/Why negative interest rates in the U.S. would be the real ‘bonehead’ move

Why negative interest rates in the U.S. would be the real ‘bonehead’ move


Another day, another salvo in the one-sided feud between Donald Trump and his handpicked chair of the Federal Reserve. To add to calling Powell and the Fed “a much bigger problem than China” and absolutely clueless (in various forms) over the past few months, the President of the United States on Wednesday took to labelling his monetary policymakers “Boneheads” — in a tweet, of course.

We already know that Trump is as fond of bashing Powell as he is of unnecessary quotation marks and odd capitalization. New for this week, however, was that Trump managed to scapegoat the Fed while running a couple of newish policy ideas up the old Twitter flagpole: one, that the Fed should embrace zero or negative interest rates, and, two, that the government should refinance its debt to take advantage of those super-low rates.

News coverage of the tweets pointed out that, as recently as last month, Trump was saying that he didn’t favour negative interest rates for the U.S. But it’s not like he wasn’t already a fan of sub-zero rates for other economies. Germany’s issuance of a zero-coupon, 30-year note in August, which had a yield of -0.11 per cent, drew his praise as an example of a country “actually being paid to borrow money.” What a deal!

As for the notion of taking advantage of low rates to “refinance” government debt, Trump was pumping that one back during the 2016 election campaign; his onetime nominee for a Federal Reserve seat, Stephen Moore, recently penned an op-ed supporting the idea, as well.

Getting paid to borrow must make the debtor inside Trump salivate at the possibilities

And hey, why not? Getting paid to borrow must make the debtor inside Trump — who has a history of debt restructurings in his private-sector career — salivate at the possibilities. In a stroke, a zero-ish rate could spark the economy up into that three- or four- or five-per-cent growth range he has long touted. It would probably devalue the greenback, too, making U.S. exports more competitive. (In Trump’s worldview, every other country with negative rates is trying to manipulate their currencies down, so why not join the club?) Meanwhile, refinancing the U.S. federal debt — which now stands at US$22 trillion, and is increasing by more than US$1 trillion a year under Trump — would lower the nation’s debt burden and give the administration room to borrow even more.

To Trump, apparently, this is clearly the sweetheart deal to end all sweetheart deals. But like much of what he proposes (Mexico paying for his wall, China paying for his tariffs, GDP growth paying for his corporate tax cuts), it’s too sweetheart-y to be true. Governments “getting paid to borrow money” isn’t the only thing negative rates do, after all. They also create a whole bunch of new risks.

Let’s leave aside the obvious problem that negative rates now would leave the Fed nowhere to cut if there were an actual recession. One thing that Trump seems not to recognize — and which makes his Twitter musing all the more irresponsible — is that perceptions matter. The Federal Reserve’s policy rate is higher than other central banks’ now not because Jerome Powell is a sucker, but because the U.S. economy is perceived to be strong by the investors of the world. Money flows into the States because it’s viewed as the largest, most dynamic and safest economy in the world, not because rates are high. The Fed hasn’t lowered rates to zero (or below) because it hasn’t had to, unlike (arguably) Europe and Japan.

Now, imagine the reaction if the Fed suddenly went to zero or below: that would be a pretty clear sign the U.S. economy is far worse off than anyone imagines at the moment. That wouldn’t be good for an economy that relies so heavily on credit. Businesses and investors wouldn’t likely say to themselves, hey, let’s get this party started! They’re more likely to look elsewhere for opportunity. When Japan turned to negative rates in 2016, the market’s inflation expectations went down — which is pretty much the opposite of what sub-zero rates are supposed to do.

The empirical reality is that sub-zero interest rates just don’t work when it comes to kick-starting growth, or at least they haven’t yet in Europe or Japan. One concern is that they function as a tax on banks, decreasing their interest margins. Depending on how low they go, and for how long, that might actually work against credit formation, which, again, is pretty much exactly the opposite of what they are supposed to do.

Not to mention that negative rates screw over savers and seniors who would like to live off risk-free income. You would think Trump might want to count on their support come 2020.

Oh well, at least he could “refinance” government debt. But it’s not clear how that would work in practice. Trump has never really got into the details, and his descriptions of what he means are often garbled, but it seems that he’s proposing that the Treasury department issue more long-term debt (like 30-year, 100-year, or whatever) and “lock in” today’s low rates (or tomorrow negative rates). But at what cost? Moving up the average duration of U.S. government debt might save a few bucks in interest payments, but it could also be a disruptive force in a liquid, complex bond market fuelled by Treasury issuances all along the duration spectrum.

And if rates go below zero, there might not be very much demand for those ultra-long bonds Trump seems to like. Those German 30-years he liked so much? The president neglected to mention that investors bought less than half of the planned two-billion-euro issue — making it technically a failed auction.

Even if Trump somehow gets his way on rates and debt refinancing, he might end up finding that nobody is buying what he’s selling.

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