One of the less notable events over the weekend was the publication of the European Commission’s Country Reports. The report will form the basis for Country-Specific Recommendations (CSRs) which will be published in May. Here is the Country Report on Ireland for the few who may be interested – Ireland: Country Report 2016
The Eurozone, Japan, Switzerland and some Scandinavian countries now have negative official interest rates, so they charge commercial banks for holding excess funds at the central bank. The idea is to incentivise them to lend more money instead into the real economy. This has not really been happening: business firms are too nervous to borrow and do not feel the need for extra productive capacity. The European Central Bank is considering whether its charge on bank credit balances should be increased to power up the incentive, that is, whether the negative rate should be even more negative. There are numerous snags attaching to this latest venture into unorthodox policy.
The first is that commercial banks, whose balance sheets remain fragile, find it very hard to make money when interest rates get this low. Healthy bank profits are hardly a priority for most people but loss-making banks are not a very attractive prospect either. The other problem is that negative official interest rates mean that monetary policy is already reaching its limits. Economists have long written about the ‘zero lower bound’ for interest rates: nobody will hold deposits at a cost and will resort instead to cash. Interest rates on demandable deposits are already zero in Ireland (or 0.01% to be more accurate) and some Swiss banks are now levying a charge. If you deposit €1000 they will pay you back only €999, or €995, a year from now. This is not an attractive deal and people will prefer to keep their money in banknotes.
The trouble is that most bank deposits by value are in amounts much larger than €1000. Many business corporations, nonbank financial companies and pension funds keep deposits in the multiple millions. They cannot stuff the filing cabinets with physical banknotes. But they are not captive customers of the commercial banks either. If they can find somebody trustworthy to hold banknotes on their behalf it might be a better deal even if there is a storage cost. It appears that storage costs could be cheaper than the negative interest rates now threatened, particularly given the availability of large denomination notes such as the $100 bill or, even more attractive, the €500 note in the Eurozone. You could fit a million easily into a briefcase in the form of €500 notes. The ECB’s negative rate is currently 0.3% and it may penalise depositors even further at its next monetary policy meeting on March 10th next. Wholesale interest rates on large deposits will inevitably follow the ECB rate. There have been calculations that storing millions in the form of €500 notes would cost less than the likely wholesale penalty if the ECB goes even more negative.
So somebody needs to come up with a cunning wheeze to escape this latest policy cul-de-sac and there are active proposals to, you guessed it, abolish the €500 note. It would not be acceptable to explain that this was necessary because of another policy misadventure, so the spin coming out of both Brussels and Frankfurt is that the €500 note is mainly used by criminals, and since nobody likes criminals, it has got to go. The coincidence of this discovery with the dilemma over negative interest rates is just that, a coincidence.
The logic is impeccable at first glance. Criminals use €500 notes, ban them and this will inconvenience the criminals. Like it did with machine guns. Ban them and, oops, the only ones with machine guns are criminals. Various international law enforcement agencies, including Interpol and Europol, have confirmed that the €500 note is popular with money launderers and drug dealers and there is no reason to doubt them. But there are many billions in €500 notes out there already and the ECB can hardly cancel them. They will continue to circulate in the shadows. There are lots of non-criminal users of large notes, not just horse dealers and bookmakers in Ireland but also wholesale traders in countries outside the Eurozone with dodgy currencies and unreliable money transmission systems. As much as half of all €500 notes is believed to circulate outside the Eurozone, especially in the Balkans, Turkey and Russia. Its predecessor was the German 1000 Deutschmark note which circulated widely in these places and the ECB version was consciously introduced so as to facilitate existing users.
As for the mafia, there have been prosecutions of numerous banks for facilitating their illicit transfers and it is hard to believe that the withdrawal of the largest ECB note will inspire their professional retirement. Readers will recall the spin justifying depositor haircuts in Cyprus including the assertion that the money belonged to the mafia, Russian chapter. They survived.
The proposal to scrap the €500 note is further evidence of the absence of a serious Eurozone macroeconomic policy.
The US Treasury were obviously unimpressed with the response to Asst. Treasury Secretary Robert Stack’s recent visit to Brussels with Competition Commissioner Margrethe Vestager responding that “it is the same argument as we have heard before”.
The US clearly feels it is an argument worth making and now Treasury Secretary Jacob Lew has written a letter to Commission President Jean-Claude Juncker. It is largely a repetition of the arguments heard before but there are some interesting elements.
On the State Aid case against Ireland in relation to Apple, Lew is pretty clear:
I notice that there is no election thread, which makes sense given that we were probably all fed up with the campaign before it even began. And I’ve nothing original to say on the subject either. But there probably should be an election thread, and if there is to be one, someone has to kick it off by saying something. So, in that spirit: do we all agree that (a) the Irish economy is now recovering, and doesn’t need further stimulus right now; (b) that the Irish economy has proved itself over previous decades to be unusually volatile; (c) that the international outlook right now suggests that there are risks on the horizon; (d) that the Eurozone is a very dangerous place to be anyway, if you are a small country; (e) that broad tax bases are preferable to narrow tax bases; and (f) that given all of the above, arguing for the abolition of the USC or water charges (water charges, as opposed to Irish Water) is grossly irresponsible, and should suffice to disqualify a party from being taken seriously as a “safe pair of hands”?
Via Warwick’s Prof. Michael McMahon, the Bank of England’s Underground blog features a nice comparison of Ireland in the 1970s and Greece in 2015. Check it out here.