When you loan money you risk it. Unless you are under the FDIC insurance limit, the bank is allowed to lose your money by lending it out wrong. FDIC insurance is actually a progressive redistribution program because people with more money pay into the system without receiving proportional protection.
"The standard deposit insurance coverage limit is $250,000 per depositor, per FDIC-insured bank, per ownership category. Deposits held in different ownership categories are separately insured, up to at least $250,000, even if held at the same bank."
Not weird at all. You lend your money to the bank, the bank operates with them and you get paid for that.
Can you give me your money so that I invest with them and I will give you less what you gave me in 10 years? Thanks!
I think philosophically this has merit (see Riba[0]). Economically, I feel like it makes perfect sense to get paid for providing a service (i.e. loaning money).
Makes more sense if you think about it as being paid to forgo consumption. Your being paid not for having money, but for not using it right away and letting someone else use it instead.
Of course, if no one else has anything better to do with it, the value of this "service" drops to zero, as seems to be happening now.
Well not simply for having money, but for not spending it immediately. By saving you sacrifice immediate benefits for future ones, and you get money for it because you lend your money to people who are willing to pay to spend it now.
This is the essence of all investing, including entrepreneurship.
Our system prints money for complex and highly debatable reasons, so what a bank pays in interest to its depositors is rarely ever enough to offset all the inflation they create.
It's not "getting paid" so much as loss mitigation.
The modern racket of fiat money and lending at interest (which all of the Abrahamic faiths prohibit or restrict) is an assault on the plebes.
I don't think they are paid for having money. When saving money in a bank, you don't have the money. The bank has it, and you are being paid for letting them have your money.
Why is that weird? Having money allows you to loan the money to people that don't have it, and they're gonna pay you for the privileged. Or, in another words, money you get today is worth more than money you get tomorrow. Both of these are very intuitive concepts.
> Originally, usury meant the charging of interest of any kind and, in some Christian societies and even today in many Islamic societies, charging any interest at all was considered usury. Some of the earliest known condemnations of usury come from the Vedic texts of India. Similar condemnations are found in religious texts from Buddhism, Judaism, Christianity, and Islam
>Banks see their margins squeezed. They’re earning next to nothing from lending but still need to offer depositors a rate above zero to keep their business.
I disagree. If every bank offers negative interest then savers will have no choice: and if that's what the market says has to happen, it will happen. Negative interest has happened before in history.
Possible but highly unlikely; they could literally keep money in a sack under their bed and get better returns. Not much difference between a sack under the bed and a bank account if you don't tell anyone about the sack.
I'm guessing it probably either speculators buying bonds assuming that they can be onsold to a central bank, or people who are forced to buy for whatever reason (eg, maybe some savings schemes are forced to put x% into government bonds). I've bought bonds exactly once on the assumption that I could on-sell them for a profit when government lowered interest rates. People like me don't have any impact on the market, but if the incentives make sense at the small level maybe it works out the same on the large.
> Not much difference between a sack under the bed and a bank account if you don't tell anyone about the sack.
They could hardly be any more different. If one person beyond yourself knows about it, then you're in trouble. One fire or disaster and it's all gone. If it's a smaller sum, you're FDIC insured against loss in a bank account, which again makes the point about just how different the scenarios are. If I feel like it I can safely protect $1 million via four distinct accounts under the FDIC at no cost. The Fed will go back to zero rates at some point to stimulate the US economy. Even when that happens, I'm essentially paying a small insurance fee (inflation vs zero rates) per year to guarantee the safety of the $1 million. That is ultimately far safer than managing it under my mattress. And cheaper, if I need any guaranteed security for the mattress. It's also easier to move at low concern (whether that's to shift it into an investment account or move it to another bank). If it's under your mattress, every move is a high risk for exposure; every person you let deep into your life creates some risk of theft (eg non-malicious gossip).
Most (all?) of the Federal Reserve banks have a money museum attached to them, and they will generally have a few stacks of money in various denominations that total $1,000,000.
1 million $1 bills is really large. The $20 bills would fit in a suitcase. The $100 bills fit into a briefcase, which will have a clear plastic cover over it so you can take pictures of yourself holding a million dollars in a briefcase.
FYI: They also give away bags of shredded cash, which you can then use as baller confetti at your kids' birthday parties.
Depends on the currency. If you can get hold of €500 notes, you can fit quite a lot of money in a small space:
> Tests by the Serious Organised Crime Agency found it was possible to carry €25,000 in €500 notes in a cigarette packet, €300,000 in a cereal box – £1 million in banknotes weighed 50kg while its equivalent in €500 notes only 2kg.
