Zero Interest Rate Policy: The Cruelest Tax of All

Who is John Galt? – Ayn Rand from Atlas Shrugged

Humanity has shown many times that we can be extremely cruel and equally capable at rationalizing it away. Taxation comes in many forms and is often not apparent. A well disguised tax is a boon for governments. The cruelest tax of all is an one hundred percent tax on income, disguised and capable of being rationalized as “good”.

Imagine for a moment a peasant farmer who has to hand over a hundred percent of his crop to a feudal lord. It is easy to see the injustice of such a tax. Yet we have a hundred percent tax in our midst and there is no moral outrage. It is the zero interest rate policy. Fortunately that other destroyer of savings, Quantitative Easing, is off the table for the time being.

We rationalize it away as a benign economic policy aimed at restoring economic prosperity. No questions asked. All “policy” happens by government decree. Do not buy into the slight of hand that the central bank is not part of the machinery of government. So the Central Bank can “follow” a zero interest rate policy but the reality of this tax is lost on the population.

Let’s put it up for scrutiny. Would a saver willingly agree to an economic environment of zero interest rates? Certainly not. Would a debtor prefer a zero interest rate? Absolutely. The saver and the debtor would negotiate a “price” for the use of money saved under normal willing economic participant conditions. That price for use of funds is interest.

The Central Bank enters the negotiation between saver and borrower and by counterfeiting money is able to destroy the negotiating base of the saver. Counterfeiting money through policies of unlimited liquidity provision is “price control” over interest rates instituted to force interest rates to zero. The interest income of the saver is completely taxed away.

I want to concentrate on the tax though the plight of the saver haunts me when I interview desperate pensioners who are forced into risk assets in the hope of making up for a loss of interest income. Often they lose capital in this game of risk taking with savings, into a downward spiral of despair. Back to the tax.

Savings will migrate to term assets for meager interest income but that income has more to do with a term premium than with interest, the cost for use of funds. No one has any moral standing to defend a policy that dispossesses the interest of the saver however, the indiscriminate redistribution of this “interest” tax is even worse.

The normal standards for a tax are that it must be fair and it must be evenly distributed. The “for the public good” argument is that tax may be levied disproportionately usually with reference to some wealth measure. In simple terms, the rich must pay more and the poor must pay less. A zero interest rate policy tax fails dismally when it is tested against this framework. There is no discrimination. All savers are taxed their entire interest rate. Some savers, usually the wealthier and more sophisticated savers can institute counter tax measures and are able to avoid or escape the zero interest rate tax to some extent. Most can’t and they fund the redistribution.

Looking at the redistribution of the saver’s interest we find the same indiscriminate principles being applied. Is it being distributed by an elected body, fairly and equitably in the interest of society? No. Who are the recipients of the interest that has been stripped from the savers? Obviously the borrowers and it takes place with no reference to the wealth, income or other discerning standards which would normally apply. By which standards do society decide that Homeowner X who bought a property priced beyond his means and who borrowed in excess, must be subsidized by Pensioner Y who had saved to survive the income drought of old age. Why must BIG BANK A have access to zero or near zero cost of funds to carry all those loss making loans while Saver B can no longer afford his child’s tuition?

So the zero interest rate tax strips the interest income from savers and hands it to government, morally justified as stimulating the economy through deficit funding. It is of no use to run up huge deficits if it involves paying a high interest rate, is the justification. Strip the interest and hand it indiscriminately to over-extended borrowers many of which had used the borrowings to speculate on asset inflations. Strip the interest and hand it to the banks to “repair” their balance sheets and to “carry” the bad debts. Strip the interest and hand it to the developers who over invested in property, capacity or trading. Strip the saver of interest to fund the carry of compounding unliquidated losses.

How totally one sided. Rip off the savers and give to the borrowers. Not even the socialist dictate of Karl Marx which proclaims that everybody should contribute according to ability and receive according to need, can contain the injustice of a zero interest rate policy tax. Surely nobody can have a zero need and a one hundred percent obligation to contribute. Neither can anyone claim one hundred percent contribution from savers against a zero contribution from borrowers (the bank margin excluded).

So, next time when the Fed or the Bank of Japan or the Bank of England proclaims its devotion to a zero interest rate policy, stop and ponder for a moment the injustice to the saver. Think on the co-operative spirit of society and ask why these Central Banks consider it fair, moral and just to strip savers of their income in their quest for self preservation. When you hear the phrase, “interest rates will remain at zero for longer” question the imposition of hardship on the saver for longer. Contemplate the weight of the burden on a small and responsible portion of society and the economic consequences of such self serving behavior by Central Bankers with the support of Central Government.

