Stephen Miller, investment strategist for multi-affiliate manager GSFM, has taken an interesting line in a note to clients on why the Reserve Bank of Australia should not, and probably won’t, follow some other countries into negative interest rate territory. The possibility of funds managers and other financial institutions “hoarding” physical cash is a potential unintended consequence.

The notion of “hoarding” is the eventual restraint to central bank rate cuts into negative territory, as happened in Europe. “When the ECB took rates negative, cash holdings went up,” Miller said. “There will be costs to do with storage, but you can hold a lot of cash and gold. There will come a point when this is a better bet… The desire for gold has been pretty consistent across history. Gold went through $1,800 overnight (July 9) and looks like staying there.”

But potential hoarding is not the main reason Miller is against negative interest rates. He believes they can lead to people saving more and spending less – particularly by people close to retirement who have a target savings figure in mind, which is the opposite to what they are intended to do for an economy.

Miller’s note to investors says: “While acknowledging the severe damage to the economy from the COVID-19 crisis and the now elevated potential risks of ‘second wave’ COVID-19 infections, the Governor and RBA Board continue to eschew the canvassing of potential ‘innovative’ measures in monetary policy – such as the contemplation of a negative rates policy. Instead, the governor and board have persisted with ‘forward guidance’ stating that ‘the board will not increase the cash rate target until progress is being made towards full employment and it is confident that inflation will be sustainably within the 2–3 per cent target band’, meaning that interest rates and bond yields will remain at historic lows for a an extended period, perhaps years.

“The statement also said the board was satisfied with the ‘…substantial, coordinated and unprecedented easing of fiscal and monetary policy in Australia’ and importantly added that it ‘is likely that fiscal and monetary support will be required for some time’. Were further monetary stimulus required, it seems the first line of defence would be a scaling up of QE measures, perhaps combined with further recourse to the Term Funding Facility.”

Miller said the RBA would be casting a keen eye toward the Government’s planned announcement on July 23 regarding any successor measures to the current JobKeeper and JobSeeker measures. It would not be a surprise if the RBA was privately urging the Government to maintain the current level of support – albeit with design changes to address some perverse incentive effects – or, at a minimum, to phase out the measures only gradually.

Why the preference for a fiscal response?

“The fundamental cause of the GFC was excessive private non-financial leverage, yet every remedial monetary policy measure since the GFC has done nothing to quell that leverage. The onset of COVID-19  has seen a raft of monetary measures also designed to encourage leverage in the non-financial private sector but it is the build-up in non-financial private leverage that is the clearest area of potential financial imbalance. In this context, there are obvious limitations to what monetary policy can achieve and potentially large medium-term complications,” Miller’s note says.

“One is always cautious of the never-say-never principle in the current environment, but I don’t think that the RBA are even close to contemplating a move to negative rates and, nor do I think they should. I suspect the RBA would be rightly sceptical of the utility of a move to negative policy rates even in circumstances more dire than we currently confront.” Other considerations in this regard, according to Miller, include:

• The RBA is in all likelihood not operationally ready for negative rates
• The BoJ and ECB experience with negative policy rates has been indifferent at best and unsuccessful at worst
• Any move to negative rates would need to preclude large-scale hoarding of cash by financial firms, pension funds, and insurance companies
• It does not address questions that currently attach to the breakdown in traditional “transmission mechanisms” attaching to central bank policy rates. That is, lower policy rates seem to inflate financial asset prices without any significant increase in spending
• Negative policy rates might enhance an “income effect” with workers, particularly those close to retirement, saving more in order to hit targeted retirement “nest eggs” – in other words, it may have the effect of reducing spending rather than increasing it.

– G.B.