Negative US Interest Rates and How We Broke Our Savings System: Steve Waldman of Interfluidity

Steve Randy Waldman writes the finance and economics blog Interfluidity. In recent writings Waldman has put forward some incisive thoughts on negative real interest rates in the United States. Negative rates, of course, mean essentially that there is no nominal reward for saving capital, even including accumulated interest. In a far-reaching discussion, Waldman outlines the nature of negative rates in the US, the struggle of the federal government and financial institutions to enable returns on growing global capital reserves, and how institutions might evolve to repair a global investment environment in which the most critical financial decisions are being made by an ever-shrinking group of actors. Partial transcript below. Five-year real rates are now negative in the United States. How did we get here?

“I think we've been here for a long time. In 2005, Ben Bernanke gave a famous speech about a global savings glut. Prior to that, starting around 2003, economists started pointing out very peculiar international fund flows, especially from China but also from petrodollars and Saudi Arabia, and the effect they were having on US interest rates and US finance in general. I think it's wrong to think of the negative interest rates that we're seeing now as an aberration. I think the right way to view them is that market interest rates have been trying to go negative for a decade, for the usual reason: there's a glut of supply and insufficient demand, and so the market tries to equilibrate supply and demand by changing the price and it changes the price to negative. There's nothing wrong with that in economic theory, but in human practice, for a variety of cultural [and moral] reasons, we think of negative interest rates as a problem. I think we, as a society, made use of the technology of Wall Street early in this decade to overcome [negative rates]. We were getting all of these fund flows from afar and also fund flows domestically (as inequality grows, there is a lot more savings from people who have more income than they need immediately). We just had a lot of savings, and if there hadn't been a housing boom, a credit boom, a boom in lending to people who, under more stringent standards and less innovative financing arrangements, would not have received loans, then we would have experienced negative interest rates in 2004 or 2005. We didn't - only because the men and women of Wall Street worked very hard to gin up people to lend to, and to find ways of masking what would ordinarily be considered bad loans as the low-risk loans that all this money was seeking.”

Are the tactics used before the crisis to artificially lift interest rates still being put to work in the system today?

“We have other things in the system. Interest rates would be much more sharply negative if the federal government wasn't doing a lot of borrowing. The federal government had to step in and replace all the questionable mortgage borrowers buying overpriced houses once they left the realm of low-risk borrowing demand. If the government hadn't stepped in and more than doubled the annual deficit we would have an even more significant savings glut then we have right now. It's certainly safe to say that the end of the CDO structured finance boom was a sharp negative shock to loans that could be funded by 'low risk' money.”

Central banks, if they attempt to intervene to produce high real rates, are facing the problem of dealing with inflation as a result of the intervention. You have advocated nominal GDP targeting in the past. Could that sort of policy be a solution to the problem?

“I do support it. I think monetary policy alone is insufficient to deal with [the problem] so I'm not one hundred percent with the so-called market monitors who are pushing NGDP targeting, but I think it is unquestionably a much better idea than inflation- or price-level targeting, which is what we're doing now. We're seeing that bite right now in the US and in Europe: so long as central banks view their credibility as managing inflation, they are in the business of frustrating the free market in terms of the price of money. If it is the case that there is more supply of low risk savings than there is low risk demand for loans, than the price of low risk savings just has to go down. But if the central bank commits to a level of inflation, that level is effectively a cap on how negative the interest rate can go. If the central bank were an NGDP targeting central bank then it wouldn't look at inflation, it would just say 'What is the price of money necessary to get the level of expenditure that we consider normal?' And if it did that it would have to let inflation go up as much as necessary to let the market interest rate re-equilibrate at the negative level that it wants to go to. A nominal GDP targeting central bank would have the ability to let the market clear, whereas an inflation targeting central bank has essentially committed itself to putting a floor under the level of interest rates – putting a cap on the price of future money. Like any other price control, that creates shortages or gluts, and that's exactly what we're seeing now: gluts of savings, of cash-like instruments, and shortages of loans and demand in expenditure.”

These savings gluts are occurring not on the balance sheets of “everyday” investors, but rather on those of the rich and on the balance sheets of sovereigns. So inequality is an important part of this story, correct?

