negative interest rates

Today’s office politics post is making way for yesterday’s fairly stupendous announcement that the European Central Bank will now be demanding payment from banks for the privilege of banking their money*.
*thanks to the FT for the cartoon above.

Some opening comments from Mr Draghi:

“Now we are in a completely different world: low inflation, a weak recovery and weak monetary and credit dynamics.”

The German reaction (at least, the German economist reaction):

“This is a desperate attempt, with ever cheaper money and penalty rates on deposits, to shift capital flows to southern Europe in order to stimulate growth there.”

At one point, someone used the phrase “monetary policy fireworks.

Now I realise that, for most people, the above was not really that dramatic. Talking about “monetary policy fireworks” is not interesting. It fills the mind with images of wet blankets and how on earth could that ever result in fireworks. And then the mind moves on to check facebook and comment on another engagement announcement.

But I’m going to try and explain it anyway.

The Background

The European Union is flawed. And not in the “we just had many years of financial crisis” way (although – that too). But more of the “this was always a political union, not an economic union; although as it turns out, we ended up without the political union” varietal.

The Eurozone contains:

  • Germany; and
  • Southern Europe.

The Germans are efficient and thrifty. The Southern Europeans are inefficient and spendthrifty.

So in the days before the European Union, Germany would efficiently make awesome cars, and then export them. Foreigners, longing for German cars, would buy up the Deutschmark to pay for them, making the currency a strong one. This would make it relatively cheap for the Germans to import Italian wine and Greek olive oil, and the Germans could happily continue to be thrifty while still buying up the products of Southern Europe.

The Southern Europeans, on the other hand, had governments that would fund their spending on a steady diet of inflation. This meant that the drachma and the lira were weak currencies, regularly depreciating to make the high local-currency-denominated costs seem reasonable to the rest of Europe. And thus, the Southern Europeans would sell their products to Germany – and everyone was mostly happy.

Then Europe decided to become one with their currency.

What this meant in the long term:

  1. The overall currency strength would be determined by the joint-activities of all the countries in the Eurozone.
  2. So Germany would get a weaker currency than it had before.
  3. And Southern Europe would get a stronger one.

If you take that a little further:

  1. German exports had just become cheaper to the rest of the world (including all the other countries in the Eurozone).
  2. So the Germans were earning more money, while remaining their thrifty selves.
  3. While Southern European exports just became more expensive to the rest of the world, (also including all the other countries in the Eurozone).
  4. So the Southern Europeans were earning less money, while remaining their spendthrifty selves.
  5. Fortunately, Southern Europe found itself with access to Germany’s credit score, so it financed itself with a borrowing spree.
  6. Which led to all the debt crises and the bailouts and so on.

However, the debt crisis was more of a side-show. It doesn’t correct the cause of the problem: Germany doesn’t spend its export earnings on Italian wine and Greek olive oil. An example:

  • in 1999 (just before Greece joining the Eurozone), Germany was buying about 16% of Greece’s exports;
  • in 2011, Germany was only buying 8% of Greece’s exports.
  • And crazily, if you looked at this from Germany’s perspective, what we’re saying is that Germany went from spending 0.37% of its total imports on Greek products to spending only 0.22% in 2011.

Anyway, now that the borrowing spree has stopped covering up this flaw, Europe is left in an awkward position where all the small countries are struggling to recover while Germany continues to do awesomely well and drive up the value of the Euro. Which, in turn, is making it even more difficult for the smaller countries to recover. And all this is not helped by the fact that the Germans with the money are thrifty.

Cue: Mr Draghi’s Announcement

So Mario came out and declared what I opened with:

“Now we are in a completely different world: low inflation, a weak recovery and weak monetary and credit dynamics.”

And I think what he meant was:

“So I think we’ve all learned this was a sh*tty idea. But that’s all water under the long-burnt bridges that you decorated the Euro notes with. I’ve appealed to your good consciences long enough. Germany – this is your fault as well.”

Followed quickly by (and I’m paraphrasing):

“So I’m going to start confiscating money from any bank that isn’t lending it by making our interest rate negative. And I’m going to take that money and use it to start offering cheap loans to any bank that will on-lend it to small and medium-sized businesses. Especially the ones on the European periphery. And if that doesn’t work, then I’m going to start bond-buying, and see if I can trash the Euro and get us looking a bit more competitive.”


“Let the dice roll, Germany. Let. Them. Roll.”

So when the conservative Germans declare:

“This is a desperate attempt, with ever cheaper money and penalty rates on deposits, to shift capital flows to southern Europe in order to stimulate growth there.”

Then yes, that’s exactly right. Duh.

PS: if you want a bit more on negative interest rates, I wrote about them some time ago: The Drag(hi) of Negative Real Interest Rates.

Rolling Alpha posts opinions on finance, economics, and the corporate life in general. Follow me on Twitter @RollingAlpha, and on Facebook at