How negative interest rates are undermining the economy
As Larry Fink of BlackRock put it in a shareholder letter in April: “Not nearly enough attention has been paid to the toll these low rates – and now negative rates – are taking on the ability of investors to save and plan for the future.”
However, the big players have been hit. And it’s instructive to see how they’re reacting. At an institutional level, banks across Europe are trying to work out what is the least expensive way to bury their cash in a big hole.
As my colleague Merryn Somerset Webb pointed out this week on her blog, Commerzbank is looking at how practical it would be to rent vaults and store its own cash rather than be charged 0.4% a year to store it with the European Central Bank. Munich Re has been doing the same.
This is the “zero-bound” problem. The point of turning interest rates negative is to force banks (and anyone else with cash) to lend it or spend it. But this only works if you can forcibly tax the cash. The easy way to avoid negative rates is simply to stick the cash under the mattress.
And of course, this is why central banks are so keen to ban cash – if all money is digital, then you can’t avoid the negative interest rate tax.
Negative interest rates imply that money has no value. You literally can’t give it away. You have to pay someone to take it off your hands. Want to lend money to the German government for a few years, because you deem it a safe bet? It’ll cost you. Want to lend to the Italian government for a couple of years (I don’t know why you might, but let’s say you do)? It’ll cost you.
This rather undermines the whole concept of saving. As Fink points out, it makes the whole process of building up a pot of capital for future use far more fraught than it should be.
The actions of central banks, he says, “are severely punishing the world’s savers and creating incentives to reach for yield, pushing investors into less liquid asset classes and increased levels of risk.”
Bonds are clearly in a bubble – but when will it burst?
The bond bubble continues to swell
The thing is, if past bubbles are any guide, even as this reflation is happening, and the outlook is getting more and more grim for the sustainability of the bond bubble,
investors will be dismissing signs of a turn and sticking to their guns.
So even when inflation starts to return, don’t expect mainstream market commentary to recognize it.
You now have to pay money to lend to the German government over seven years. Lending to Japan will cost you money right out to ten years. And – stunning as it may seem – the Italian government is now able to charge anyone who lends to it for up to three years.
Like most bubbles, this is obviously nuts.
It didn’t make fundamental sense for a tiny stretch of central Tokyo to be worth more than the whole of California in the late 1980s. It didn’t make sense for companies that consisted of nothing more than a business plan and a rudimentary website to be worth billions in the late 1990s. And today, it doesn’t make sense that hugely indebted, economically fragile governments can literally charge people to lend them money.
Does the ongoing strong performance of bonds mean we’re missing something, or that there’s no bubble here? Nope. It just highlights yet again, that bubbles last for an awful lot longer than they should (which makes sense – if market prices corrected reliably when the underlying assets moved out of line with the fundamentals, then bubbles would never form).
As John Plender points out in the FT, past recoveries from similar crises offer a sobering lesson for bond investors. After the 1890s Latin American debt crisis, US bonds lost 1% a year from 1900 to 1910, in real (after-inflation) terms.
Doesn’t sound too painful? Think again. From peak to trough, from 1900 to 1920, US bond investors lost half their money. The data, says Plender, is worse for the post-Great Depression period. And they’re worse again if you use UK rather than US bonds.
The thing is, if past bubbles are any guide, even as this reflation is happening, and the outlook is getting more and more grim for the sustainability of the bond bubble, investors will be dismissing signs of a turn and sticking to their guns.
So even when inflation starts to return, don’t expect mainstream market commentary to recognize it.
Remember – pretty much since the Alan Greenspan era, it’s paid off to bet on the Fed’s ongoing desire to keep money as cheap as is humanly possible. Yellen will take every excuse she gets to keep rates as low as she can until inflation figures force her to do otherwise. Stick with those weak dollar trades.
DYI Comments: Over the next few years the higher probability event is a world wide recession causing a deflationary smash. This scenario, if it happens would drop U.S. rates negative for maturities of 5 years of less. Of course central bankers will react with digital money printing in overdrive seeding the future for inflation.
The U.S. and many other first world governments have their demographic time bomb. Worldwide Boomer's will be retiring in huge numbers taping their countries version of Social Security and Medicare. Governments will increase taxes on these programs, alter and/or reduce benefits, whatever remaining costs their central bank along with the Federal Reserve will digitally print.
The 2020's will be known as the roaring 20's marked by high taxes, high inflation with increasing interest rates, AND A LABOR SHORTAGE! Boomer's will exit the work force(but still consuming) in statistically significant numbers beginning in 2023 producing spot labor shortages and in the later 2020's an outright labor shortage causing wage push inflation. Add on the Fed's digital printing to pay the remaining costs of our social programs inflation will be back and with a vengeance. High inflation most likely peaking in the high teens. The Fed's will be caught between the rock and a hard place in their desire to quell inflation to satiate Generation X and the Millennial's and at the same time appease the large high percentage voter block Boomers. Boomers will win out. However as they pass in statistically significant numbers beginning in the 2030's inflation will recede along with the labor shortage and our social programs will be in better balance.
Today long term bonds and the U.S. stock market are in bubble as illustrated by my sentiment indicators.
The 2020's will be known as the roaring 20's marked by high taxes, high inflation with increasing interest rates, AND A LABOR SHORTAGE! Boomer's will exit the work force(but still consuming) in statistically significant numbers beginning in 2023 producing spot labor shortages and in the later 2020's an outright labor shortage causing wage push inflation. Add on the Fed's digital printing to pay the remaining costs of our social programs inflation will be back and with a vengeance. High inflation most likely peaking in the high teens. The Fed's will be caught between the rock and a hard place in their desire to quell inflation to satiate Generation X and the Millennial's and at the same time appease the large high percentage voter block Boomers. Boomers will win out. However as they pass in statistically significant numbers beginning in the 2030's inflation will recede along with the labor shortage and our social programs will be in better balance.
Today long term bonds and the U.S. stock market are in bubble as illustrated by my sentiment indicators.
Market Sentiment
CapitulationGold and the precious metals mining companies are currently the best bargain setting up for future profits as time moves closer to the 2020's.
DYI's model portfolio reflects this reality.
Updated Monthly
AGGRESSIVE PORTFOLIO - ACTIVE ALLOCATION - 6/1/16
PAST PERFORMANCE IS NO GUARANTEE OF FUTURE RESULTS.
The Great Wait Continues
DYI
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