Europe Cuts Rates to Below Zero, Good or Bad?

Image by © Dreamstime

by Mark Skousen

The European Central Bank, under Italian banker Mario Draghi, cut its bank deposit rate below zero in an effort to “avert the dangerous threat of deflation” and to spur the “sluggish” euro-zone economy.

European monetary policy gradually has shifted toward more and more inflation. It started off with a hard-core resistance to inflation under a Dutch president of the European central bank, then made way for a Frenchman, and now an Italian has taken over.

The idea is to encourage bankers to start making loans instead of depositing their funds with the central bank. In the United States, the Federal Reserve actually pays interest on bank deposits. Not surprisingly, U.S. banks are not lending to small business like they used to.

Stocks in Europe and around the globe (especially emerging markets) rallied on the news, and we’re profiting with new positions in India and Greece.

Is deflation really a “bugbear?” According to the standard view, “Deflation cuts into business profits, raises real debt burdens and discourages consumer purchases, hampering investments and jobs. The strong euro has not helped because it has damped inflation by lowering import prices, while also making Europe’s exports more expensive in foreign markets.”

Yet there have been times of robust growth in the midst of deflation — look at the United States in the 1890s, the 1920s and the 1950s. Deflation does not necessarily hurt business profits if costs are falling, too.

My fear is that the never-ending low-interest rate strategy by the Federal Reserve and the European Central Bank will create an artificial boom and more asset bubbles that will end badly. Only time will tell.

Top investment managers and advisers will debate in full the implications of these permanent low-interest rates at this year’s FreedomFest. Join Peter Schiff, Alex Green, Adrian Day, Joel Stern, and yours truly in our “All Star Prediction Panel” July 10: www.freedomfest.com.

Source: Finance Townhall