The next recession cannot be avoided and it is not far away

[Baruch]

Joe - just one relevant question ... if you have a money supply that grows slower than the economy ... isn't that deflationary?

http://www.shadowstats.com/alternate_data/money-supply-charts

What constitutes the money supply ... depends, just like any other economic question (what is the GDP).  But certainly the money supply isn't matching the GDP curve (and with the US being the primary currency provider, you have to look at more than just the US GDP).  The initial part of the current recession/depression was strongly negative on money supply growth.  But though it has recovered a little, it might not yet be growing fast enough (in conventional economic theory let alone post-modern theory).  The Big-Mac economic indicator matches the general impression that most countries are deflationary, based on using a common food item to iron out the currency trade distortions.

So Jason-H is right about our current deflation.  Was it something else he said in response to you, that you objected to?

[josephpalazzo]

Joe - just one relevant question ... if you have a money supply that grows slower than the economy ... isn't that deflationary?

In a deflation, that is prices are falling,  it means that demand is falling - (1) either people have lost confidence for whatever reasons, or (2) there is too much supply of goods/service in the market place. In either case, people will start to lose their jobs and the unemployment rate will start to increase. To offset that trend, if you want to do this, then you need to increase the money supply, with the four tools I've outlined in post #54.

The recent idea, negative interest rates, would take money away from people and usually this would decrease demand - you have fewer dollars, you're going to buy less. So one could think that this strategy is counter-productive. However, the thinking is that this will force many to not let their money sit in the banks but to go out and spend it, hence increase demand, which is the desirable goal. That's why this idea is controversial. No one knows for now how it will pan out.

So Jason-H is right about our current deflation.  Was it something else he said in response to you, that you objected to?

My last post to him was a "what-if scenario": what if Bush and Obama had done nothing, what would have happened? The consequence being that there would have been additionally millions of people who would have suffered. This is what he thinks that what  should be done in a recession - do nothing. Instead of answering my arguments, either he willfully ignored my arguments or he's incapable of dealing with this kind of abstract thinking. Whatever, he's a waste of time.

[josephpalazzo]

The interest on Japan's negative interest (no pun intended) is getting more and more attention.

The Japanese economy has been in the doldrums for about a decade and a half at this point. Back in 2012, Prime Minister Shinzo Abe rolled into office with a three-part plan of loose monetary policy, fiscal stimulus, and structural reform. But so far the results of "Abenomics" have been middling. So on Thursday, Japan's central bank decided to get unusually adventurous: They're gonna try negative interest rates.

To review: Interest rates are the price of lending and saving money. When interest rates throughout the economy are low, banks charge less for loans and individuals have less incentive to save; when they're high, lenders charge more and individuals save more. This is why central banks tighten interest rates when they're worried about inflation: Discouraging loans and encouraging individuals to sock their money away slows economic activity, which keeps inflation in check. Conversely, cutting interest rates in a recession encourages credit and consumption, which boosts job creation.

If interest rates could go negative â€" and banks started charging people for depositing their money â€" then this logic extends out: Not only would we be encouraging people to save less, we'd be actively penalizing them for saving rather than consuming. But the general assumption in economics has been that interest rates can't go below zero. Cash already has an implied interest rate of zero, so if banks started charging negative interest rates, people would just stuff paper cash in mattresses.

But in the last year and half, central banks throughout the advanced western world became desperate enough to start experimenting. In 2014, the European Central Bank (ECB) started charging eurozone banks a -0.2 percent interest rate. Central banks in Denmark and Switzerland set deposit rates at -0.75 percent, and Sweden set it at -1.1 percent. Last Thursday, the decision-makers at the Bank of Japan surprised international observers by getting in on the act as well: By a 5-to-4 vote, they decided to impose a -0.1 percent rate under certain circumstances.

Will it work? No one really knows, as the close vote indicates. But to even approximate an answer, we need to work through a few of the specifics of how central banks function.

As Scott Fullwiler, an economics professor at Wartburg College, explained to The Week, a central bank like the Bank of Japan is basically a bank for the rest of the banks in the economy. Those banks all hold reserves at their accounts at the central bank. They're constantly lending these reserves back and forth, and charge one another interest on those loans. That interest rate in turn filters out into the rest of the economy: A high interest rate between the banks means they'll charge higher interest rates throughout the rest of the economy, and vice versa.

Generally, central banks can change the interest rate on reserves by increasing or decreasing the total supply of reserves in the system: More supply means the interest rate goes down, less supply means it goes up. But at this point, like the U.S. Federal Reserve, the Bank of Japan has responded to economic downturns by flooding the system with reserves. "They've pushed the supply curve [for reserves] way beyond the demand curve," Fullwiler said. So interest rates on reserves hit zero. "But if you can charge people that are holding reserves? Well now the price is below zero."

So the Bank of Japan is applying a fiat charge of -0.1 percent to reserves, to drive the interest rate on them below the "market rate" of zero. But it will only apply to reserves that have been newly deposited at the Bank of Japan, and even then only on reserves that exceed certain limits. The Bank of Japan will also continue increasing the supply of reserves by buying up more government debt and other financial instruments as well.

