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Unintended Consequences, Part 3: “How Do I Get Away From Negative Yields?”

The theory was pretty straightforward: push interest rates down far enough — in some cases to negative territory where borrowers actually turn a profit on their debts — and people will borrow money, spend it, and growth will ensue, with all that that implies for incumbent party election victories, banker year-end bonuses and other extremely important public policy goals.

But the theory’s designers apparently missed some crucial concepts — like the fact that people would be free to interpret their self-interest in ways that conflict with the needs of government and Wall Street.

Let’s start with the recent negative rate milestone:

Negative-Yielding Debt Tops $10 Trillion

(Wall Street Journal) – The amount of global sovereign debt with negative yields surpassed $10 trillion for the first time in May, according to Fitch Ratings.

The measure stood at $10.4 trillion on May 31, up 5% from $9.9 trillion on April 25, when the rating agency last measured the amount, according to a Thursday report. It is spread across 14 countries, with Japan by far the largest source of negative-yielding bonds. Of the total, $7.3 trillion was long-term debt and $3.1 trillion was short-term debt.

The amount of debt with yields below zero has increased sharply this year as global central banks have instituted unconventional policy measures, such as negative interest rates. The Bank of Japan in January surprised markets by driving its rates below zero, pushing Japanese government-bond yields sharply lower.

Banks in the euro currency bloc have also increased demand for government debt to meet regulatory requirements, another factor weighing on yields, Fitch said.

“Higher amounts of Japanese and Italian sovereign securities with sub-zero yields were the biggest contributors to the monthly changes,” said Fitch analysts, led by Robert Grossman.

Now — again in theory — lower interest rates are good for banks because it cuts their cost of capital and increases loan demand, making banks healthier and more valuable. But that’s not happening. Japan’s Topix bank index has fallen close to 30% this year, while the Euro Stoxx banks index is down by around 20%.

A big money manager weighed in on this paradox yesterday:

Negative interest rates ‘really starting to bite’ – Blackrock

(Reuters) – Rock-bottom interest rates, with some $10 trillion of sovereign bonds carrying negative yields, are fast becoming the biggest worry for investors, asset manager Blackrock said on Thursday.

“Interest rates are really starting to bite. Cash is now expensive,” said Stephen Cohen, global head of fixed income beta at the world’s largest asset manager, said at a briefing.

“Cross-border flows are being driven by ‘how do I get away from negative yields’,” he told reporters in London.

Banks are responding to the failure of their conceptual framework by trying to quit the game:

Negative Interest Rate Mutiny in Germany, Japan

(Financial Times) – Lenders in Europe and Japan are rebelling against their central banks’ negative interest rate policies, with one big German group going so far as to weigh storing excess deposits in vaults.

The move by Commerzbank to consider stashing cash in costly deposit boxes instead of keeping it with the European Central Bank came at the same time as Tokyo’s biggest financial group warned it was poised to quit the 22-member club of primary dealers for Japanese sovereign debt.

The ECB and the Bank of Japan have for months imposed negative rates for holding bank deposits in an attempt to push lenders to deploy their cash in the real economy through more aggressive lending to businesses. The policy in effect taxes banks for storing excess liquidity.

The central bank policies have hit bank profitability in both regions and German banks have been vocal in criticising Mario Draghi, ECB president, accusing him of punishing savers and undermining their business models. The policy cost German banks €248m last year, according to the Bundesbank.

Japanese banks have been more muted but Bank of Tokyo Mitsubishi UFJ has become the first leading lender to break ranks, confirming it is considering giving up its primary dealership status for sales of Japanese government bonds.

Not surprisingly, the growth that NIRP promised is also evaporating:

World Bank cuts global growth forecast on weak demand, commodity prices

(Reuters) – The World Bank slashed its 2016 global growth forecast on Wednesday to 2.4 percent from the 2.9 percent estimated in January due to stubbornly low commodity prices, sluggish demand in advanced economies, weak trade and diminishing capital flows.

