This article first appeared at The McAlvany Intelligence Advisor on Monday, May 4, 2015:
There's a corollary to the insanity rule. It's called the Keynesian Corollary: When something doesn't work, do more of it. When history is written about the coming Second Great Recession, historians will likely note July 2012 as the turning point. That was when Mario Draghi, head of the European Central Bank (ECB) said during a panel discussion that the ECB “is ready to do whatever it takes to preserve the euro. And believe me, it will be enough.”
Other historians might list that as one of the top ten “famous last words” ever issued by a human being. Since that moment bond yields across the world have dropped, and dropped, and dropped. On Thursday Jeremy Warner, the London Daily Telegraph's assistant editor, announced that nearly one-third of all government debt in the eurozone is paying a negative return. That works out to be more than $2 trillion. And, it appears that investors seeking safety havens are glad they're aren't being charged more for the privilege.
The Federal Reserve Bank of St. Louis enlisted the help of two Keynesian worthies to try to explain away the phenomenon. After 1500 words of persiflage and obfuscation, the reader is finally enlightened with this: “In unusual times, negative nominal and real yields are not unusual.”
They likely continued to receive their regular salary after this profound utterance was published on the St. Louis Fed's website.
In the real world, far, far away from St. Louis, investors are trying to find places to hide their money to wait out the coming storm. Fifty percent of French bonds are trading at negative yields, while 70 percent of Germany's are yielding negative returns. Almost 20 percent of Spain's bonds are negative, just a few years after that country suffered a near-death experience with insolvency.
This is counterintuitive, which explains why Keynesians have no explanation for it. In theory, the cheaper money is, the more will be demanded. If an investor can borrow at one percent and earn five percent, why wouldn't he?
He would, if he could find a place to earn five percent. But most places don't pay five percent and those that do have enormous downside risks. It's the old question: what's more important: the return on your money, or the return of your money?
Warner explained the policy, and the fallacy:
The whole purpose of QE – quantitative easing (i.e., printing money to buy government bonds) – [is] to depress the yield on government bonds to the point where investors are forced to seek higher risk alternatives.
But what if there aren't any – or any that didn't have such high risks as to take them out of consideration? With the stock market motoring higher every day despite lack of earnings to support it, and with the bond market so overbought that it now yields less than 3 percent, investors have seen through the Draghi sham and fraud, and are looking for safety of principal and hang the return. Wrote Warner:
The flip side of the cheap money story is soaring asset prices. The bond market bubble is just the half of it: since other assets are priced relative to bonds, just about everything else has been going up as well.
Eventually, there will be a massive correction, in which creditors will suffer sickening losses.
For further evidence that the economy has stalled (using Hillary's word), if more be needed, note that major U.S. retailers are closing more than 6,000 stores. These include Abercrombie & Fitch (180), Barnes and Noble (223), Chico's, Dollar Tree/Family Dollar (340), Office Depot/Office Max (400), Pier One (100), Radio Shack (1,784), Sears (77), and Staples (55). It's no wonder investors are seeking safety, and are willing to pay for it.
Mark Hendrickson, an economics professor and a blogger at Forbes, had trouble explaining the concept to his students: “Who in their right mind would invest in a financial instrument that would guarantee a loss of principal?” At first blush, it makes no sense:
We have the spectacle of widespread acceptance of a nominally negative return on [a] paper-denominated currency that the relevant central bank is actively trying to depreciate.
What this spectacle portends is the destruction of the capitalist system. People now perceive that the safest place to put money is in bonds issued by a government whose central bank is determined to boost its economy through beggar-thy-neighbor policies of reducing the value of its currency to make its products more attractive abroad. When that happens, it reflects, as Hendrickson put it, “a weird and alarming symptom of profound economic dysfunction.”
interest rates, in normal times, are the market's signals to investors upon which they base their investment decisions. Without those signals, or worse, without signals that mean anything, the economy will shift into neutral. “Today,” wrote Hendrickson, “those vitally important market signals are mangled, broken, shattered.”
Whether intended or not, the consequence of trying to restart the economy by pushing interest rates down has now taken on a life of its own. Investors are hoarding their cash, and the economy as a result is slowing, not growing. As the economy slows, tax receipts will drop, deficits will increase, and more money will need to be printed by central banks to pay their governments' bills. The day of reckoning draws ever closer: the day of the Great Default.
The Daily Telegraph: Negative interest rates put world on course for biggest mass default in history
Bloomberg: Less Than Zero When Interest Rates Go Negative
St. Louis Fed: How Low Can You Go? Negative Interest Rates and Investors' Flight to Safety
New York Times: Europe Gets Negative Interest Rates. What Does That Even Mean?
Forbes: Negative Interest Rates: A Brilliant Concept!
The Economic Collapse blog: Major U.S. Retailers Are Closing More Than 6,000 Stores
30-year US Government bond price chart