The Negative Interest Rates Abomination

Our readers are probably aware that assorted central bankers and the economic advisors orbiting them occasionally mention the “natural interest rate” (a.k.a. “originary interest rate”) in speeches and papers. It is generally assumed that it has declined, which is to say, time preferences are assumed to have decreased.


This is actually an understatement…


Although interest is generally associated with money, the originary interest rate would exist even if there were no money and regardless of the type of economic system that is in place. It is the manifestation of time preference, i.e., it simply is the discount of future goods against present goods – and that is all it is. As long as time passes and the terms “sooner” and “later” have meaning, the natural interest rate can never decline to zero or go negative.

Hypothetically, if the natural interest rate were to decline to zero,  all action would become future-oriented and there would no longer be any present consumption – people would literally starve to death and never live to see the future they were provisioning for. Obviously, such a state of affairs is unthinkable.

Conversely, the natural interest rate can in theory rise without limit. For example, if we were to know with absolute certainty that a giant asteroid was going to destroy the planet in two months time, all provisioning for the future would cease (since there would no longer be a future) and time preference and consumption would soar.


Ludwig von Mises wrote extensively on the natural interest rate in Human Action (p. 522-534 of the scholar’s edition). We have excerpted several quotes below.


Ludwig von Mises wrote on this:


“We cannot even think of a world in which originary interest would not exist as an inexorable element in every kind of action. Whether there is or is not division of labor and social cooperation and whether society is organized on the basis of private or of public control of the means of production, originary interest is always present.” […] “Originary interest cannot disappear as long as there is scarcity and therefore action.”


Consumption of Capital

Gross market interest rates include the natural rate and two additional components: a price premium (or inflation premium) that accounts for the debasement of the monetary unit and the associated loss of purchasing power and a risk premium that accounts for the probability that a borrower will default.

With some mental gymnastics it may be conceivable that these premiums could  turn negative: the purchasing power of money may be expected to increase (fat chance in a fiat money system) and paying up for a “risk-free” government bond may be preferred over the risk of holding deposits with banks.

Given the existence of cash currency, this ceases to make sense as soon as the cost of storing and insuring paper money is less than the loss incurred by holding bonds with a negative yield to maturity. In the euro area investors may also pay a premium on certain bonds to account for re-denomination risk in the event the euro falls apart, but at the moment the markets are definitely not concerned about this possibility.


With yields on Italian 10-year BTPs well below 1% it is clear that re-denomination risk is currently not on anyone’s mind. Such concerns briefly flared up again after the election that brought the odd couple coalition of Lega and 5-Star to power, but soon dissipated again.


From this we can conclude that the buying of negative yield debt is primarily driven by central bank intervention and expectations of more of the same – including price-insensitive buying in the context of QE programs – financial repression type regulations, passive investment strategies (indexing) and last but not least, speculation.

Contrary to the assertions by various central bankers, the sunbed-crisped IMF chief and future ECB president and other bien pensants, negative interest rates are not “helping the economy”, they are destroying it. Slowly but surely, more and more capital will be consumed.

With respect to attempts to abolish interest, Mises stated:


“If the capitalist no longer receives interest, the balance between satisfaction in nearer and remoter periods of the future is disarranged. The fact that a capitalist has maintained his capital at just 100,000 dollars was conditioned by the fact that 100,000 present dollars were equal to 105,000 dollars available twelve months later. These 5,000 dollars were in his eyes sufficient to outweigh the advantages to be expected from an instantaneous consumption of a part of this sum. If interest payments are eliminated, capital consumption ensues.” […]  

“If one eliminates the capitalist’s role as receiver of interest, one replaces it by the capitalist’s role as consumer of capital. There is no longer any reason why the owner of capital goods should abstain from employing them for consumption.” […]

“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)


Capital consumption is generally an insidious process. It is never obvious while it occurs, as it usually tends to be masked by an economic boom and the associated – often quite strong, but illusory – accounting profits. Interest rate manipulation and money printing distort relative prices in the economy, which throws economic calculation into disarray. The inevitable result is malinvestment of capital and ultimately capital consumption.

Imposing zero or even negative interest rates is even worse than merely suppressing market rates below the levels dictated by time preferences. As Mises points out, time preference cannot be abolished, neither by decree, nor by market manipulation.

Next: The Bizarre Obsession with Inflation


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