A Rothbardian Take on Negative Interest Rates
Joe Weisenthal, who made his name in financial circles while an editor at Business Insider from 2008–2014, has been wondering aloud on his popular Twitter account why so many analysts think it’s weird for the world to be experiencing negative interest rates. Since Weisenthal has collected his thoughts into a recent article at Bloomberg, it’s worthwhile to analyze them from a Rothbardian perspective.
As we’ll see, Weisenthal is fuzzy on several key distinctions, but his basic intuition does serve to illustrate a problem with the conventional understanding of (fractional reserve) banking. Specifically, Weisenthal is right to think that rich people should have to pay to warehouse their wealth, but he’s wrong to think that this phenomenon should be classified as “negative interest rates.”
Weisenthal’s Perspective on Negative Interest Rates
Let me provide some lengthy excerpts from Weisenthal’s column to fairly portray his approach:
Imagine … a time before the existence of a financial system. Rather than people accumulating wealth in pieces of paper (cash, bonds, stocks, etc.), the main way to build up wealth is to buy lots of physical things. Mansions, art, stores of grain, and so on. It should be obvious that this kind of wealth costs money to maintain. It degrades. You have to pay security guards. It can all go up in smoke in a fire. You can keep your wealth in physical things, but you’ll constantly pay a price for that — a negative interest rate, if you will.
Of course, all this exists today. If you want to hold gold and watches and sentimental things at a bank, you pay to rent a safe deposit box. If you want to hold oil or grain to use it or sell it next year, you can pay for storage in a tank or some other facility. And if there’s a surge in the supply of oil or a bumper crop of grain, and storage capacity is scarce, then you can expect to pay even more for warehousing capacity…
But this is money we’re talking about! Why are we even talking about a storage fee? We all know that money in the modern era is just an entry in some digital ledger on the servers of a bank…
Well, it’s important to remember that money in the bank isn’t really something you have. It’s something that you are owed. When you log into your bank and see that you have $10,000 in your savings account, what that means is that your bank owes you $10,000.
And where does the bank get the money to pay you? From the entities that owe the bank money…
In other words, to store money at a bank requires the existence of some other borrowers who will pay the bank. As such, just as you’ll pay more to store grain when grain is abundant and warehouse space is scarce, you have to pay more to hold money when savings are abundant but demand for borrowing is scarce. [Weisenthal, bold added.]
Weisenthal’s reflections at first sound pretty insightful, and it is refreshing whenever someone approaches financial topics from “outside the box.” Unfortunately, I think Weisenthal’s analysis is quite fuzzy, because he’s mixing up a few related, but distinct, issues.
Depositing Money versus Lending Money to the Bank
The fundamental problem with Weisenthal’s commentary is that he throws the physical warehousing of wealth into the same category as lending money to a bank, and thinks “the interest rate” is the way to handle the payment flows in both cases.
The confusion here is typical. Whenever someone in the Rothbardian tradition argues against fractional reserve banking, the critics will wonder how banking could even exist with 100% reserves. (For example, here is my recent podcast episode on the topic, and in the comments you can see that some listeners were mystified by the discussion.)
Because of this popular confusion, it’s worthwhile to start from first principles: There are two basic functions that commercial banks perform. One is that they make it easier to store/spend your money, and another is that they act as credit intermediaries. The modern practice of fractional reserve banking conflates the two, but in principle they are distinct functions.
Specifically, under a 100% reserve rule, the money you deposit into a checking account is held by the bank, and is not lent out to other borrowers. Because of this, yes indeed the bank must charge the customer a fee. In this respect, Joe Weisenthal is on the same footing as Rothbardians, who see nothing weird about paying a bank for the valuable services of holding their cash securely, establishing a worldwide network of ATMs and card payment systems, having convenient online bill-pay features, etc. (I thank Jeff Deist for this observation.)
However, it’s not really helpful to call this a “negative interest rate.” Instead, you are paying the bank a fee for its services in giving you a (100% reserve) checking account. When you leave your dog in the kennel, you’re not being paid a negative interest rate on canines. When you stay in a hotel room, you’re not earning a negative interest rate on the deposit of your suitcase and body. It’s not helpful to think like that.
