Ban on Cash, Negative Rates, and Super Bubbles

Recently there has been has been a rising chorus to do away with cash, here, here, and here. You will hear several reasons why this is necessary but there really is only one. The banking interests want to be able to implement significant negative interest rates and participants in the economy being able to opt out of negative rates by removing cash from the banking system makes this very difficult.

So how did we get here? Over the past 70 plus years we have been living in a credit created bubble that has supported the economy, but as Von Mises said:

"There is no means to avoiding the final collapse of a boom brought on by credit expansion. The alternative is only whether the crisis should come sooner as a result of a voluntary abandonment of further credit expansion, or later as a final and total catastrophe of the currency system involved.”

Unfortunately for us this boom is much larger and has been going on for multiples longer than any other in history. Considering the last one ended in the Great Depression, and was the result of a credit created boom of about 20 years, the upcoming collapse could be very ugly. The bigger, and longer in this case, they are the harder they fall, as the saying goes.

To prevent that collapse central banks have stood ready, lowering interest rates to ensure further credit expansion in past decades. They have now reached the Keynesian end point, the infamous zero lower bound. Central banks have lowered interest rates to zero and no longer have the ability to lower them much further without the threat of depositors pulling their money from the system and sitting in cash. The central banks had to not only reduce rates to zero to recover from the most recent financial crisis, but as you all know, also had to essentially print money and hand it to the wealthiest among us via the “policy tool” dubbed quantitative easing. There has not been a major central bank who hasn't used this new ‘tool’ over the past several years.

Though quantitative easing is still taking place in many nations, its effects of exacerbating already historically large income inequality is showing the political limitations of this very new central bank policy tool. It appears as if buying assets, mainly held by the wealthy, with newly created money, isn't quite as opaque and confusing to the general public as is lowering interest rates.

Again the problem is the central planners want desperately to get back to their old game of lowering rates, and have done so by forcing rates negative in limited instances. Because rates are barely in the negative territory in a few places there has not been the natural reaction to go to cash. This is mainly because there are small storage, transportation, and security costs involved, as well as some regulatory requirements (coercion). That said the central banks are aware that to institute negative rates sufficient to allow the prescribed reaction to over indebtedness, financial repression, the market participants will shift to cash, and thus their solution to simply ban cash.

I would find this reaction of Keynesian's to change the rules every time their theories fail comical, if not for the serious detrimental ramification to nearly every person on earth. A read through Keynes’s book: The General Theory of Employment, Interest and Money, where he lays out the economic system we have been following for the entirety of this credit created boom, will reveal not once does he mention zero or negative interest rates. He never considered it a possibility, but changing the rules to fix this horribly flawed system in favor a very small minority has been the hallmark of Keynesianism. I consider it akin to a game, where whenever the one participant gets close to scoring the other participant changes the rules preventing the opponent from having any chance to win. These types of games have been played by children thousands of times and always results in one kid quitting. The unfairness of the game always results in its failure, and the same should occur for our debt based monetary system, but conditioned adults can be denser than kids.

As previously outlined, debt levels have risen to the point where financial repression will not work and I doubt negative rates, of even several percent, will change this. It will buy some time, kick the can so to say, but one thing it will do is create not just bubbles but super bubbles. This should be obvious but I have notice on sites where I would have thought the readers would have been well aware of this, there are comments showing that they are ready to make the same mistakes we observe in every asset bubble. Not all the comments of course but enough to cause concern.

Some of the comments I have seen when discussing negative rates include how individuals will take out huge loans paying back the principle with the money borrowed and living off the negative interest. I hate to dignify these comments with a response but considering there are obviously those with these thoughts I figured I would address it. First, a negative rate world would not mean every Tom Dick and Harry gets to dictate the terms of their loan. Even if the Federal Government were borrowing at -3% or -4% a personal loan would still carry a positive rate of a few percentage points. Not to mention without the ability to take your money out of the banking system your deposit would be subject to a negative rate. So for anyone who might have thought they would be able to live off of interest paid by the bank, not surprisingly, this will not be the case.

Similar to today’s ultra low interest rates, negative rates will only be available to individuals for certain kinds of loans, namely secured loans. The first and likely only type of loan an individual will likely see negative rates is for a mortgage. Again I am reminded of comments after a story about slightly negative rates for Swiss Mortgages; to paraphrase “If there are ever negative mortgages in the United States I am going to buy a farm”. This brings me to my next point about negative rates, they will not just cause bubbles but super bubbles.