In your heart, if you have a heart, you will know that robbing the saver is not moral. You will realize that the indiscriminate redistribution of income rights from the responsible and the cautious to over burdened borrowers, speculators, government and risk seeking banks serve not the short or long term interests of economic society. Most of all do not rationalize this mean policy and indiscriminately cruel tax into a benign and caring action by Central Banks.

Look no further than the escalation in Total Public Debt and compare it to the Federal Interest Outlays to see but a portion of the sacrifice extracted from savers. See how the debt expanded exponentially but the cost of funding the debt dropped dramatically. Interest tax need not be calculated or declared because the tax has already been calculated, declared and transferred to government through the application of the zero interest rate policy of the Fed.

Disclosure: No Positions in stocks mentioned.

Comments

[Ferdinand E...:]

Interesting. What the author forgot to mention is that in one way or another George W. Bush robbed just about everybody in the US except those lovely citizens who were/are in good condition cash-wise, and his policies are still robbing them. Somebody should explain that to the new president the next time the subject of Afghanistan comes up. .

As for a low interest rate, it makes all the sense in the world when a country's economy is in danger of going into the tank. Of course, the important thing here is that people like Profs Bernanke and Summers are smarter than most of the street-corner and wine-bar critics of the present economic policy. They have the answers we need, and the commander in chief would be doing himself and the country a favor if he listens to them..

Nov 03 09:59 AM

[Pat C:]

I think "rip off the savers to give to the LENDERS" is most appropriate.

Nov 03 10:01 AM

[daphne does...:]

excellent article. thank you--i'm sending it to my congressman.

Nov 03 11:07 AM

[PTF:]

Excellent analysis..... of the "immediate /short run" effects of Fed Policy, and it's intrinsic unfairness to those who have not over consumed and created capital.

Is not the "immediate/short run" policy just a likely precurser and harbinger to this country's probable long term policy of inflating our way out of the debt (national and private)... and of course inflation is the cruelest tax of all.

I would love to see the authors thoughts on this.

Nov 03 01:24 PM

[Mr. Big:]

Great article! You target an excellent point that interest rates determine the balance of savers and borrowers. And that explains why we have the zero-interest rate policy. The whole Obama strategy for the economic "recovery" is to eliminate the saver and boost the spender because savers do not contribute to GDP.....but spenders do.

This is absolutely a redistribution of wealth, to steal from savers and transfer the benefit to borrowers. Again, this is another example of prudency being punished and recklessness rewarded, but this time, via zero interest rates.

And let's add to this the destruction of the purchasing power of the US dollar. In a currency depreciating environment, the ones who spend the dollars first (i.e. spenders) wins over those who spend them last (i.e. savers). The zero interest rate policy further supports a weaker dollar and therefore adds even more punishment to the saver. All this....to benefit the borrower.

That's why it is only a matter of time, when the saver will be squeezed to the point where there's nothing more to give to the borrower. When the treasury bubble finally pops. And the dollar carry trades unwind. And we will witness the massive selling in the markets to cover the dollar shorts, as the borrowers scramble to save themselves from financial ruin. As interest rates ramp up to the natural equilibrium between borrowers and savers, the still-weak economy will grind to a halt. And interest rates MUST go up, lest the Treasury find themselves without a lender, or should the Fed be that lender, risk further destruction of the USD (and hyperinflation).

It is only a matter of time before one of the seams of this massive (and wasted) stimulus experiment breaks. And we will see first hand what the true state of the economy is....

Nov 03 02:02 PM

[Pat C:]

We really should clarify how much is going to the borrowers and how much is going to the lenders. I haven't heard alot of noise about how low, small business and individual borrowing rates have become. It is all being trapped by the lenders.

Nov 03 02:33 PM

[ryanclarke:]

The Fed "thinks" the ZIRP policy is helping the banks ... in fact, it isn't ... money has come out of average joe's checking and savings account at the banks and gone into any liquid asset he can find ... average joe isn't as dumb Bernake thinks he should be. Since deposits at the banks are going DOWN and not UP ... funny how JPM how a great 3Q09 but a quick glance at JPM's 10-Q says the money deposits held at the bank have gone DOWN and not UP ... tells me we've got another market correction in the making.

