Here we are in the midst of The Great Stagnation Middle Class Elimination and some central bankers and mainstream economists are promoting negative interest rates. One economist was quoted in a Marketwatch piece by Greg Robb as saying,

“…pushing rates into negative territory works in many ways just like a regular decline in interest rates that we’re all used to.”

OK. That’s false. We know exactly what negative interest rates do since Europe has made a fine case study of it. They don’t work just like a “regular decline in interest rates.” I mean not that a “regular decline in interest rates,” does what economists think it does, but that’s another story. The issue here is how negative interest rates work.

Negative interest rate proponents ignore the basic tenets of double entry accounting.

Because there are two sides to a bank balance sheet, negative interest rates are the mirror image of positive rates. The move to negative rates imposes new costs on the banks, unlike low positive rates or ZIRP which reduce bank costs.

Liquidity moves markets

The greater the negative interest rate, the higher the cost imposed, which is the same as a central bank raising interest rates when they are positive. When the Fed lowers a positive interest rate, it lowers the bank’s cost. But when there are trillions in excess reserves held by the banks as deposits at the Fed and the Fed lowers the interest rate to below zero, that becomes a cost to the banking system which it cannot avoid, except by using those cash assets to pay down debt.

So the banks in Europe did exactly what I said they would do in mid 2014 when the ECB announced negative deposit rates. It’s exactly what any person with common sense would do, and therefore knew the banks would do. Those with the ability to do so pay off loans, which extinguishes deposits, thereby getting rid of the added cost. As opposed to stimulating growth, the European banking system shrinks. As opposed to encouraging borrowing and spending and economic growth, the policy encouraged deleveraging.