Set them free.

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'Neglected Prophet' of Economics Got It Right

Leonid Bershidsky is a Bloomberg View columnist. He was the founding editor of the Russian business daily Vedomosti and founded the opinion website Slon.ru.
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In some parts of Europe, negative interest rates are creating absurd situations. In France, some corporate bonds pay interest to the issuer because they were linked to a benchmark rate that has dropped below zero. In Sweden, Denmark and Switzerland, banks are turning depositors away with threats of negative interest rates. If this goes on much longer, we'll be living in the world of "free money" imagined by the economic dreamer and adventurer Silvio Gesell in the 19th century.

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Gesell was  born in Germany, made a modest fortune as an importer in Argentina. After he returned to Europe, he became finance minister of the short-lived Soviet Bavarian Republic in 1919, was arrested and charged with treason but acquitted. He kept publishing his works in Berlin until his death in 1930. John Maynard Keynes called Gesell "a strange, unduly neglected prophet" and described his bold idea as follows:

According to this proposal currency notes (though it would clearly need to apply as well to some forms at least of bank-money) would only retain their value by being stamped each month, like an insurance card, with stamps purchased at a post office. The cost of the stamps could, of course, be fixed at any appropriate figure. According to my theory it should be roughly equal to the excess of the money-rate of interest (apart from the stamps) over the marginal efficiency of capital corresponding to a rate of new investment compatible with full employment. The actual charge suggested by Gesell was 1 per mil. per week, equivalent to 5.2 per cent per annum. This would be too high in existing conditions, but the correct figure, which would have to be changed from time to time, could only be reached by trial and error.

This amounts to a tax meant to prevent money-hoarding. Cash would still be used as a medium of exchange, but it would lose its significance as a store of value. In a way, that's what central banks are trying to achieve when they keep lowering interest rates, sometimes breaching what is called the "zero bound." They want money to get out and work rather than languish in bank accounts, with the idea that spending will increase demand and thus inflation rather than deflation.

The Gesell tax has a side effect that is particularly relevant today: Those who still try to use "melting" money would be open to buying negative-interest bonds, as long as the interest they have to pay the issuer is lower than the stamp tax. That, apparently, is already beginning to happen in France. In a Bloomberg article, Alexandre Akhavi, chairman of the French Association of Corporate Treasurers’ legal committee, said some institutional investors are still buying bonds with negative coupons because they offer security. That means these investors can't find a secure way to park their money that would offer even zero interest.

Even though the economist Irving Fisher once extolled Gesell to President Franklin Roosevelt, his ideas drifted into obscurity in the ensuing decades, as the economy picked up and interest rates rose. Six years ago, the Gesell tax was such a forgotten concept that Greg Mankiw, chairman of the economics department at Harvard and the author of one of the most popular macroeconomics textbooks, failed to recognize it when a "clever grad student" came up with a variant as a way to make negative interest rates viable. The grad student's idea solved the messy problem of stamping all the cash in circulation:

Imagine that the Fed were to announce that, one year from today, it would pick a digit from 0 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 2 percent. Losing 2 percent is better than losing 10. Of course, some people might decide that at those rates, they would rather spend the money by, for example, buying new car. But since expanding aggregate demand is precisely the goal of the interest rate cut, that incentive is not a bug but a feature!

Now, European economies -- and not just the smaller ones such as Denmark but also France -- are beginning to reproduce the Gesell tax situation -- but only for the biggest hoarders. The system that carries cash to the economy's lower levels -- small businesses and workers -- is so broken that institutional investors would rather pay interest on their investments than do what the monetary authorities want -- namely, push money out into the retail economy. In Sweden, the central bank has just pushed down its main interest rate to minus 0.35 percent from minus 0.25 percent because it said a strengthening krona was "a risk to the upturn in inflation."

We should hope that negative rates get inflation to a point that is acceptable to central banks or else governments will start thinking in earnest about a Gesell tax for everyone. If they do, we'll soon be looking for store-of-value alternatives: jewelry, real estate and whatever else can be hoarded for a rainy day -- a flaw Keynes pointed out in the Gesell model. Most people aren't ready for a communist, non-accumulative society. 

The widespread negative interest rates, however, are already a Gesellian experiment, a move into uncharted territory that may lead us to rethink the function of money. 

This column does not necessarily reflect the opinion of Bloomberg View's editorial board or Bloomberg LP, its owners and investors.

To contact the author on this story:
Leonid Bershidsky at lbershidsky@bloomberg.net

To contact the editor on this story:
Max Berley at mberley@bloomberg.net