reach double digits by June. With global demand cratering, the Fed’s preferred measure of inflation will likely fall to 1% or even lower by the end of the year — well below its target of 2%. And in the absence of a Covid-19 vaccine, the malaise will likely persist well into 2021.

Why the fear of negative rates? A decade ago, the answer would have been that it was impossible to go below zero: Banks would simply avoid the charges by withdrawing their reserve deposits and holding the funds in paper currency, which pays zero interest. But economists now recognize that doesn’t happen, because it’s costly to store billions (or trillions) of dollars of paper currency safely. Several European central banks, as well as the Bank of Japan, have successfully taken interest rates below zero. 1 This stimulates consumer demand in the usual ways: by incentivizing banks to make loans at lower interest rates, to bid up the prices of financial assets, and to charge higher fees for deposits.

When rates go negative, the banks get paid to borrow money from the Fed. On our end, the public may pay the banks to hold their money.

It’s bad enough that the new rules coming out of the Countrywide Bank case a few years ago reclassified our savings account as unsecured loans to the bank. In other words, the banks own the money in our bank accounts, and if they go bankrupt, we simply lose the money that we have “loaned” to the bank, unless it is FDIC insured.

But what happens if the FDIC itself is overwhelmed? Virtually all banks are tied together, and where we go one, we go all. Like ships lashed together in a storm, they either all stay afloat or they all go down together. How long would it take to get back your money in such a scenario?

And they still want us to trust the banking system, just because the big banks have marble columns out front to project stability?

The deeper problem is the derivatives problem. A derivative is a paper contract to provide something real in the future. The recent collapse in oil futures is a good example. When oil prices went negative, these prices were all on derivatives, not real oil. No one was paying anyone to buy real oil products. Derivatives have been pricing things for a long time, as men speculate in the marketplace, going long or short on their futures contracts. Unfortunately, derivatives have been used to manipulate market prices in unrealistic ways.

The same is true with gold, silver, and most other metals. Derivatives have been used to suppress and manipulate their prices in order to make the dollar look better, relatively speaking. But with the recent shortage of silver and gold, the differential between real metal and paper metal (i.e., derivates) has started to decouple (or separate). The paper price of an ounce of silver is about $15, but to buy any real silver will cost $25-30/oz.

The same is now happening with oil as the “petro” is being decoupled from the “dollar.” The petrodollar’s backing shifted in 1971 from gold to oil. The dollar’s value was based largely on oil. So what happens when the price of oil goes negative? It either takes down the value of the dollar or the dollar decouples from oil and has to find a new backing to give it value.

There are major shifts in the world going on right now. Next week we should watch what the Fed does.