Yellen Looks Down into Trap Door of Deflationary Collapse

Fed Chair Janet Yellen replied to Sen. Bob Corker in testimony Feb. 11 that the Federal Reserve was again studying the possibility of adopting a negative Fed Funds rate, as the central banks of Japan, Europe, and several individual European countries already have in this crisis. Yellen said the Fed had studied and rejected the idea in 2011-12. But unaccountably, she said that Japan and Europe have had “no problems” with negative rates.

The opposite is the case, and the problems are becoming severe, threatening, paradoxically, a deflationary economic collapse. Since the European Central Bank (in December) and the Bank of Japan (in January) adopted negative rates, they have seen results exactly opposed to what they expected and intended. Their currencies have gone up sharply, and their stock markets have plunged. Price deflation has immediately reappeared in Japan, and the very small price inflation which had been “accomplished” by ECB head Mario Draghi by last Fall, has largely disappeared.

Negative interest rates “paid” (i.e., actually fees charged) on the large excess reserves which big banks have been holding at their central banks, are intended to drive those reserves out of the central banks and into lending in the economy. The opposite has occurred. As zero interest becomes negative interest — in a credit crisis — banks and other financial firms are buying and holding their own currency, government bonds and precious metals for “safe haven” speculations. In addition, they have begun to charge negative interest to their depositors in the form of fees, and tighten their lending criteria, as Handelsblatt reported Feb. 12. Bank lending in Europe is again declining overall.

The effect is to lead toward a deflationary collapse.

The effect is worse for Japan, because so much of its wealth is usually invested outside the country. Europe’s negative rates, stock collapse, and bail-in policy, as well as the plunge in rates on U.S. Treasury securities, are driving Japanese capital and savings back into Japan while BoJ policy is giving it nothing to invest in.

In the Telegraph Friday morning, financial columnist Ambrose Evans-Pritchard, in “Bank of Japan loses control as QE hits limits,” writes, “The drastic developments have been nothing less than a disaster for Governor Haruhiko Kuroda who pushed through negative rates. This could be the death of Abenomics. Events are going horribly wrong…” Pritchard notes that the yen has appreciated by 9% against the dollar in less than one month under negative rates (the euro, which he does not discuss, has gone up by about 6% against the dollar since Jan. 1). Producer price deflation in Japan is suddenly -3.1% at an annual rate.

Evans-Pritchard quotes one bank analyst: “This is a reverse policy shock. We are reaching the limits of quantitative easing as we know it.”