One reason to think the Bank of Japan's gambit could help is that a lot of actors in the economy can't really "stuff money in the mattress" in practice. Big financial firms and corporations and the like are dealing with huge sums of money parked in all sorts of wild financial instruments. In many cases, turning those holdings into cash and thus escaping the bite of negative interest rates will just be prohibitively difficult and expensive. So they may well eat the cost of the negative interest rates, and respond to the incentive the way the Bank of Japan hopes they will. This may explain why the negative interest rates from the ECB and others haven't resulted in dysfunction.

But then, it's important to remember that banks are not passive lenders of capital, following orders from the central bank. Every individual bank makes pro-active, profit-driven decisions about when to create new loans and when not to.

"Banks make money on the spread between what they're receiving on their assets and what they're paying on their liabilities," Fullwiler continued. With a negative interest rate, "you've reduced the income they're receiving from their assets." So to maintain profitability, banks could cut interest rates on loans to attract new borrowers. But that still depends on how many opportunities for profitable investment there actually are. An economy in the doldrums â€" like Japan â€" is simply not going to provide too many attractive opportunities, so banks aren't going to invest much more. By lowering interest rates, a central bank gets out of the way if other banks want to issue new loans. But it can't make them want to.

But banks have other options to increase their income. "They can cut rates that they pay on their liabilities, like maybe a negative rate on their deposits," Fullwiler said. "Or they can find other sorts of fees to sneak in there, like increased fees on checking accounts and increased fees on ATMs and things like that." Those would discourage individuals from parking money at their banks, so they may spend more of it instead. That means more aggregate demand, which means more of the concrete economic activity and job creation banks do want to invest in.

The one problem is this relies on consumers who have money to save, i.e. more well-off ones. Poorer people in poorer communities can't be discouraged from saving money when they have no money to save. So fees and negative rates may boost demand in richer areas, but not in poorer ones. And Japan does have higher poverty rates and higher inequality than most western countries.

So, as Fullwiler concluded, changes in interest rates have very complicated effects on various parts of the economy. And -0.1 percent is pretty paltry if you're looking for negative rates to push the economy in one particular direction.

But all this also shows the more fundamental limitation of all central bank policy: It really can't help but be "trickle down." Fiscal policy is really the main tool that can move money into the economy from the bottom up. That means deficit spending by the central government. As big as Japan's deficits have been recently, and as bad as its demographic problem is, it still has tepid growth and rock-bottom inflation rates. Those two in combination are generally evidence that deficits aren't big enough.

http://theweek.com/articles/602283/could-bank-japans-crazy-gambit-actually-work

[josephpalazzo]

Why it would be wise to prepare for the next recession

Some excerpts:

Yet another instrument is negative interest rates, now used by the ECB, the BoJ and the central banks of Denmark, Sweden and Switzerland. With clever gimmicks, it is possible to impose negative rates on bank reserves at the margin, thereby generating negative interest rates in markets, without imposing negative rates on depositors. How far this can be pushed while cash is still an alternative is unclear. Beyond a certain point, people seek to move into cash-backed warehouse receipts, unless a penal tax were imposed on withdrawal from banks or cash were abolished altogether. Moreover, it is unclear how economically effective negative rates would be, apart from lowering the currency.

A final instrument is “helicopter money” â€" permanent monetary emission for the purpose of promoting purchases of goods and services either by the government or by households. From a monetary point of view, this is the equivalent of intentionally permanent QE. Of course, actual QE might become permanent after the event: that is now likely in Japan. Again, supposedly permanent monetary emission might turn out to have been temporary, after the event. But if the money went directly into additional spending by government or into lower taxes or to people’s bank accounts, it would surely have an effect. The crucial point is to leave control over the quantity to be emitted to central banks as part of their monetary remit.

Personally, I would prefer the last instrument. But at this stage it is crucial to recognize the great likelihood that something even more unconventional might have to be done next time. So prepare the ground beforehand. Central banks should be filling in these blanks now, not after the next recession hits.

[Baruch]

Negative rates on government paper?  Clever ... you get a ten year government bond, with -10% interest ... so that when you cash it in in 10 years, you not only don't get any interest, you don't get any principle either, if you hold it past maturity, then you owe the government even more money.  Only an idiot would buy such a bond.  What is planned, some say, is that you will be required indirectly to buy self-destruct bonds ... because your pension/IRA/401k/money market (credit union deposits) will be required to turn over their good assets, to the government in return for worthless government bonds.

And that is exactly what the Japanese did.  Godzilla can't save them from their own gullibility.

[josephpalazzo]

The first sign of negative feedback from negative interest rates:

European banks have been caught in a perfect storm of market turmoil, lately.

Lackluster profits and negative interest rates, have prompted investors to dump shares in the sector that was touted as one of the best investment ideas just a few months ago.

So what happened? At the end of last year, banks were singled out as one of the most popular sectors for 2016 because of expected benefits from higher bond yields, rising inflation expectations and improved economic growth. That outlook, however, was before the one-two punch of plunging oil and a slowdown in China sapped investor confidence world-wide.

...

But there is more to the sector slump than just the individual bank problems, according to Garnry. The negative interest rates set by the ECB means that banks effectively have to pay to have cash on their balance sheets, while at the same time getting squeezed on their net interest margins. Debt levels are already really high on the continent, which means further loan growth is expected to be low, he said.

Full article at: http://www.marketwatch.com/story/why-a-selloff-in-european-banks-is-ominous-2016-02-07