Nov 03 03:59 PM

[Sarel Oberh...:]

<IMG class=authors_reply src="static.seekingalpha.co..."> PTF

Thank you. I have wrestled with the “inflating away debt” premise for a long time and re-wrote the GDP formula (Yd = C + G + I +{X – Z} = C + S + T = Yi; the Hicks-Hansen cross) to accommodate the actions of the Central Bank in stimulating debt formation. I have concluded that a deflationary depression will follow once the debt channels for private and public debt becomes saturated with the economy stuck in stasis. The deflationary depression can be converted into a hyperinflationary depression with concerted central bank money creation and particularly Quantitative Easing which will “inflate away the debt” at the cost of economic structural destruction (a very high price). I have also dealt with the technical conditions of an economy under a “zero interest rate policy”. Please download “War on Savings” in PDF format from my blog (sareloberholster.blogs.../ ) for more detail or at this link

careergazer.net/Wa...


On Nov 03 01:24 PM PTF wrote:

> Excellent analysis..... of the "immediate /short run" effects of
> Fed Policy, and it's intrinsic unfairness to those who have not over
> consumed and created capital.
>
> Is not the "immediate/short run" policy just a likely precurser and
> harbinger to this country's probable long term policy of inflating
> our way out of the debt (national and private)... and of course inflation
> is the cruelest tax of all.
>
> I would love to see the authors thoughts on this.

Nov 03 04:11 PM

[Amouna:]

This is exactly what happens when government becomes overly involved in the daily economic activity. As one wise former president pointed it out on his inauguration day: "We look to the government for solutions but actually government is not the solution, government IS the problem"

cut useless spending, let failed business go bankrupt and restore a viable business environment where thrifty entrepreneurs and innovators can have access to resource capital, not consumers and speculators.


On Nov 03 02:02 PM Mr. Big wrote:

> Great article! You target an excellent point that interest rates
> determine the balance of savers and borrowers. And that explains
> why we have the zero-interest rate policy. The whole Obama strategy
> for the economic "recovery" is to eliminate the saver and boost the
> spender because savers do not contribute to GDP.....but spenders
> do.
>
> This is absolutely a redistribution of wealth, to steal from savers
> and transfer the benefit to borrowers. Again, this is another example
> of prudency being punished and recklessness rewarded, but this time,
> via zero interest rates.
>
> And let's add to this the destruction of the purchasing power of
> the US dollar. In a currency depreciating environment, the ones
> who spend the dollars first (i.e. spenders) wins over those who spend
> them last (i.e. savers). The zero interest rate policy further supports
> a weaker dollar and therefore adds even more punishment to the saver.
> All this....to benefit the borrower.
>
> That's why it is only a matter of time, when the saver will be squeezed
> to the point where there's nothing more to give to the borrower.
> When the treasury bubble finally pops. And the dollar carry trades
> unwind. And we will witness the massive selling in the markets to
> cover the dollar shorts, as the borrowers scramble to save themselves
> from financial ruin. As interest rates ramp up to the natural equilibrium
> between borrowers and savers, the still-weak economy will grind to
> a halt. And interest rates MUST go up, lest the Treasury find themselves
> without a lender, or should the Fed be that lender, risk further
> destruction of the USD (and hyperinflation).
>
> It is only a matter of time before one of the seams of this massive
> (and wasted) stimulus experiment breaks. And we will see first hand
> what the true state of the economy is....

Nov 03 06:16 PM

[derryl:]

"Saving" is not an unmitigated good thing. Saving can only generate real returns if it is invested in productive capital formation. The only other ways of getting a return on savings is through wealth redistribution and/or the fantasy return of inflation. Nominally you 'earn' 5% interest, but if your savings did not generate a 5% increase in goods production all you have done is transfer buying power from borrowers to savers, no different than winning bets at a casino. Or someone somewhere added an additional 5% of money into the system to inflate the money supply and devalue your money's buying power by 5%. Without increased real economy production there can be no real return on money. If savers "save" by way of buying some land that they can grow food on and live cheaply they can escape the boom and bust cycles of the economy. There is no other way.

Sarel wrote, "I want to concentrate on the tax though the plight of the saver haunts me when I interview desperate pensioners who are forced into risk assets in the hope of making up for a loss of interest income. Often they lose capital in this game of risk taking with savings, into a downward spiral of despair."

