ZIRP is Deflationary

ZIRP is Deflationary



Most economists agree that lower interest rate will encourage American to borrow and spend and thereby stimulate the economy.  Therefore the lowest interest rate of all (Zero) would pack the most stimulating punch for the economy.
Result?  During our post-2008 economy stagnation, the Federal Reserve established a Zero Interest Rate Policy–commonly known as ZIRP.

That policy would certainly be reasonable if we still had a physical money (gold and silver) that would be effectively “trapped” in the US by the Atlantic and Pacific oceans.  So long as the US dollar had physical substance, creditors’ dollars could not easily leave the US economy.  Therefore, creditor had little choice but to accept whatever interest rate was established by the gov-co.

But, today we live in the age of digital fiat currencies which have no physical substance or reality and can therefore cross oceans at the speed of light on the internet.

Result?  Currencies are no longer trapped in their domestic economies.

Result?  When today’s interest rates are lowered, the net result is not to make borrowing more attractive but rather to drive domestic credit out of the US—where interest rates are ZIRP (Zero Interest Rate Policy) and irrationally low—and into foreign markets that pay higher rates of interest.

Result? Today’s irrationally low American interest rates (ZIRP) should push currency out of the US economy, reduce the money supply available for borrowing, and tend to cause monetary deflation (falling prices; rising purchasing power of the fiat dollar) which, in turn, push the economy toward recession or depression.

Because digital dollars are is no longer trapped in a particular economy, the assumption that lowering interest rates will stimulate the economy is no longer valid—or it’s no longer as valid as it was before digital currency and the internet came to town.

•  More, I begin to suspect that interest rates may be more important than the “printing” of fiat currency.

“Helicopter Ben” and the Federal Reserve can print an additional four trillion fiat dollars to “stimulate” economy—but there won’t be much stimulation if the Fed simultaneously reduces interest rates to near zero.  No matter how much currency they print, the low interest rates will push that currency out of the US economy in search of higher interest rates.

I believe that’s why the “emerging economies” recently enjoyed two or three years of “stimulation” and impressive growth while the US economy remained stagnant.  The Fed printed an extra $4 trillion (purportedly intended to stimulate the US economy) but also lowered interest rates to near zero.  Some or all of the $4 trillion fled the US economy in search of higher interest rates, found them in emerging economies, and stimulated those foreign economies.

Implication:  In a world of fiat digital currency, the negative effects of irrationally low interest rates will be greater than the positive effects of printing trillions of more dollars.

Yes, since A.D. 2008, the Fed has printed an extra $4 trillion to stimulate the US economy.  But, because digital dollars are no longer trapped in the US economy, the Fed’s Zero Interest Rate Policy (ZIRP) pushed much of that $4 trillion out of the US and into emerging economies that paid higher interest rates.

I think the same effect would’ve taken place if the Fed had printed an extra $50 trillion in fiat dollars and simultaneously held interest rates near zero.  The primary “stimulus” of that $50 trillion would be felt in foreign countries that paid high interest rates.  Relatively little stimulus would be felt in the US economy locked own with ZIRP.

Implications:  1) Interest rates are more important to managing the money supply than the quantity of domestic currency being printed; 2) high interest rates actually increase the money supply, increase inflation, and thereby “stimulate” the economy; and 3) low interest rates (ZIRP) actually serve to drive currency out of the economy and thereby contribute to deflation, recession and perhaps even economic depression.

•  Therefore, it appears that if the government wants or needs higher rates of inflation to “stimulate” the economy, the government must raise interest rates and thereby attract currency back into the US from foreign markets and increase the domestic supply of domestic dollars available for loan in the US.

On its face, lowering the interest rates sounds like a great policy since it will encourage people to borrow currency.  In reality, ZIRP drives currency out of the country and there’s less currency remaining in the domestic money supply to be loaned.

In essence, what difference does it make if the interest rate falls to zero, if there’s no money available to be loaned?  ZIRP is about as effective as stimulating the domestic economy as is advertising that I’ll sell brand new Cadillacs for just $5,000 each (Wow! Whatta deal!)—when I don’t actually have any Cadillacs available for sale (Wow . . . whatta bummer).

•  Assuming the Fed really wants to stimulate the US economy, the Fed should soon raise interest rates, attract currency back into the US markets, and thereby increase inflation and economic “stimulus”.

Of course, if my assumption (that the Fed truly wants inflation and economic stimulation) is false, Janet Yellen won’t raise interest rates any time soon.  If so, you should fasten your lap straps because the Fed’s true object is to collapse the US economy and give us a very bumpy ride.