The Financial Wonderland of Covid-19

According to economic experts, Ireland does not have to worry about paying back the massive borrowings that were needed to fund the endless lockdowns : 

“Government debt does not have to be paid back, particularly the kind that sits minding its own business in the vaults of the ECB” - Chris Johns, Irish Times

 The problem with that is Article 123(1) of the Treaty on the Functioning of the EU :

 

 This means that it is illegal for any Member State to use the ECB as a bank overdraft facility.  The only reason why we can afford the luxury of endless lockdowns is our access to lots of free money. The Irish government have already borrowed €20 billion interest free this year and they plan to borrow another € 20 billion next year.   This is in addition to around €35 billion borrowed at very low interest rates since 2015 from the ECB's PSPP programme, prior to the covid "pandemic". So the free money bonanza that has enveloped the EU is not a new thing as some commentators have argued. 

All this free money being created by the ECB has resulted in the ECB becoming the largest single creditor of the member states in recent years. The German Council of Economic Experts have warned that this could present a threat to monetary policy independence in the long term.

In 2008, after the banking crash, the debt laden on to the backs of the Irish was paid back through taxation. This makes the situation at present different as there is no pressure to increase taxes. 

The natural effect of all this free money is massive inflation but we have not seen any sign of that yet (it may help to reduce government debt by de-valuing the euro). What is the most likely outcome - my guess is that we will see some inflation next year but more importantly negative interest rates will skyrocket so that most of the extra cash lying around on deposit will be recouped.   

There is already a similar precedent for this in the EU banking system, when deposits were confiscated in Cyprus in 2013 in what became known as a bail in. 

So as Mr Johns maintains, the ECB may well continue to play ball by printing infinite quantities of free money but the price will be an eradication of savings, either through inflation or negative interest rates or a combination of both. It will also mean that the EU will once again bend and mold its own laws laid down in it's treaties. This further erosion of the rule of law will sow yet more discontent within the union. 

Negative Interest Rates - How They Came About

Negative interest rates are well and truly with us here in Ireland with the news that Bank of Ireland are to begin imposing negative interest rates on pension funds that deposit cash with them. This means pension funds holding cash will be hit on the double (also inflation).

Here is a quick summary of how negative interest rates came about. Many articles that you will have read in the media about negative rates don't fully explain how we have got here, so this could be the first such article.

The ECB gave the game away here : 

Meanwhile, the first-order and tangible effect of Negative Interest Rates Policy on financial stability has been that it has enhanced it by improving the sustainability of outstanding debt.

There is nothing sustainable about the mountains of debt piled up, it is not possible to improve the sustainability of colossal amounts of debt except by eradicating it and preventing it from happening again by implementing high interest rates . Negative interest rates are actually doing the opposite - they help create new debt by making it so cheap. 

So, the main reason why negative interest rates are here is because spending is out of control in the EU and in Ireland and we are more reliant on debt than ever before.

The other main reason is because of Quantitative Easing (QE), or money printing. As you can see in the figure below, after QE, the commercial bank such as Bank of Ireland or AIB, holds more reserves with the central bank. The central bank has been charging negative interest rates for holding these reserves, so the commercial bank has no choice but to pass this on to consumers.   

 

So as economies in Europe become increasingly dependent on QE, the central bank will come under pressure to charge for holding these higher reserves, and the commercial banks will have no choice but to pass on these costs to consumers. 

This process of never ending debt and continuous QE is a feedback cycle, whereby more QE allows governments to borrow even more by offloading longer term bonds into the market. As you can see from the above, the pension fund sells their government bonds to the central bank to get the QE process going.

Negative interest rates are the direct consequence of this continuous cycle of QE and debt that has been the central policy of the ECB since 2014. Only recently are customers feeling the pinch from negative rates so we are in uncharted territory as to what will happen. But my prediction is that they are the harbinger of a very bad recession and widespread poverty. As it becomes clear that no real production is taking place and the high consumption levels are a mirage.

There is also a calamity coming when people retire, as savings are no longer being encouraged  and the alternative of investing in pensions are now being hit. The days of high interest rates are over but that also means prudence is over and that can only end one way.