Who'd a thunk it? That's what a famous ventriloquist's dumbest dummy was made to ask on a now-gone radio program whenever he confronted anything new and, to him, inexplicable, although obvious to anyone else. It came to mind when the central bankers of Sweden decided to take current interest rates further into negative territory. As share prices here plummeted, as the chair of our Federal Reserve Bank was grilled by two congressional committees about the possibility of the Fed adopting NIRP – a negative interest rate policy, an acronym that will live in infamy along with QE in the halls of hard money traditionalists – and ducked and dodged before refusing to rule it out, and as fear for the safety of the international financial structure mounted, one can imagine the Swedes asking, "Who'd a thunk it?", although in a slightly more elevated way.
Here in America, two factors are intersecting to cause the fear factor to mount and traders to dash for the exits. Proving that my profession is aptly known as Political Economy, the first is political. Investors, businessmen sitting on cash piles, and Joe the Plumber have watched as avowed socialist Bernie Sanders drags Hillary Clinton to the left in their fight for the Democratic nomination. Sanders, who spent his honeymoon in Moscow, lays the problems of America, which in his view are numerous, at the feet of "millionaires and billionaires" who control the political process, and bankers whose incontinence and excessive risk-taking in pursuit of obscene profits caused the recent Great Recession. All to be corrected by taxing financial transactions, the wealth of said millionaires and billionaires, and requiring bankers who benefitted from a taxpayer bailout to seek still other bail, this to get out of the jails to which they will be consigned when Sanders takes over the White House. Unsettling talk, but not very. At least at first.
Then Bernie moved from a fringe candidate to a serious contender for the Democratic nomination by fighting Clinton to a virtual draw in Iowa and thumping her by 20 points in New Hampshire. His proposals can no longer be regarded as merely the rantings of a marginal candidate. Worse still, Clinton, who never needed a long spoon to sup with Goldman Sachs and others on Wall Street, and who along with her husband accepted millions in campaign contributions from the financial sector over their long political career, suddenly joined the Sanders chorus. "No bank is too big to fail and no individual too big to jail," is her new anthem. Never mind that it is a criticism of the Obama administration's willingness to settle for fines, or that turning on your major benefactors is not usual behavior outside of the world of politics. The point is that the business and financial communities' bulwark against the anti-business faction of the Democratic Party has lost its most prominent advocate. Panicked businessmen are imagining the sounds of tumbrils rolling over the Washington Mall, the modern version being confiscatory taxes, stifling regulations and a loss of access to the political process. A circumstance made all the more likely by Republicans' insistence on destroying one another in a series of debates and primary battles, leaving the road to 1600 Pennsylvania Avenue to the now-anti-business Hillary Clinton, and possible control of the senate to Democrats eager to ally with Massachusetts senator Elizabeth Warren, ready with a gaggle of new regulations of the financial sector.
Add to that frightening political prospect what is widely seen as a threat to the stability of the financial sector, involuntarily imported from unhealthy European banks. When Sweden's Riksbank dropped its negative interest rate from -0.35 percent to -0.50 percent earlier this week, markets became even more convinced that the profitability of the banks in NIPR countries, in which are domiciled large and medium-size companies that account for 30 percent of the value of all shares traded, is under threat. The reasoning is simple. Negative rates impose a cost on banks, which they can escape only by deploying their capital in riskier loans and other assets. When they do that, they drive up the value of the assets they purchase, mostly bonds, lowering the interest rate they earn on those assets. Result: a classic margin and profit squeeze between rising costs and falling charges for services, threatening banks' ability to lend and, indeed, their stability. Central bank policies, concludes the Lindsey Group, are "crushing" banks' profitability.
As if that were not bad enough, banks are under pressure from low oil prices, which have taken gasoline down to an average of less than $1.75 per gallon, headed lower by most reckonings. Low oil prices, you will recall, were to enrich consumers, who would then spend their windfalls, adding to the growth rate of our recovering economy. It is not yet certain just what consumers will do with their gains in the long run. What is certain is that in the here-and-now the credit-worthiness of smaller oil companies has dimmed, and banks are ruing the day they lent money to frackers and oil field supply companies. Not to mention businesses in Houston, an economy so sensitive to the price of oil that one of its posh restaurant now sets the price of its Wednesday-evening three-course dinner at the lowest going price of crude oil, lately under $30. Rumor has it that the Federal Reserve Bank of Dallas has told banks to work with these borrowers to avoid the need to write their IOUs off as bad debts.
So you have a political climate that is frightening, to say the least; negative interest rate policies that are squeezing the margins and profits of European banks, driving their shares down by about 20 percent this year, twice as much as the all-share average; energy loans that don't seem as safe with oil at $30 per barrel as they did with crude at over $140 per barrel in June of 2008; and the world's most important central bankers, our Federal Reserve Board, only two months after raising interest rates and planning further increases, admitting that further increases are unlikely.
Worst of all, David Smith, economics editor of The Sunday Times (London) and a colleague of mine, has been proved right. Negative interest rates, he wrote earlier this week, are "a good way of persuading people and businesses that something must be badly wrong…." Janet Yellen please note.