Among major emerging market economies, the World Bank kept China’s growth forecast unchanged at 6.7 percent this year after 2015 growth of 6.9 percent. It expects China’s growth to slow further to 6.3 percent by 2018 as the world’s second-largest economy rebalances away from exports to a more consumer-driven growth model.

Let’s go through the above articles and play a game of “what’s wrong with this sentence?”:

“Higher amounts of Japanese and Italian sovereign securities with sub-zero yields were the biggest contributors to the monthly changes,” said Fitch analysts. This one’s easy: How can the world be paying Italy to borrow?? Rational investors should never, ever lend money to an entity that irresponsible and incoherent, and the idea of paying for the privilege will occupy entire chapters in future history books. The conclusion will be that today’s central banks are anything but rational.

“Cash is expensive.” Cash by definition costs nothing and yields either nothing or next to nothing. Never in living memory has it cost its owners anything (other than the secret tax of inflation). That it’s now “expensive” illustrates how much the world has changed.

The World Bank kept China’s growth forecast unchanged at 6.7 percent this year after 2015 growth of 6.9 percent. Borrowing a bunch of money and wasting it, as China has done (the big exception being its aggressive gold buying) is “growth” only in a snapshot-of-the-moment sense. In a broader time frame that includes both the spending and future cash flows from projects thus financed, China has simply impoverished the future in order to maintain a facade. Which I guess makes it a member in good standing of the modern financial system.

Anyhow, this is a story with several more chapters. And the next, very exciting one, will be the development of new policies to replace the current failures. These will — as befits the size of the problem — be breathtaking in both scope and wrong-headedness.

10 thoughts on "Unintended Consequences, Part 3: “How Do I Get Away From Negative Yields?”"

  1. Never before has it been more important for individuals to divorce themselves from exposure to the financial system. Non-discoverable assets are absolutely critical to survival.

  2. Yes, I too am looking forward to the new tranche of idiocy. However, what I really hope to see – ultimately – is even the insiders who think they know everything and are two steps ahead of it all get fleeced by circumstances they won’t foresee or can control.

    In the meantime – and as a possible example – I like the irony of banks/investors storing cash in vaults at the same time the financial authorities are trying to eliminate cash.

    1. Don’t believe the cash in vaults line. There is no cash, the wealth is all stored in electronic digits. It is just a musing taken too literally.

      1. Not so. That’s the whole point. Digital “cash” is what gets diminished by negative interest rates. Physical cash does not. NIRP is not the same thing as monetary debasement. Mathematically they are equivalent in terms of the reduction in purchasing power but the mechanism is different. Both methods are intended to do inspire consumption – to spend the money before it loses value – but that’s not what people are doing. By saving physical cash they are effectively gaining purchasing power relative to digital cash.

        1. There is not that much physical cash out there for major investors or banks to hoard. This may happening in Japan but it is Mom and Pops on a small scale. We don’t have NIRP here in the US yet. The only organizations here stashing real cash are the Mexican drug cartels and the criminal bankers who launder it for them.

          1. It’s an interesting and complex subject. You sound like those on the committees who on the one hand want to eliminate cash – using criminals as an excuse to do – but also realizing that there isn’t enough out there compared to the total money supply to be worth it. They’re real reason is to close the one and only relief valve for escaping NIRP. If people start hoarding cash it will cause more cash to be created (“printed”). Lots of small hoarders can add up to a lot. Also, remember that all that cash the Mexican drug cartels are making comes from their customers. Almost every person has and uses some cash for some things and there will be a lot of political backlash if they try to eliminate cash because everyone will be affected. Also, consider that 65% of US cash is overseas, and that presents a practical problem too for the capital controllers.

          2. No, I do not want to eliminate cash. I’m just stating the facts. The middle class is going broke. They have minimal cash on hand and are deep in credit card debt. I am concerned about keeping cash in the hands of bankers who pay me nothing to use it and have plans in place to steal it. But, keeping it under the mattress could be a fatal decision. Withdrawing sizable cash from the banking system triggers a report to the Feds that you may be a criminal when it is really the other way around. We are all being herded into the slaughterhouse pen.

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