The Consequences of Imposing Negative Interest Rates

Courtesy of Peter Tenebrarum @ Acting Man Blog:

Negative Interest Rates and Capital Consumption

Ever since the ECB has introduced negative interest rates on its deposit facility, people have been waiting for commercial banks to react. After all, they are effectively losing money as a result of this bizarre directive, on excess reserves the accumulation of which they can do very little about.

At first, only a small regional bank, Deutsche Skatbank, imposed a penalty rate on large depositors – slightly in excess of the 20 basis points banks must currently pay for ECB deposits. It turns out this was a Trojan horse. Other banks were presumably watching to see if depositors would flee Skatbank, and when that didn’t happen, Commerzbank decided to go down the same road.

However, there is an obvious flaw in taking such measures – at least is seems obvious to us. The Keynesian overlords at the central bank who came up with this idea have failed to consider a warning Ludwig von Mises once uttered about the attempt to abolish interest by decree.

Obviously, the natural interest rate can never become negative, as time preferences cannot possibly become negative: ceteris paribus, consumption in the present will always be preferred to consumption in the future. Mises notes that if the natural interest rate were to decline to zero, all consumption would stop – we would die of hunger while investing all of our resources in capital goods, i.e., while directing all of our efforts and funds toward production for future consumption. This is obviously a situation that would make no sense whatsoever – it is simply not possible for this to happen in the real world of human action.

Mises warns however that if interest payments are abolished by decree, or even a negative interest rate is imposed by decree, owners of capital will indeed begin to consume their capital – precisely because want satisfaction in the present will continue to be preferred to want satisfaction in the future regardless of the decree. This threatens to eventually impoverish society and reduce it to a state of penury:

If there were no originary interest, capital goods would not be devoted to immediate consumption and capital would not be consumed. On the contrary, under such an unthinkable and unimaginable state of affairs there would be no consumption at all, but only saving, accumulation of capital, and investment.

Not the impossible disappearance of originary interest, but the abolition of payment of interest to the owners of capital, would result in capital consumption.

The capitalists would consume their capital goods and their capital precisely because there is originary interest and present want-satisfaction is preferred to later satisfaction. Therefore there cannot be any question of abolishing interest by any institutions, laws, and devices of bank manipulation. He who wants to “abolish” interest will have to induce people to value an apple available in a hundred years no less than a present apple. What can be abolished by laws and decrees is merely the right of the capitalists to receive interest. But such laws would bring about capital consumption and would very soon throw mankind back into the original state of natural poverty.”
(emphasis added)


Ludwig von Mises: he warned that the abolition of interest payments would induce the owners of capital to consume rather than invest it. Society would soon be impoverished as a result.

(Photo via Wikimedia Commons)

Of course today’s central bankers to a man seem to believe that what makes the economy grow is “spending” and consumption. This is putting the cart before the horse. Since the accumulation of capital threatens to go into reverse due to their policies, there may well come a time period during which reports of aggregate economic statistics appear to indicate that “economic growth has returned”, while all they reflect in reality is the fact that scarce capital is in the process of being consumed. This process is also known colloquially as “eating one’s seed corn”.

How to Counter Deposit Flight: The Cash Ban Debate is Revived

In practical terms, the main reason why large depositors have only grumbled, but not (yet) fled the banks imposing penalty rates on them – in spite of the fact that fractionally reserved banks are not merely warehousing and guarding their funds, but using them for their own business operations – is that withdrawing money in the form of cash and storing is doesn’t come for free either.

Not only must one pay for storage, security and insurance in that event, but one is also cut off from the convenience of effecting payments with a mouse click. Moreover, possession of large amounts of cash, although officially not illegal, is dangerous because it is “suspicious” in the eyes of the State’s minions.

In the US, private persons who are found in possession of large amounts of cash must fully expect that it will be confiscated without trial or any evidence of a crime by means of the “civil forfeiture” procedure. As the Washington Post informs us, in spite of a recent storm of negative publicity regarding these government-directed shakedowns, “the racket is still humming”.

Nevertheless, large depositors could presumably take the necessary legal precautions (again at a cost) to ensure their cash does not become suspect. So there is certainly a possibility, especially if the penalties incurred for keeping large amounts of money on deposit should become even greater, that depositors may decide to remove their money from the banking system and keep it in the form of cash currency.

The probability of this happening has increased further due to the decision of European governments – which governments elsewhere are planning to emulate – to “bail in” bank creditors in the event of bank failures. In the modern fractionally reserved banking system, depositors are legally held to be creditors of the bank, even though this flatly contradicts the contractual promise that they will be able to withdraw their money on demand.

Absent this legal contradiction, fractional reserve banking would of course not be possible. By extending this privilege to banks, governments have greased the wheels of modern-day welfare/warfare statism, so depositors holding money in demand deposit accounts will continue to be regarded as “creditors of the bank”, regardless of the obvious absurdity of this legal doctrine. While we believe that it is proper and laudable to shield tax payers from having to bail out failing banks, the situation in which owners of demand deposits find themselves in is completely untenable.

