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.