Kill the Messenger (1) has a bit about this where the CIA was funding the Contras by pushing cocaine through the US. One of Oscar Blandon's minions describes hotel rooms full of cash and they had to have people circulate the money from the top to the bottom to prevent mold.
> Not much difference between a sack under the bed and a bank account if you don't tell anyone about the sack.
Burglary isn't the only danger. Paper money can be eaten by moths, so you probably want to vacuum seal it. That still won't keep out rats. You could lose it all in a flood, landslide, tornado, fire, or earthquake.
The individual probabilities of all these events are quite low but multiplied with your all your liquid cash, the cost is unacceptably high for most people.
You're also likely to be charged for taking your money out in paper form and depositing it back later. Not much, especially if you're going to keep it under your matress for a long period, but everying adds up.
This assumes that cash or bank money has the same counyerparty risk as a government bond. That is not the case. Negative interest rates essentially signal that everybody is short on the future overall.
> But, the market seems to be saying that there are too few good investment opportunities. Maybe consumption should be higher?
The market has very little say in the matter when the central banks force interest rates to near (or equal to) zero -- somewhat ironically to increase consumption by de-incentivising saving.
Central banks control the supply of some very safe investments and usually that determines the price. But, someone still needs to own government debt and that depends on demand.
There are plenty of other choices for investors, like the stock market or real estate. So, you could either spend the money or choose a riskier investment.
Do you blame a certain class of investor for being extremely risk-averse?
Imagine if you're managing people's retirement money. How would you invest it? People's nest eggs.
To put it into computer-nerd context; remember the saying, "nobody ever got fired for buying IBM".
Isn't this the same kind of thinking?
By the way, what do you think about the idea some are proposing that crypto-currencies are more solid than a gold standard?
Instead of transitioning from this central bank backed fiat currency malarkey (which in theory ought to work just fine but doesn't because of greed, collusion, corruption, hubris – i.e., human weakness) back to the gold standard, some say we should move to crypto-currrency standards. I'm not at all versed enough in the tech and theory to know if this is a good idea or not.
I'm not blaming anyone for wanting very safe, secure investments. What I'm saying is that, if people want safety, maybe the government should provide it?
Cryptocurrency is high risk, with both dramatic changes in price and insecure exchanges, so I'm not sure why you bring that up in this context?
With negative interest rates, it truly will make financial sense to put all of your money under the mattress, so to speak.
In reality, keeping liquid cash will no longer make any sense whatsoever, and further push all other assets up in value, property and equities for example.
Supply and demand, and fear. Imagine a customer who needs safety more than a return. They are willing to put down $1 now in exchange for a GUARANTEE they will get 0.99 in 10 years.
When sums of money are sufficiently large (millions or billions of USD), it sometimes makes sense to secure a very small loss (0.5% per year) than to park it in an account or fund or etc which could have a positive or negative yield (maybe you win maybe you lose).
Also, to the original commenter, I will never put all my cash under the mattress. One break in and it's all gone.
I currently have all my cash parked in a 1% interest checking account with strong protections and fringe perks.
I am content with taking an extremely small loss on inflation while I wait for the market to eventually tank. It's been longer than I expected (2 years already), but I do not ever shed a tear over the what, $16,000 in pretax capital gains I theoretically could have made?
I have spoken with several people recently who tried to time the market by selling their equities, then lost out on these recent all-time-highs.
I don’t know what the answers are and no one does. In my opinion there has been a global phenomena of easy money in various ways for a decade, and it has filtered out in all sorts ways, from the premium in equities, the absurd rise in housing prices, the art market, basically anything that can eat excess cash has been eating it. A crash and hangover is coming but it will primarily affect richer people though it will bleed out to the non-monied classes via job losses and retirement accounts falling in value.
But when this will happen? It could be next year or in 50 years! The governments of the world have so many options to keep the party going.
Yes I agree with you, it's been a very interesting decade where we went from "the sky is falling" to "let the good times roll"!
However at least for me, my current earning potential in my job is not that high, and my cost of living therefore has been what I've sought to optimize instead of capital gains.
For people who have lots of taxable income, lots of asset exposure, and a high cost of living, then a mixed bag of investments is definitely crucial to preventing those people from going bankrupt.