This is the ancient conundrum of "excess savings" or a "savings glut". It is why the Hebrews instituted "Jubilee Year" every 50 years, to clear out the imbalances that inevitably develop due to the fact that some people are very good acquisitors and they end up owning everything. Read the prophet Isaiah who lived about 650 BC, "Woe to you who add house to house and field to field until you live alone in the land." Isaiah is talking about "savers" and "investors".

If there has been so much monetary accumulation in the hands of savers/investors that the amount of money is greater than the amount of productive investments to absorb that money profitably, profit levels and interest rates shrink. John Stuart Mill describes this in "Principles of Political Economy" published in 1848:

After a good economic run savers end up with lots of investable money competing for a limited stock of profitable investments (over time technological advances increase the stock of profitable investments, but in the short term we can assume stasis). Investment demand becomes too high, so in an attempt to gain acceptable levels of return investors turn to speculative ventures.

For awhile this can fuel asset price inflation and some gains for those who bought early and sold late, but ultimately there comes a "revulsion" in which all of the misallocated money is lost by the speculators, asset values collapse, and the economy eventually starts up again from a lower price level. The economy can only recover after those excess savings are redistributed via malinvestment and loss. The savers lose their money.

Mill is writing about England's gold standard economy of the 19th century so there is no question of QE or other species of money creation confusing the mechanics of this 'capitalist cycle'. The supply of money is assumed to be fixed throughout the cycle.

Sarel wrote, " I have concluded that a deflationary depression will follow once the debt channels for private and public debt becomes saturated with the economy stuck in stasis. The deflationary depression can be converted into a hyperinflationary depression with concerted central bank money creation and particularly Quantitative Easing which will “inflate away the debt” at the cost of economic structural destruction (a very high price)."

This is the phase of Mill's capitalist cycle that our monetary and fiscal authorities are currently desperately trying to prevent. To purge the malinvestment we have to accept Andrew Mellon. "Liquidate them all. Purge the rot from the system." The values of all those speculative assets--in our case houses and stripmalls--collapses. Anybody who invested in them goes broke and loses everything. You get a deflationary depression. Or if the government chooses to avoid that route via excessive QE, you can get a hyperinflationary depression. Bernanke and friends are trying to discover a middle way that does not include "depression" and I hope they succeed. But maybe it's not possible, I don't know.

If "poor pensioners" did not accept .25% interest from their bank and joined the speculators to try to get higher returns, in a world where there was too much money chasing too few real investments, then the poor pensioners get liquidated along with everyone else. After all the speculative money is wiped out and asset prices and the economy collapse, the economy can begin to offer some real investments again and a new round of economic activity and capital formation begins. It will end just like all the other rounds have ended, in tears.

Money is just numbers. Unless it is employed to generate real wealth money is sterile. Money in a sock generates no returns. Money in an unbalanced economy, where spenders have no money to spend and savers want to invest rather than spend, generates no spendable incomes and thus no demand for consumption and business capital formation and thus no returns. "Saving" is not an unmitigated virtue. At the micro level of individuals it is virtuous and prudent, but at the macro level of the economic system it is fatal. Hence Keynes' "paradox of thrift". Whatever else Keynes was wrong about, he nailed this one.

Nov 03 07:08 PM

[User 164069:]

In this article, substitute "savers" by China (United States' biggest creditor) and the Chinese (savings rate of 40%) [or India/Indians], and "borrowers" by the US (biggest debtor nation) and Americans (living with negative home equity and maxed out credit cards). At the macro-level, whom will zero interest rates help? This explains FED's policy.

In this situation, what will the savers do (especially with Eurozone and UK also following monetary policies similar to the FED's)? Hedge by buying into "real" assets. Witness China going after commodities and India buying 200 tons of gold. Hence the rising commodity and gold prices, a trend that will probably continue.

Where are all the QE monies going? US banks, corporations and individuals are de-leveraging, so a lot of money has gone into re-inflating the US stock market, and much of the rest into the giant carry trade Nouriel Roubini is warning about. Hence the asset price inflation visible in stock markets worldwide and property prices e.g. in Hong Kong, Singapore (The latter also considerably aided by Chinese savers/investors seeking better returns on their money.)

How will it all play out? As the availability of cheap or zero interest rate financing from savers starts diminishing, borrowers will either have to raise interest rates or reduce spending. Hobson's choice - the former would deflate the international asset bubbles, while the latter would hurt industry and thus economic prospects. It all looks too much like Japan's lost decade in store for the global economy going forward.

Nov 09 12:38 AM