Editor's note: Not only are we nowhere near an inflationary environment today, we could be on the cusp of outright deflation...
With central banks around the world implementing zero-percent (and in some instances, negative) interest rates, Chris Mayer says the global economy is entering dangerous territory.
As he explains in today's Masters Series – originally published on the Bonner & Partners website last month – central bankers are making a terrible mistake that could soon become apparent...
What Negative Interest Rates Actually Do to the Global Economy
Last week, I traveled to St. Croix, in the U.S. Virgin Islands, with E.B. Tucker, editor of the Casey Report... to dig deeper into how this works.
We met with Warren Mosler, a legendary money manager who retired there about 13 years ago.
Mosler racked up a truly amazing track record. From 1978 through 1997, his fund was one of the top ranked in the world. And he had only one losing month – a drop of one-tenth of one percentage point.
Mosler's secret weapon was his grasp of how the "plumbing" of the modern fiat-based money system works. His specialty was exploiting other investors' misunderstanding of the fiat money system.
E.B. and I met Mosler for breakfast at the Tamarind Reef Resort. He had just come in from a game of tennis. He is a trim 67, friendly, and easygoing.
We talked for nearly two hours. And Mosler explained why lower rates don't help the economy...
As he put it, lower income payments – on either bonds or bank deposits – suck money out of the economy. This is completely contrary to what most people think.
As Bill has been warning, central bankers are laboring under a dangerous myth.
They believe lower interest rates stimulate economic growth.
But the truth is that ZIRP (zero-interest-rate policy)... and now NIRP (negative-interest-rate policy)... further depress an already weak global economy.
Lower rates simply mean the private sector earns less income than before. That means less money floating around.
That's deflationary, not inflationary.
When you realize that ultra-low... and negative... interest rates just take away people's money, the insanity of what central banks are doing becomes apparent.
Mosler believes – and E.B. and I agree – that the world economy is on the edge of a deflationary recession.
And ZIRP and NIRP are making it worse.
Mosler's advice: Bet on a stronger euro against the dollar.
Most people think the European Central Bank (ECB) will continue to drive rates lower. And that these actions will weaken currencies and spur inflation.
But this is a myth.
Governments are net payers of interest. If you hold a government bond, the interest payments are part of your income. When a central bank lowers rates, they lower that income. That's deflation... not inflation.
Lower rates mean less money floating around. It strengthens currencies. And that's what we've seen with the U.S. dollar.
And there's another reason to expect a stronger euro...
The European Union (EU) has a large and growing trade surplus. When EU exporters ship goods, they're paid in a foreign currency. But that currency has to be converted back to euros to pay their workers. This drives the demand for euros higher.
Mosler pointed out that for two decades, Japan ran large and persistent trade surpluses (and had zero interest rates). During that time, the yen was among the strongest currencies in the world.
In sum, lower income due to falling interest rates, coupled with rising exports, makes the euro harder to get... and more valuable.
So why has the euro fallen so much over the last two years?
Because almost everyone thinks that lower rates will weaken the euro. So they're selling euros. It's a self-fulfilling prophecy.
Mosler had a memorable analogy:
If a corn crop failed because of a drought, you'd expect the price to go up because of supply and demand. But say a big company had a huge warehouse full of corn and believed the drought was going to cause prices to go down instead of up. If they started selling their warehouse full of corn, the price would go down even though there was a drought and a shortage. That's because all of the supply is coming out of the warehouse. That's portfolio selling, so to speak. Eventually, they're going to run out [of euros]...
When the euro selling ends, the turnaround could happen quickly. So you want to be in the trade before a big move. But getting the timing right is tricky on this trade...
One clue might be some big gaining days. For example, on December 3, the euro had its biggest one-day percentage gain against the dollar in over six years.
A harbinger of things to come...
Regards,
Chris Mayer
Editor's note: Chris' track record is among the best in our business. His recommendations have outperformed the world's greatest investor, Warren Buffett, by nearly two times over the last decade.
That's why Agora founder Bill Bonner is investing $5 million of his family's trust into Chris' recommendations. Learn more about his investment strategy – and claim a special, limited-time offer to his brand-new Bonner Private Portfolio advisory – right here.