Credit Intermediaries Under 100% Reserve Banking
Now if there is a genuine credit transaction, in which you really are lending your money to the bank in exchange for its promise to repay you in the future, then it makes sense to talk about interest rates. In a banking system respecting 100% reserves, this type of operation is still feasible. For example, customers could buy bank-issued Certificates of Deposit (CDs) with implied yields. A customer might spend (say) $980 on a CD that will pay the bearer $1,000 in twelve months’ time, for a yield of 2.04%.
Notice that if a bank customer buys a CD, there’s no question that he has lent his money to the bank — he no longer has control of it. He can’t go down to the grocery store and use the bank CD to pay for his bill at the register. In contrast, he can write a personal check or swipe his debit card, because claims on money owed by a reputable bank are considered interchangeable with money proper (such as $20 bills) in our society. This is the whole problem of what Mises called “fiduciary media,” and it’s why fractional reserve banking has the ability to cause the business cycle. (I spell all this out in my podcast episode, which itself is tied to my recent QJAE article on fractional reserve banking and the boom-bust cycle.)
Physical Structures versus Market Value
Another major problem with Weisenthal’s discussion is that he flips back and forth between the physical structure of wealth versus its market value (expressed in price). This is how he ends up with the ludicrous notion that in a primitive economy, interest rates would be negative. In reality, other things equal interest rates are very high in a society with a low capital-to-labor ratio. The normal course of economic development has interest rates falling over time, as people become wealthier and are able to defer more of their consumption to the future.
(A note for purists: There is an extensive literature on the Austrian “pure time preference theory” of interest. In particular, the very notion of a negative interest rate is nonsensical in this tradition, because it implies that people would be willing to defer a given satisfaction forever. See Walter Block’s article for a discussion. However, in this article I’m not even taking a purist Austrian line; standard neoclassical economics also endorses the basic Böhm-Bawerkian point I’m making here, vis-à-vis Weisenthal’s thought experiment.)
In any event, Weisenthal’s fundamental mistake is that he looks at the physical embodiments of wealth — houses, pieces of art, stores of grain, etc. — and realizes that they require physical maintenance, and from this concludes that their owners must “constantly pay a price for that — a negative interest rate, if you will.”
Huh? Did Joe Weisenthal just “prove” that everyone who invests in real estate always loses money on the deal?
What’s going on here, of course, is that even though a physical piece of wealth might require physical maintenance (which costs money), the market value of the object can nonetheless rise over time. And indeed, in an economy where the rate of interest is positive (let’s put aside for the moment what makes it positive), the current or spot price of the piece of wealth would reflect investor requirements for long-run appreciation.
For example, if the “safe” interest rate is 5%, then an investor might insist on a 10% return on a house. And so if he expects (given his forecast of market conditions) that a house will sell for $110,000 next year, right now the investor would be willing to pay up to $100,000 for it. If you include the real-world expenses of maintenance, property taxes, etc., that Weisenthal mentions, then the investor would lower his maximum price, so that his total out-of-pocket payments would only be $100,000, in order for him to yield a 10% return on the investment over the year.
The same holds true for art. Investors can buy art because they appreciate it, but also as an investment. (Experts argue about whether it’s a good investment, to be sure.) This isn’t because a Picasso has the physical ability to multiply into more paintings, it’s because people expect its market price to rise over time.
And so we see that Weisenthal’s “deep thoughts” about the distant past and negative interest rates are actually pretty goofy. He makes a very basic mistake at Step 1 of his analysis.
It’s refreshing that Joe Weisenthal is challenging the notion that people should be able to deposit their money in a checking account and be paid interest on it — Rothbardians have been saying that for decades. However, most of Weisenthal’s analysis is silly, because he conflates a physical structure’s integrity with its market value. Just because you have to pay money to maintain an item of wealth, it doesn’t follow that you “naturally” should earn a negative return on investing in it. In any event, the officially negative interest rates across Europe and Japan have more to do with central bank shenanigans rather than thought experiments about a primitive economy where — contrary to Weisenthal — we would expect interest rates to be very high, not negative.