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Negative Real Rates Of Interest


IBDDs destroy money velocity.

1961 "Operation Twist"

Savings-investment process.

By using the payment of interest on interbank demand deposits as a credit control device (when excess reserve bank’s balances become artificially designated as earning-assets by Congress, and thus subsidized by the public) thereby artificially bolstering short-term money market rates, money velocity will decelerate -- as monetary savings (all savings originate within the payment’s system), income not spent (funds held beyond the income period in which received), will be further idled (lost to both consumption and investment). Keynesian economists have achieved their objective: that there is no difference between money and liquid assets.

The FOMC’s Romulan cloaking device vastly exceeds the level of short-term interest rates which is still illegal. Remuneration of IBDDs destroys money velocity when the FOMC’s administered rate is higher than money market rates (as contrasted to the capital market). The financial instruments traded in the money market include: Treasury bills, commercial paper, bankers’ acceptances, certificates of deposit, repurchase agreements (repos), municipal notes, federal funds, short-lived mortgage and asset-backed securities and E-$ CDs (liabilities of a non-U.S. banks operating on narrower regulatory margins).

The money market is differentiated by its position on the yield curve (i.e., short-term borrowing and lending with original maturities from one year or less). Domestic liquidity funding is customarily benchmarked by SOFR, whereas today, the offshore reference rate (LIBOR) is generally higher than the onshore reference rate (PRIME).

In turn, money market paper funds the capital market (earning-assets greater than 1 year). Non-bank financial intermediaries in the capital market include hedge funds, SIVs, conduits, money funds, pension funds, selective mutual funds, hedge funds, sovereign wealth funds, insurance companies, finance companies, foundations, universities, and wealthy individuals, etc.

The IOR acts just like Regulation Q ceilings did (but now without its .75% differential funding in favor of the nonbanks imposed by the 1966 Interest Rate Adjustment Act, which offset the disproportionate volume of mortgages held by the thrifts). The IOR illegally and baselessly INVERTs the short-end segment, of singularly, the non-bank funding yield curve-- in the borrow-short to lend-longer, net interest rate expense spread / the profit margin in credit and risk transformation (between the weighted-average interest earned on loans, securities, and other interest-earning assets, and the weighted-average interest paid on deposits and other interest-bearing liabilities). A flatter yield curve and/or lower rates shrink bank profit margins (reduce profits on new loans and new investments).

And investment spending by business, CAPEX, is capitalized over longer periods and is generally financed with longer term financial instruments (as opposed to financing inventory expansion, using capital related to a portion of current assets, e.g., accounts receivable). For example, the acquisition of producer goods, are related to changes in MACRS depreciation (Modified Accelerated Cost Recovery System) allowances on tangible and intangible property (patents or copyrights ) and “Straight-line”, a depreciation method that gives you the same deduction, year after year, over the asset's useful life, are financed over longer time frames, as opposed to “Section 179 deduction”. Likewise, consumers generally finance “durable goods” which have 3 years of useful life, over longer payment schedules.

What is MACRS and MACRS convention?

What is straight-line depreciation?

What is a Section 179 deduction?

IOeR’s sport a "floating", remuneration rate (consonant today, with 30yr bonds). Interest is paid on the Deposit-Taking Financial Institution’s (DFIs) IBDDs balances averaged over the reserve maintenance period (7 or 15 days, depending upon the institution), and credited 15 days after the close of the respective maintenance period (unlike overnight FFs or repos).

The BOG’s policy rate "floats" (like an adjustable rate mortgage), via a series of either, cascading, or stair-stepping, interest rate-pegs. I.e., as with ARMs, a "note is periodically adjusted based on a variety of indices". Similarly, "Among the most common indices (for ARMs), are the rates on 1-year constant-maturity Treasury (CMT) securities".

See: "The 2006 Financial Services Regulatory Relief Act gives the Fed permission to pay interest on reserves. The IOR rate is higher than "the general level of short-term interest rates" which is imposed in the Law. "A Legal Barrier to Higher Interest Rates," The Wall Street Journal, Sept. 28, p. A13.

This perverse monetary policy is oddly akin to the 1961’s “Operation Twist”, where: “the intent was to flatten the yield curve in order to promote capital inflows and strengthen the dollar”.

Apparently, the Manager of the Open Market Account who operates from an office in the Federal Reserve Bank of New York and who is in charge of all open market purchases and sales for all 12 Federal Reserve banks thinks that the “demand for reserves” should reside with the American banksters, as opposed to its own “trading desk”.

Link: “Treasury Supply, Liquidity, and Bank Demand for Reserves” - September 2018

“Treasury asset swaps and bills are close substitutes to reserves for LCR and have cheapened with Treasury supply”

How now?

Effective Federal Funds Rate (FEDFUNDS)

Effective Federal Funds Rate

The only tool at the disposal of the monetary authority in a free capitalistic system through which the volume of money can be properly controlled is legal reserves. I.e., Keynes's liquidity preference curve (demand for money) is a false doctrine.

The money stock (and DFI credit, where: loans + investments = deposits), can never be managed by any attempt to control the cost of credit, R *, or Wicksellian: equilibrium/differential real rates, [or thru a series of temporary stair stepping or cascading pegging of policy rates on “eligible collateral”; or thru "spreads", "floors", "ceilings", "corridors", "brackets", IOeR, or BOJ-yield curve type control, YCC, of JGBs, etc.].

“The “demand for money” should not be confused with the demand for loan-funds. The demand for loan-funds is not a demand for money, per se, but a demand which reflects the advantages of spending borrowed money. Insofar as there is a relationship, it may be said that an increase in the demand for loan-funds tends to be associated with a decrease in the demand for money.

Monetarism has never been tried. Past Chairman Paul Volcker never changed his operating procedures (just read Paul Meek’s description, FRB-NY assistant V.P. of OMOs and Treasury issues: how Meek described the “desk’s” procedures in his 3rd edition of “Open Market Operations” published in 1974.