However, depositors have now been put on notice: not only will they bear the full risk of losing the bulk of their funds when overextended banks are failing next time around, on top of this they will now also have to pay for the dubious “privilege” of bearing this risk. If banks were indeed merely warehousing the money in demand deposits at arm’s length, the payment of a fee for their warehousing services and any other services they may offer in connection with such deposits would be entirely proper and sensible. However, if depositors are forced to take the risk that their money could be lost as a result of the bank’s business activities (over which they have no control), they have very little reason to happily pay such a fee.

Interestingly, when the Austrian press recently reported on the decision by Commerzbank to impose a penalty interest rate on its large depositors, Kenneth Rogoff’s idea of simply banning cash currency was mentioned in the same breath. Apparently Mr. Rogoff is currently touring the world beating the drums for this dubious (to put it very mildly) plan. Here is a translation of the respective passage in the article:

“Harvard economist Kenneth Rogoff even argues in the daily paper FAZ that cash currency should be banned altogether. Central banks could impose negative interest rates more easily that way, he explained. Tax evaders and criminals would also find life more difficult. From this perspective, banknotes and coins appear superfluous, he said at a presentation at the IFO institute in Munich. Measures to spur the economy could be implemented more easily that way.”
(emphasis added)

Since we have discussed Rogoff’s plan in great detail before (see “Meet Kenneth Rogoff, Unreconstructed Statist”) there is no need to rehash all the arguments we made against it. We note though that Mr. Rogoff continues to craftily associate cash with “criminals”, while concurrently asserting that it is our duty to make central planning of the economy easier for the interventionists, in spite of its recurring failure.

In our opinion, a cash ban would constitute a criminal act. One of the reasons is precisely that people would no longer be able to remove their funds from fractionally reserved banks. They would be forced to bear the risks these banks are exposed to, whether they want to or not. Implementing a cash ban would not only amount to an abrogation of all financial privacy, it would clearly represent an abrogation of fundamental property rights as well.

It is noteworthy that Mr. Rogoff is a member of the “monetarist” Chicago school. As Hans-Hermann Hoppe has rightly pointed out, it demonstrates how utterly infested with statism modern society has become that the Chicago school is today held to be the most “conservative” and “free market oriented” school of thought that is still considered acceptable to the establishment.

No wonder – as Mr. Rogoff so clearly demonstrates, it is statist through and through. Ludwig von Mises reportedly once left a meeting at the Mount Pelerin Society in medias res, muttering something along the lines of “you are nothing but a bunch of socialists” after having listened to various representatives of the Chicago School drone on about which liberties the State should abridge next in its relentless pursuit of welfare statism. While it is apparently not certain that this incident really happened, Mises would have been quite correct with this assessment. As Mr. Hoppe notes:

“This seemingly unstoppable drift toward statism is illustrated by the fate of the so-called Chicago School: Milton Friedman, his predecessors, and his followers. In the 1930s and 1940s, the Chicago School was still considered left-fringe, and justly so, considering that Friedman, for instance, advocated a central bank and paper money instead of a gold standard. He wholeheartedly endorsed the principle of the welfare state with his proposal of a guaranteed minimum income (negative income tax) on which he could not set a limit. He advocated a progressive income tax to achieve his explicitly egalitarian goals (and he personally helped implement the withholding tax). Friedman endorsed the idea that the State could impose taxes to fund the production of all goods that had a positive neighborhood effect or which he thought would have such an effect. This implies, of course, that there is almost nothing that the state can not tax-fund!

In addition, Friedman and his followers were proponents of the shallowest of all shallow philosophies: ethical and epistemological relativism. There is no such thing as ultimate moral truths and all of our factual, empirical knowledge is at best only hypothetically true. Yet they never doubted that there must be a state, and that the state must be democratic.

Today, half a century later, the Chicago-Friedman school, without having essentially changed any of its positions, is regarded as right-wing and free-market. Indeed, the school defines the borderline of respectable opinion on the political Right, which only extremists cross. Such is the magnitude of the change in public opinion that public employees have brought about.”
(emphasis added)

Harvard economist Kenneth Rogoff wants cash to be banned to make the imposition of central bank intervention “easier”. Ironically this unreconstructed statist found himself hounded by the political left when a few errors were found in the data used in his book on government debt and growth (the book tried to prove with the help of statistics that too much government debt retards growth. The incident illustrated the danger of relying on statistics instead of sound economic theory to make one’s case).


(Photo via Imago)


The “unintended consequences” of the negative interest rate policy will vastly outweigh the perceived advantages of any short term boost to economic activity they may provoke. Consumption is not what produces economic growth, and giving capital owners an incentive to consume rather than invest their capital will only hasten Europe’s economic decline.

Given that the failure of these interventions is already absolutely certain, we must be prepared for even more interventions to “fix” the failures produced by the previous ones. Mr. Rogoff’s plan would certainly enable more State control over the citizenry and the economy. Many modern-day intellectuals appear quite keen on abolishing the market economy and replacing it with some form of command economy (just as long as their personal plans are implemented of course). They should be careful what they wish for.


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