Out of the Box: The Governments Said to Investors
“The more there is of mine, the less there is of yours.”
-Lewis Carroll, Wonderland
That is what they are saying, you know. Oh, they don’t say this in public, and they extol the virtues of monetary policy, and financial conservatism, but that is what they are saying, none the less. After thousands of years the governments of the world have finally figured out how to pay for their follies without taxing citizens, or corporations, and this is by making money from nothing, at their central banks. Someone just addles up to their keyboard, presses a few keys, that they learned to press on “Fortnite,” and money is created that can be used to pay for all the goods and services that anyone likes.
The governments, of course, all point at their central banks and claim that it is their doing. “Nonsense,” I say, “All stuff and nonsense.” With the exception of the Fed, none of the other central banks have any kind of “Independence,” and even with the Fed, these people do represent the interests of the United States. It says so clearly in the Federal Reserve Act of Congress of 1913, that created the Fed.
So, here we sit with $13.7 trillion in negative yielding bonds and that number grows daily as 25% now, of all corporate bonds outstanding, have negative yields. I say this is “Wonderland.” Some say this is “Nightmare” but it is clearly a boon for borrowers, of any sort, and clearly a tragedy for investors. This is why I prefer the “Wonderland” title because, as you weed through the financial markets, there is so much “Wonder” that you pause and muse about how we are all going to “Land” on our feet when we hit $25 trillion or $50 trillion in bonds paying less than Zero.
Currently all of these “Less than Nothing” bonds are over there. “Over There” includes Switzerland and Germany and France and the Netherlands and most of the countries in the European Union and then Japan, who led the way into the glorious position, where the lender pays the borrower for the privilege of handing him, or her, the money. For thousands of years, as you all know, we were denied this privilege and now we can be thankful that we finally found it.
Of course, that corporations, or individuals, could borrow money for nothing, and even less than nothing, was just an afterthought, and an appendage to the governments’ actions. What you must understand is that these European governments, and the Japanese government, are all virtually insolvent. This means that they can’t afford the cost of their government, their budgets, their social service programs, without raising taxes and that if they did this then they would all be tossed from power and so they don’t do it, and, instead, raid the central banks’ cookie jar.
“Now, here, you see, it takes all the running you can do, to keep in the same place.”
I have been asked, a zillion times, how this all ends. The predisposition on Wall Street, you see, is that everything must come to an end. Well, maybe not. Interest paid, by borrowers, to lenders, didn’t come to an end for thousands of years. No one sat around and asked when it would end. As a matter of fact, no one ever thought it would end. If I would have postulated negative interest rates 15 or 20 years ago everyone would have thought that I had already entered “Wonderland” and was totally bonkers. Yet, here we are, and I don’t expect this to end for years, if not decades, or maybe even not then.
Then, many on Wall Street believe that, “it can’t happen here.” I point out that this is not 1903 and that the markets are global. We invest “over there” and they invest “over here” and money flows from the giant spigots and splats around all over the world. This is why I think negative interest rates are coming to America. It is a financial opioid for governments and our government is no exception, as free Medicare, free housing and debt forgiveness for all is tossed about like manna from Heaven.
“Tax the rich” is going to morph into “Have the Fed pay for it,” as the new, and much better, policy. The poor are happy, the middle class is happy, the wealthy are happy and who knew that the Fed would be the “lender of first resort.” We are living in “Wonderland,” I am telling you!
“The rabbit-hole went straight on like a tunnel for some way, and then dipped suddenly down, so suddenly that Alice had not a moment to think about stopping herself before she found herself falling down a very deep well.”
Financial markets are pricing in 100% odds of a quarter-point Fed rate cut and about 25% odds of a half-point cut today. Wall Street also expects the Fed to bring its balance-sheet tightening, that began in October 2017, to an immediate end. Earlier this year, the Fed decided to halt the run-off of its Treasury and mortgage security holdings by the end of September. We are almost there.
I also think the Fed will cut the interest rate on excess reserves (IOER) held at the Fed by commercial banks relative to regulators’ requirements. The effective federal funds rate has climbed to 2.40%, which is towards the top of the 2.25%-2.50% policy range. That means the Fed’s key rate, linked to market interest rates on credit cards and auto loans, has gotten slightly tighter. To reverse that tightening, I would not be surprised to see a 30-40 basis point cut in the IOER rate vs. a 25-35 basis point cut in the policy range.
So there you have it. We live and dwell in a “Wonderland” where make-believe money is really made, and then people believe in it, and it can be spent freely by the governments that created it.
“When I used to read fairy tales, I fancied that kind of thing never happened, and now here I am in the middle of one!”
Mark J. Grant
Chief Global Strategist, Fixed Income
B. Riley FBR Inc.
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