Monday, April 20, 2009

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How to have negative Federal rates 101

Interest rates have always been a motivator to circulate money in the market, with fed rates bottoming out i always wonder would there be a chance of fed going negative percentage. What i mean is say fed loans you 1000 bucks and your return 970 a return that is negative 3%. Why would anyone is such a sane mind would do that? any kindergartner would answer as!!.. instead people would hoard it !!!..however this would not solve the problem we got in the first place by lending money to unqualified borrowers who foreclosed resulting in a spanner thrown in credit circulation.

I was reading a article in new york times by author Proff Gregory Mankiw one of his student suggested the following LINK

Unless, that is, we figure out a way to make holding money less attractive.

At one of my recent Harvard seminars, a graduate student proposed a clever scheme to do exactly that. (I will let the student remain anonymous. In case he ever wants to pursue a career as a central banker, having his name associated with this idea probably won’t help.)

Imagine that the Fed were to announce that, a year from today, it would pick a digit from zero to 9 out of a hat. All currency with a serial number ending in that digit would no longer be legal tender. Suddenly, the expected return to holding currency would become negative 10 percent.

That move would free the Fed to cut interest rates below zero. People would be delighted to lend money at negative 3 percent, since losing 3 percent is better than losing 10.

Of course, some people might decide that at those rates, they would rather spend the money — for example, by buying a new car. But because expanding aggregate demand is precisely the goal of the interest rate cut, such an incentive isn’t a flaw — it’s a benefit

Although this is a very clever scenario has never been happened before and chances are almost what Taleb would call as Black swan that it might happen :D. A seemingly Ridiculous thought which might make lending more money than hoarding feasible, hands down to the thinker.Interestingly China recently published that it has about 1.29tr $ hard cash will be driven to insanity if such a event occurs and might lend US back in negative interest terms , who knows actually this has tickle my brains to build castles in air. I don't know what other tricks the proff Mankiw's students have in their hat .... like currency expiration date, private circulation of money (deteroit dollar).In these days of electronic exchange of currency how do i know that currency given to me as salary has the number selected by fed to abolish...less than 5% of currency is circulated or stored in physical form.
There is continuing article in economist on this LINK on how to scare the hell out of china...
Rationally thinking china is doing a great national service for survival of United States, by buying and fed treasury bill, supplying high quality goods at reasonable price, and thus allowing the sinking dollar to cling straw. Scaring china out of 10% of its foreign exchange holding would be the day US would be out of existence.

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