On Friday, the big financial news was the Bank of Japan (BOJ) announcing an interest rate cut into negative territory.  The news sent stocks soaring higher, including in the United States.

The announcement also drove down the Japanese yen and drove up the U.S. dollar.  The gold price was also up slightly.  It would have been up much more if it hadn’t been for the big gain in the U.S. dollar.

It is easy to read the headlines and say that Japan now has negative interest rates.  One might wonder if people will be lending money in order to receive less back in the future.  But let’s dig into this and find out the specifics.

The BOJ specifically cut the interest rate on excess reserves.  The rate will now be -0.1%.  In other words, it is just barely below zero.

This negative interest rate only applies to excess reserves.  For required reserves, the banks will not be charged anything.  Here is an article explaining the details.

So what does this mean?

It means that any money held by banks beyond their required reserves will get charged a fee.  It is a small fee, but the BOJ could always decide to make it bigger.

The purpose of this is to get the banks to lend out their excess reserves.  At some point, it becomes costly for banks to hold these excess reserves and it makes more sense to lend out the money, even if they are risky loans.

At some price, you can get people to borrow, at least on the margin.  If the banks start giving out loans at zero percent interest, I’m sure  a lot of people would be happy to borrow money at no cost.  If the rate were to go further negative, it is not inconceivable that banks could lend out money at a zero percent interest.  If the administrative fees are low and the risks are not deemed high, then it would be less costly than to hold the money as excess reserves.

This is interesting because some speculate that it will mean global currency wars.  Will other major central banks follow?  Actually, Japan is following the lead of other central banks in introducing a negative interest rate.  Different variations of negative interest rates have already been attempted by the ECB, Switzerland, and Sweden.

The BOJ’s announcement is going in the opposite direction from the Federal Reserve.  The Fed announced a hike to the federal funds rate back in December.  The only way it could achieve this hike was by hiking the rate it pays on bank reserves.  So while Japanese banks will get charged a 0.1% fee for excess reserves, U.S. banks are collecting 0.5% on their reserves.

This move by the BOJ is a rather desperate one.  It is supposed to be an attempt to get banks to lend, which means fractional reserve lending.  This policy is inflationary.  On the margin, it will be inflationary, but we don’t know if it will be significant.

In our Keynesian-dominated world, the central bankers think we need positive price inflation.  They can’t stand the idea of price deflation.  So they create money out of thin air, but it doesn’t always drive prices higher, as we have seen in Japan.

One of the main reasons is that the demand for money is high, which is partly because of the weak economy itself.  When people try to hold money for security, it slows down velocity and has an equivalent effect of reducing the money supply.  Money is changing hands less frequently.  The BOJ is trying to increase velocity by this move, and it is trying to increase the money supply through fractional reserve lending.

The Japanese economy is already a mess due to massive spending, massive debt, and years of money creation and interest rate tampering.  Resources have been misallocated everywhere, although not as bad as China.  The Japanese government debt is outrageous, making Greece look fiscally conservative by comparison.  But for some reason – national pride or something – the Japanese people keep buying government debt at low rates.

I don’t know if it will be this year or ten years from now, but eventually this whole thing is going to blow up.  Interest rates will spike and the debt will quickly become unmanageable.  It isn’t going to end well.

The problems are similar in the U.S., but I think to a lesser degree.  At least for right now, the Fed is not pumping in more money.

There is going to be a global recession.  The only thing is, when central banks make these moves, sometimes it enables them to kick the can down the road.  It ultimately makes the situation worse, but it can delay the inevitable.

The BOJ is in desperation mode.  Let’s see if the Fed turns to the same desperation at some point, if the economy gets bad enough.  In the U.S., there is a large pile of excess reserves in the banks.  If they come pouring out via bank loans, then we could see massive price inflation very quickly.  At this point though, there is no sign of that happening.