New York (CNN Business)The Federal Reserve is running out of runway to lower interest rates. President Donald Trump wants the Fed to keep cutting anyway.
Trump on Wednesday urged the “boneheads” in charge of the Fed to import the controversial negative interest rate policies from foreign central banks. “The Federal Reserve should get our interest rates down to ZERO, or less,” the president tweeted.Desperate to boost growth, central bankers in Europe and Japan in recent years dropped interest rates into negative territory for the first time in modern history.
Negative interest rates are about as un-American as you can possibly be."
Jerome Powell, Trump’s handpicked Fed chief, has already cut interest rates to a range of 2% to 2.25%. Although many on Wall Street believe the Fed will need to keep lowering rates to avert a recession, perhaps even near zero, negative rates would be an extreme step.Read MoreThere is a growing chorus warning that the Bank of Japan and European Central Bank’s subzero regimes have backfired. Critics and some new academic research argue these unorthodox policies are crushing banks, keeping a lid on inflation and failing to juice growth. Worse, they harm savers and retirees hoping to earn safe returns in bonds.”Negative interest rates have failed in Europe and Japan,” Richard Fisher, former president of the Dallas Federal Reserve Bank, told CNN Business in an email. “They are anathema for savers and our community and regional banks that bank the average American.”How negative rates could backfireTrump’s suggestion of negative rates flies in the face of the economic optimism expressed by the White House. If the economy is so strong, why would the Fed need to resort to policies it didn’t even pursue during the Great Recession? The Fed dropped rates to near-zero in 2008 after the implosion of Lehman Brothers, but never ventured into subzero territory.How negative interest rates helped turn Deutsche Bank into a disasterDanielle DiMartino Booth, a vocal critic of modern central bank policy, cautions that negative rates would bring the debt-reliant US economy “to its knees.” “Negative interest rates are about as un-American as you can possibly be,” said DiMartino Booth, CEO and chief strategist for Quill Intelligence. “We are a nation that, for better or worse, needs credit creation to grease the wheels of the economy. Without that, growth would truly come to a standstill.”Of course, no one can say for certain exactly how negative rates in the United States would play out. And the Fed has not suggested it will need to resort to such tactics anytime soon.Financing $1 trillion deficitsTrump himself was recently against the idea of negative rates. He told reporters on August 30 that he did not want to see negative rates in the United States. But now Trump is voicing support for zero or negative rates as a way to “refinance” America’s mountain of debt, which has only grown larger due to tax cuts and a spending surge under the current administration.”INTEREST COST COULD BE BROUGHT WAY DOWN,” Trump tweeted. It is true that Washington is paying more to borrow than other nations, such as Germany and Japan, where rates are negative.The federal government’s net interest costs are expected to grow by 14% this year to $372 billion, according to the nonpartisan Congressional Budget Office.The CBO recently raised its estimate of the projected federal budget deficit to $1 trillion for the 2020 fiscal year.Exhibit A: Deutsche BankThe problem with negative rates is they act as an outright tax on banks. And banks are the vehicles by which central bank policy is transmitted to the real economy.Normally, banks earn interest when they park excess reserves at central banks. But under negative rates, the opposite happens. Central banks charge lenders interest for sitting on that cash. The aim is to encourage lending — but in practice it has squeezed lending profitability, which is also known as net interest income.The European Central Bank’s negative interest rate policies have amplified the disaster at Deutsche Bank (DB), Germany’s largest bank. Deutsche Bank’s stock has lost about three-quarters of its value since the ECB introduced negative rates in 2014. The Euro Stoxx Banks Index, a basket of eurozone lenders, is also down sharply over that timeframe.Mohamed El-Erian, chief economic adviser at Allianz, argued in a recent Bloomberg column that negative rate policy “eats away at the integrity of a well-functioning market-based economy” by constraining bank credit, encouraging risk taking by non-banks, discouraging financial protection products and “causing misallocation of resources.”Nonetheless, the ECB is seriously considering dropping rates further into negative territory.Deutsche Bank CEO Christian Sewing warned earlier this month that another rate cut by the ECB “will have serious side effects.”Supporters of negative rates argue that the environment would be tougher if central bankers hadn’t introduced these extreme policies.Christine Lagarde, the incoming ECB president, recently said the eurozone would be “worse off” without negative rates.Unintended consequencesHowever, it’s impossible to prove a counterfactual. And new academic research details the unintended consequences of negative rates. Bank margins and profitability fared worse in countries that adopted negative rates, according to a research paper published last month in the Journal of Banking and Finance and the Journal of Financial Services Research. That in turn has weakened banks’ ability to lend.”Our study shows negative interest rate policy has backfired,” Ru Xie, an associate professor of finance at the University of Bath in the United Kingdom, said in a statement last month. The paper found that the “adverse impact” of negative rates has been stronger for smaller banks. Trump has previously promised to boost America’s community banks by speeding up the economy and cutting regulation.Wall Street's favorite recession signal suggests the economy is in troubleEven research from the Federal Reserve has found negative rates have failed to boost inflation.Research published last month by the San Francisco Fed found that market expectations for inflation “fell immediately” after the Bank of Japan announced negative rates in 2016.”The reaction stresses the uncertainty surrounding the effectiveness of negative policy rates as expansionary tools when inflation expectations are anchored at low levels,” the Fed paper said.Bringing negative rates to the United States would harm savers and those hoping to earn safe returns in fixed income. Instead of earning very little interest, they would get penalized.”The 10,000 baby boomers turning 65 everyday who want to retire would certainly be disgusted with that,” Peter Boockvar, chief investment officer at Bleakly Advisory Group, wrote in a note to clients on Wednesday. All of this suggests the Fed would face a backlash if it tried to move rates below zero. The banking industry, retirees and even mainstream economists would cry foul. And they would point to the failed experiments in Europe and Japan.