Out of the Box: Negative Yielding Debt — The End of the “Old Paradigm”
“It is a capital mistake to theorize in advance of the facts. Insensibly one begins to twist facts to suit theories, instead of theories to suit facts.”
I believe I have finally figured out why so many people, and institutional money managers, are arriving at wrong conclusions, these days, about interest rates, risk assets, and some kind of possible recession. What is happening is that they are using the “Old Paradigm,” to reach their conclusions. I don’t blame them.
This “Old Paradigm” has existed for thousands of years, where the borrower paid the lender for giving them money. This was true at the banks, and in the securities markets. Yes, you can point at a couple of isolated instances, with negative yields, after the Great Depression, but they were insignificant. Nowhere, in recorded history, has there been a significant amount of “Negatively Yielding Debt” and, as of today, according to Deutsche Bank, it stands at $15.1 trillion.
So let me explain what happened. The “Old Paradigm” went out of existence shortly after the financial debacle of 2008/2009. The world’s central banks entered the markets, to save the financial system and, in doing so, they realized that they could make money from nothing and then turn around and use the money to buy sovereign bonds, corporate bonds, equities, and even ETF’s, if it suited them. A lesson was learned and the “New Paradigm” began.
Also, and pay attention here, for thousands of years the national governments were also in the “Old Paradigm.” Their budgets were based on taxes and other forms of money raising, such as selling off property or other assets. The national budgets could only afford so much, and their social programs could only be so big, depending upon the amount of money that was available.
This is no longer the case.
“How often have I said that when you have excluded the impossible whatever remains, however improbable, must be the truth.”
The nations of Switzerland, Japan and the European Union have learned that they can have their central banks, which have no “Independence” from their national governments, make money from nothing, and then support the various governments, and their bond and equity markets, through debt and equity purchases. No new taxes need to be raised. No assets need to be sold-off. Moreover, and here is the ruse, their GDP is not affected and their debt to GDP ratios are not affected because it is all done behind the closed doors of their central banks.
This also has another positive affect, for them, which are national yields that are either slightly more than nothing, nothing, or less than nothing and hence, the $15.1 trillion of negatively yielding debt. The governments are financing themselves through their central banks, which is the “New Paradigm,” and one that won’t likely be going away anytime soon. Why I say that many governments in Europe are insolvent is because they cannot afford, as a country, their current budgets or their current social programs. They can afford them, with the help of the ECB, and their “Pixie Dust Money,” but that is the “ONLY” way they can be afforded.
“Pay no attention to that man behind the curtain.”
-The Wizard of Oz
So, the financial chicanery in Switzerland, Japan and the European Union, then leads us to the United States. It is having a marked effect on us and make “NO” mistake about that. These nations are running the game and we are suffering as a result as the Fed, our central bank, is not responding properly to the antics of the other central banks. Our Dollar is too strong. Our interest rates are too high and the whole scenario is a “Boon for Borrowers” and an “Incursion for Investors.” Moreover, the investors in the foreign countries are running over here, with their money, to buy equities and bonds, as it is the last safe place, with any kind of yield.
The truth of it is that the Fed has to lower interest rates, to keep America competitive in the global marketplace. There is really no other choice. Then it gets even more interesting. The Fed does have choices about its investments.
The Fed should start buying Treasury Bills, it does not buy them currently, and then the “Yield Curve” would normalize and stop all of the ridiculous talk about some type of recession. The Fed could use their balance sheet to not only buy Treasuries, but taxable infrastructure Municipal bonds to help the country. They could also expand their balance sheet and give even more of their profits to the government, which would help to reduce the national deficit.
Let me be very clear. The “Old Paradigm” is dead and buried and won’t be coming back. The “New Paradigm,” where the central banks are involved in supporting national budgets, is here to stay. Money managers, and ratings agencies, need to therefore include the size and scope of the central banks’ assets, and investments, as part of their consideration, about any given country. No central bank is a stand-alone institution. We are off on a new road and your recognition of this is vital, to your success.
“Come, Watson, come! The game is afoot.”
Mark J. Grant
Chief Global Strategist, Fixed Income
B. Riley FBR Inc.
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