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Friday, February 12, 2016

More on Negative Interest Rates

It seems the Central Bank in the Euro Zone is continuing to embrace the notion of negative interest rates. The notion of the natural rate of interest is based in the individual's time preference of their utility ranking. In English, this simply means that all of us rank things that we are going to consume from lowest to highest. Of course, since we are limited to only 24 hours in a day, many of those preferences must be done in the future. That is the foundation of interest: The net between things consumed in the future, as compared to those things consumed in the present.

This notion is the foundation of many theories in finance and business.  The notion of interest helps price out long term loans, debt, and large long term capital projects, just for starters. Business owners need to have the ability to price things, in the present, in the terms of future prices. They can adjust these present prices in the terms of the future based on a calculation using the interest rate.

You maybe asking yourself, "How does the notion of negative interest rates fit into this definition?" Answer: It does not. It is against nature. Yet, these central bankers will continue to push for "negative" interest rates simply to stimulate the economy. Think of it this way: The lower the central bank pushes a form of price control by using negative interest rates, this will encourage more consumption, in the present. Long term capital projects will not happen, shorter term projects will take place. Savings and hoarding become extinct. Without proper savings, the economy can not expand and grow organically. This will lead to many asset bubbles, market swings, and crashes.

Of course, this impacts the Euro, as it will debase the Euro. All of this makes the Dollar, and commodities, look sweeter for folks who have the euro.

Read more of the ECB's exploration in Negative Interest Rates here: 

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