But for me, as long as I find ways to continue to live healthy, have a good network of friends, a job, money in my main bank accounts in case I need to put up a security deposit or take an extended vacation, then I am very happy. I therefore would never want to keep $40,000 or something in a market account when I really do need all of that money at any time.
while your point about negative interest rates is valid, note that your conservative investment strategy is misguided (as you've already noted in foregone gains). there is no way to time the entire market, going up or down, without vast and extreme insider information.
so the safe strategy is to make sure you have an appropriately balanced portfolio (among cashlike securities, equities, bonds, etc.) and to leave your equity investment in place while riding out the downturn.
If you are riding out the downturn there's little need for diversification. Sure don't keep your portfolio in a single stock but the S&P500 is sufficient diversification. You don't need cash likes or bonds. Equities have the highest rates of return and that's what you should be having.
it really depends on your risk appetite. the conservative investor will want downside protection against rare market collapses that last for decades (e.g., 1929).
investors typically get more conservative as they get older, so your advice might be ok for most 25 year olds, but not for most 65 year olds. the conventional wisdom then is to hold increasing proportions of weakly/negatively correlated securities like bonds in your portfolio as you get older, particularly through downturns.
and the s&p500 is a reasonable basket of equities, but it's not perfectly representative of the asset class either, since it's composed of primarily large cap domestic stocks. it doesn't include any startup equities, for instance.
It might help to think of it as going beyond zero interest rates to the point of intentionally punishing traditional savings to try to force consumer spending (if you hold onto it, we'll devalue it), entice borrowing (we'll essentially pay you to buy a house [1]), etc. There are various approaches to pushing rates below zero. Japan and the ECB have done a lot of experimenting, the US will probably take some notes from them when it comes time to push US rates below zero persistently.
Some institutions are bound (legally and/or contractually) to hold (a certain percentage of) their assets in government bonds. So they don't really have a choice. Also, their performance isn't measured in absolute percentage terms, but only as relative to the benchmark - so if the benchmark goes just as negative as the fund, they didn't actually "underperform".
Keep in mind Modern Portfolio Theory, in which we measure the total return of a portfolio, not just the individual components.
A huge number of retirement plans and endowments and pension programs will still hold negative yielding bonds, because they need to diversify their assets.
In theory those safe government bonds will shoot up in price just as equities crash. Because these assets aren’t correlated, your long term return will actually be higher. So, yes, that is probably worth paying a bit of money for.
Is that really true when the yield is negative though? Wont investors just, like, go into checking accounts or safe deposit boxes when they need to flee to safety?
For large institutional investors, government-backed securities can be safer than bank accounts, given that they need to invest sums that are much larger than deposit insurance (e.g. FDIC) limits.
Holding cash almost always has a pretty bad negative rate, i.e inflation. Real rates of bonds might be negative, but they should always be bigger than inflation.
The idea is that for cash, the nominal rate is zero, so the real rate is (-inflation). Whereas for negative-real-rate bonds, the real rate is (r - inflation). Since r < inflation this is negative, but since r > 0, the magnitude is still below inflation.
The parent comment was maybe being slightly imprecise, but his core point isn't wrong that positive nominal rates means that your losses are less than inflation (whereas for cash they're equal to inflation).
But that misses the point that one can have negative (nominal) yields which give you very negative (real) yields. So it's not true that "they should always be bigger than inflation."
What's the notional value of all negative nominal yield bonds? Surely it can't be that much? Though, if you expect rates to go ever lower, I guess you could argue that a negative nominal yield bond could be a good investment.
Right, it requires nominal r > 0. I think the parent comment point was that violating that condition is rare, but as you point out below, apparently it isn't.
Interest rates are always positive. You are referring to yields which are part interest rate and part trading issues. Yields can and do go negtaive from time to time from the trading issues around the products. The interest rate (as shown on the coupon payment on the bond) will always be positive.
edit: let me add, I mean the consumer space. There can be some oddity in the bank-to-bank market because of various technical reasons, but it is extremely rare.
There are mortgages in Europe which are indexed to Euribors, which have been negative for a while, and you have been able to end up having a mortgage where index + margin is below zero. Obviously banks argue that actually mathematics is wrong and negative numbers do not exist, so customer needs to pay more than what was originally agreed, and I am not sure if that issue has been sorted out in courts.
What comes to interbank markets, it is far from rare and far from only technicalities, it is nowadays pretty normal that the floating leg of the swap pays negative interest rate. (In Euro, that is, USD has higher rates)
Euribor rates are just short end bank-to-bank reference pts. The interbank markets are mostly technically driven on the short end. Central bank policies (eg reserve requirements) play the largest role.
And can you show me euribor-based long-term loan where the interest rate is negative? For the most part, banks have no need to loan unless compelled, so maybe where is some policy forcing them to? I would call those extremely strange technical factors.