I have read several stories about negative rate mortgages in Europe and there are similar comments to the one above, indicating that given the opportunity at these negative rates people will jump into the real-estate market with both feet. What is most surprising is these stories are mainly on Zerohedge, a site which has outlined over and over how low interest rates cause bubbles, thus I would expect the readers would understand that if unnaturally low interest rates cause bubbles negative rates will cause even more dangerous distortions. The fact that some (again not all) Zerohedge subscribers still don’t understand this dynamic means the general public doesn't have a prayer.

For clarification I will outline how a negative rate super bubble in real-estate would occur. First imagine due to another financial crisis the government is “forced” to take the drastic measure of banning cash to allow the central bank to implement negative rates. When 15 and then 30 year mortgages are forced negative, individuals like the one who wants to buy a farm above, will be enticed to purchase property, in love with the idea of the bank ‘paying them’ interest. This will inevitably cause more demand for real estate and more demand will cause increases in price. Just as in the early 2000’s there will be those who sell these properties making huge profits.

To give an idea of where negative rates might initially take real estate prices we can look first at what property price the same payment will support between current rates and a slightly negative rate. Not including a down payment, a budget of about $1000 using a current 30 year mortgage, at a 4% rate, will allow you to spend $200,000 on a property, but at -0.5% it will increase that number to $366,000. An 80% increase. Home owners could expect to see such paper increases in their value of their homes during the initial phases of a bubble, and home flippers would see real profits of this magnitude. With a population of people with very short memories these real and paper profits would only entice more to play the game pushing prices far past what would be rational based on the monthly payment example shown above.

When naysayers would surface asking the obvious question, haven’t we been here before, they will be rebuffed by the normal cheerleaders saying: This time it’s different! They will go on about how negative rates are the greatest thing since sliced bread, and why the increases in home prices are based on fundamentals, and even if prices falter the Fed could just push rates further negative. Even with the 'this time its different' crowd, there will be those who know there will be limitations, even with the absence of cash, as to how far the Fed can push rates into negative territory. Most of all, the Federal Reserve itself.

The crash will be similar to all others; the price put on property will reach levels that cannot be supported even with negative rates and the game will end. Still, it is worth exploring the dynamics.

A hair dresser or plumber, after watching friends or family make profits selling property, or even flipping and seeing those profits themselves will make one, final, purchase. We’ll say it’s a farmette that in 2015 was valued at $500,000, but in 2022 after several years of negative rates it has a price tag of $1,700,000.

The buyer has made a $200,000 down payment, using the profits from a previous flip as well as some retirement savings, and has secured a -1.0% 30 year mortgage on the remaining 1.5 mil. This leaves the monthly principal and interest payment at about $3500.

While there has been wage gains for those in home-building, realtors, and bankers, the wage gains for hair dressers and plumbers has been much more modest and our buyer is only making 50k a year. One may look at these numbers and say the buyer can’t even pay the monthly payment but, as always, they have a plan. The buyer is planning on selling off the little farms land in lots, put that money toward the principal, and refinance. Approvals are given to divide the land, unfortunately only one of the ten lots is able to be sold and for far less than they were expecting. It seems demand is finally drying up.

The money from this sale is quickly eaten up with a few months of bills. As all property owners know the principal and interest is not all of the cost that goes into owning a home; maintenance, taxes, utilities and other costs add to the expense. In our example the real-estate bubble not only is a windfall for home-builders and flippers but the municipalities, who don’t change their 1% annual tax on property, use every penny, and borrow on top of it. The monthly tax bill alone for our hairstylist/real-estate mogul would be $1416. Similar stories occur by the thousand and the bubble again pops.

As mentioned above negative rates do not appear as if they could remedy our present enormous total credit market debt, though it might kick the can, and exacerbate the boom and bust cycle. While I thought that perpetual bubbles caused by central banks lowering rates was starting to be understood, I felt compelled to write this because it appeared as if even informed readers were again being tricked by yet another little shift in the rules. The banking industry loves to confuse the public and negative interest rates seem to be a perfect move to perplex would be investors. Though I used housing as an example bubbles would be possible across asset classes at different times due to the reckless nature of these policies. I hope this piece clarifies that a negative sign in front of an interest rate changes little in the workings of a failed debt based monetary system.

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