“It's a very pivotal part. When we talk about a savings glut, which really means that people are trying to shift their consumption into the future, that is certainly not a phenomenon of everyday people. Everyday people have lots of wants and needs that are unmet. We don't yet live in a society where the vast majority of people basically feel that their day-to-day wants are met and if they get some extra income they're just going to bank it. It's easy to forget that most Americans live paycheck to paycheck and the number of people who have any savings at all is probably less than half the country. So it's an odd thing to talk about a savings glut in the middle of a depression. But there is a savings glut, and that has to do with both institutional factors and inequality. Inequality is a obvious point – we are worldwide and in the US in an era where there are levels of inequality that are unprecedented since the 1920's. There is some fraction of the population that has income that is a lot more than a person is likely to want to consume – today, or tomorrow, or even over the course of a lifetime. [In these cases]You've endowed your planned consumption for pretty much a whole lifetime. A person in that position still wants to save their extra income; just because you're Bill Gates doesn't mean you necessarily want to give all your income away. You can make a lot of money and still want to keep it, because you never know what's going to happen. We normally think of investors as trying to maximize the future consumption value of the wealth that they save. But that's not what very wealthy investors do. Generally when governments invest, they do things that are different than trying to maximize the future consumption value of well [as well]. The most obvious example is China, where most observers have believed for years that every time the Chinese central bank sells yuan for dollars they are locking in losses of real purchasing power. But they engage in that form of investment because they are purchasing the most successful development program in the history of the world. So accepting those capital losses is worth the gains to development in their country. These pools of money – money from the very rich, who are an increasingly large portion of the investing public, money from governments, and money invested on behalf of more ordinary affluent people but managed by professional investors who behave very differently than individuals would managing their own money – dominate investing today. I think that they dominate to the point that if your model of markets is a traditional model of markets – in that the cost of capital is set by investors looking for an informational edge, trying to maximize the future consumption value of the resources that they invest today – if that's your baseline model, the reality is such that you're just wrong; that's just not how markets are functioning.”

Does this mean that collective decision-making is being put into the hands of too-few individuals? Is this causing inefficient capital allocations?

“I think that is absolutely the case. Ultimately, the community of billionaires is small, governments are small, and managed money behaves more like a concentrated actor than like a highly competitive, widely disbursed actor. There might be lots of different banks and investment funds involved in managing money, but they are part of the same community, they're often co-located in the same places. It's certainly reasonable, I think, to say that from an informational perspective we are evolving, even in terms of the management of notionally-private money, a system that looks more like central planning than [one of] competitive, disbursed-agents competing for an informational edge in determining the cost of capital. Banking systems are more public than private. The vast majority of the risk is born by the states that backstop the banks, not by the banks themselves. But we as a society resist terribly the notion of admitting that we have a public banking system. And what we end up getting is the worst of both worlds, because the reality of decision-making is very concentrated like there is a central planner, but if we had a [de jure] central planner, we would try to make it as smart as we could and have good procedures for doing the central planning. What we have is a kind of central planning infrastructure, a set of institutions that are concentrated in terms of how they behave, that mimic one another so that really only a relatively small number of decision-makers end up determining where the vast majority of capital goes and how it is allocated or withheld. But it's almost happenstance – it would be better if it was a self-conscious conspiracy of central planners, because at least they would be smart about it. It's just an institutional arrangement that has evolved; it's a central planner that's unconscious of itself and therefore makes foolish choices.”

In your blog you write that debt is not a good instrument with which to fund speculative outlays. How can we guide institutions that foster more of an equity-financing approach rather than debt-fueled growth, ones that encourage expiration and idiosyncratic judgment calls?

“There is a lot that we can do. The biggest thing that we can do is change how we subsidize finance. Right now the risk behind the banking system is the state, and the banking system is designed to make only apparently low-risk loans. There is no reason why we couldn't put the risk-bearing capacity of the state behind equity investments and venture investments. There is no reason why we couldn't develop a system of banks where the government would take equity stakes alongside bankers. We could have a set of institutions that would be kind of like venture capital funds that would be willing to fund local ventures, small entrepreneurs and their ideas in the way that we hope that banks do. The whole reason we developed formal financing is so that entrepreneurs could limit risk, could come up with good ideas and find people willing to share both the risk and the upside. There is no reason why we couldn't develop a set of banks that have similar support that existing banks currently have from the state, that would actually do better than current banks do in terms of return. So that is one thing that we could do to move to a public-private partnership, ubiquitous venture finance model. Another thing that we need to think about: when there is insufficient demand, it is hard to have a boom in business enterprises of any sort. When people are not willing to buy because they are in debt or because they are frightened, it's really hard to get a boom in productive activity. I think we need to recognize the role that consumers play in the investment process. We can only know if a business is good if consumers get to vote on it. But if consumers are only going to vote no because they don't have the money to vote yes, we're not going to learn which ideas are good ideas and which are bad. From an informational perspective, people often divide very sharply: there are the producers and the consumers, there are investors and there are customers. But those groups of people are really not as distinct. They're collaborating. Most of what we want investors to do is provide information, but that's also what consumers do. I think we need to recognize that part of the investment process is enabling consumers to be able to express their preferences, so we need to think of demand-side interventions. By that what I really mean is helicopter drops. When we're in a time of diminished demand, the government should cut checks to everybody until we get the level of aggregate demand to a certain level. It's really important that the government do that in a flat way, meaning everybody gets a little bit of money, not via fiscal expenditures and infrastructure programs and things like that, because there's the conservative complaint that the government is corrupt and a poor allocator of capital. But even putting that aside and spreading stimulus money very widely among the public, we are investing – because we get that information advantage; we learn what the public wants. Dispersing funds very widely gives us the most robust and accurate view of the general public's preferences and demands."