Out of the Box: Wandering in Wonderland
“Thus grew the tale of Wonderland: Thus slowly, one by one, Its quaint events were hammered out…”
Well, we are in a land of “quaint events,” alright. Something that was once thought impossible, has actually happened, and it is causing havoc, and confusion, in the markets. What’s worse, it is not going to get better anytime soon, but only worsen, as various nations instruct their central banks to create even more money, out of nothing but imagination. Then they will use it to buy up their debt, and drive interest rates ever lower, and lower still, into yields below Zero.
Bloomberg reported, on Friday, that the amount of negatively yielding debt had surpassed the $17 trillion mark. We were just at $15 trillion last week, then $16 trillion on Wednesday, and we seem to be on the Indianapolis 500 Speedway, as we race further and further into territory once thought unimaginable, by most sane people. I tell you, when the lender pays the borrower, for the privilege of handing him money, then you know we are in a strange new world, that I label “Wonderland.”
Alice: “Where Should I go?
Cheshire Cat: “That depends, where do you want to end up?”
Most people don’t understand what is really happening here, and they lay the blame on the central banks, who are not really the culprits, if you think the issue through to its conclusion. First, you must bear in mind, in America, that the Fed is part of the government of the United States and that Congress gave it certain rights, and one of them is “Independence.” This, however, is absolutely NOT the case for the other major central banks of the world, as they have no “Independence” at all. They are, in fact, one hundred percent controlled, and directed, by the governments that created them. They are a front, if you will, because they do exactly as told, by the nations to whom they report.
Consequently, when you read in the Press that the Swiss National Bank is doing this, and the ECB is doing that, then you must get it squarely in your mind that whatever they are doing is at the request, and behest, of the nations they represent. Therefore, Mr. Draghi’s famous “Whatever it Takes” speech was handcrafted in Berlin and Brussels, or, at a minimum, approved by Berlin and Brussels, long before it ever made it into the public domain. It doesn’t matter if you liked the plan or disliked it. What really matters is that you understand that it came from national governments, and that is was put in place for their benefit.
The “WHY” of it is easy enough to understand, if you comprehend their dilemma. For thousands of years nations paid for their budgets, and social programs, by raising taxes, or selling off assets, or borrowing money, and paying interest on it. Therefore, they were constrained, in what they could afford, by the limitations of their revenues. This is no longer the case.
Governments have found the financial “Fountain of Youth,” where “Pixie Dust Money” appears in the vaults of the central banks, created from a wink and a blink and a nod. Then it is spent to force interest rates into the “Subzero Refrigerator” so that their “cost of borrowing” becomes a “profit to borrow.” If you don’t think that is some kind of Wonderland, then you are sorely mistaken.
“Perhaps it doesn’t understand English.”
I am constantly asked, by institutional investors, “How does this all end?” My answer is succinct, “It doesn’t for years and years and maybe for decades and decades.” The reason is, once you have begun this process, that there is virtually no way out of the rabbit hole. The nations of Europe, as an example, cannot afford, either their budgets, or their social programs, and so they learned a lesson from the financial crisis of 2008/2009 and have utilized their “Money for Nothing” to live beyond their means.
The ratings agencies, I point out, are doing us no favors as they don’t take the ministrations at the central banks into account, when rating a country’s debt, or projecting their debt to GDP ratios. I am hopeful that this will change, at some point, but then I recall the ratings on Collateralized Debt Obligations (CDO’s), prior to the Great Recession, and the gross mistake that was made there.
Fortunately, unfortunately, the Fed is going to be forced to respond to these new circumstances. There is just no way around it and the ostrich’s strategy, of hiding your head in the sand, is just not going to work. To remain competitive, and to lower the value of the Dollar, against other currencies, the Fed, as the central bank of the United States, and NOT the world, is going to have to lower our rates, start buying Treasury Bills, to correct the Yield Curve, and implement other plans to strengthen our economy.
Americans tend to be quite myopic. What the Europeans are doing here, as they are trying to help themselves, is a decided negative, collateral damage, if you will, for the United States. It may not be the main purpose, but the European Union is putting us under siege. Then we have a contracting German economy, our “Game of Thrones” war with China, where the “tariff tussles” are just one part of it, and an upcoming ECB meeting, where I think that Berlin and Brussels will begin a new “shock and awe” campaign.
In any event, over time, American yields will go down, in my estimation. When you are the only major country with positive yields then everyone else is going to be buying our bonds until the “positive” gets damn close to “negative.” Hopefully, however, the Fed will respond, before the Europeans gain the advantage. They certainly should!
So, as our wandering in Wonderland continues along, we all have to readjust our sights, out of necessity. There is nothing else to do about it, with Negative Yields massively expanding. Nothing at all.
“But when the Rabbit actually took a watch out of its waistcoat-pocket, and looked at it, and then hurried on, Alice started to her feet, for it flashed across her mind that she had never before seen a rabbit with either a waistcoat-pocket, or a watch.”
Mark J. Grant
Chief Global Strategist, Fixed Income
B. Riley FBR Inc.
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