> And can you show me euribor-based longe-term loan where the interest rate is negative?
My old mortgage would have become technically negative a couple of years ago, but I was forced to prepay it due to selling my apartment before the rates went that far down. As I said, my understanding is that my bank would have refused to honor our contract, though, and insist there is a zero floor in my mortgage even if nothing like that was agreed when I took the loan, so in that sense you are right.
> The interest rate (as shown on the coupon payment on the bond) will always be positive.
Negative coupons would be quite difficult to implement but having a positive coupon doesn't really mean anything: bonds are not necessarily sold at the nominal price even when they are initially issued.
"Henkel and Sanofi sell first negative yielding euro corporate bonds"
Already it seems like cash has an expiration date. I keep trying to explain to my kids how different cash was in the '80s versus now. How much less a dollar buys and what that means to them.
We're fucked unless we get after the massive debt pile and do some kind of cleanup in our system. It will launch into hyperinflation if we don't.
Bank accounts are only FDIC insured (or equivalent) up to some limit. If you have hundreds of millions and would otherwise stuff that in a bank account buying bonds are a safe alternative
to get around that limit.
Vaults cost money. Insurance costs money. And it's still not quite as safe. The ability to hold the money yourself acts as a soft cap on how negative rates can be, but that cap is not at 0%.
Because holding cash costs money, you need to have a big place to stash it and keep it secure. Some banks are trying to do that though, but it is not easy to do in scale of billions.
Banks hold their excess reserves at the Federal Reserve[0] and receive interest on top, currently 2.35%. Scales up to at least a couple trillion give or take a few hundred billion.
European banks hold their excess reserves (or at least their required minimum reserves) at the European Central Bank or their country's central bank; all of which are currently charging interest for the privilege.
Cash holdings still have risk for large amounts of capital. For example, if you had 1,000,000 in cash at a bank, it's only guaranteed up to 250,000. The other 750,000 is as risky as the institution. Compare this to a US treasury, which is substantially safer than any individual institution.
Banks can and do fail, particularly during crisis... and during a crisis safe bonds (e.g. US Treasuries) will gain in value.
I think there are a lot of people (like myself) that think it's only a matter of time before another major crisis... and are waiting to buy stocks at a steep discount.
If you mean holding in a bank. Some European banks are already charging negative rates for large deposits. They have to, because ECB is charging them. You see, all money is either physical or credit or excess reserves deposited at ECB. There is no electronic money outside of ECB system.
If you mean physical, it's also costly. Vaults, protection etc. And to make this option harder, they cancelled the 500 Euro. If people starts piling up 200s, they will cancel that too.
I think they are coming to the wrong conclusions. They lost the plot at 7, so 8 is based on bad data.
If the Time Value of Money has disappeared, then I suggest it is the money that is not worth the time. We have many historical case studies that show what happens on a broader time scale when a society's money is debauched.
Time is the one true scarcity we all face. I am working at using it wisely... What have I got to lose? :)
Wouldn't that depend on which part of the cycle we are in? I repeatedly read that prognosticators are expecting both deflation and rapid inflation, but they are arguing over the order.
And I am referring to large time cycles, the ones that play out over societal reformation periods, so I would not expect the bond market to reflect that scale of timing.
Who are the prognosticators? I've not read and not sure you accurately can predict medium/long term inflation rates.
And what part of what cycle? I assumed when you said debauched, you meant quantitive easing and general money printing. If you, say, double the money supply there isn't going to be double the things to buy, so the cost of what there is will rise to compensate (inflation), or so the theory goes. That seems distinct from any kind of economic cycle, although obviously if you start printing money when theres deflationary pressures then that could act to stabilise the currency, but that doesn't sound like debauching the currency, and doesn't necessarily mean you need to keep printing the money when the inflationary pressure returns.
Sorry, I am multi-tasking, and that poorly. I will look up some of the references, the names that seem to be coming to mind (looking over my RSS feeds) are Kuppy from Adventures in Capitalism, Chris Martensen from Peak Prosperity, Simon Black of Sovereign Man, Charles Hugh Smith of Of Two Minds, I think less-doom-prone authors on fee.org and mises.org. It is highly likely a biased list, I seem to have been gravitating towards the overall message of decay/decline, helped along by the citations of urban areas not doing too well in various places throughout the US. I live very rural along the northern coast of California, so more selection-bias there, as well.
Yes on my debauchery reference, QE, TARP, increasing debt (temporary removal of the debt ceiling - oh boy), increasing obligations incurring more debt (social programs, retirements and benefits), the general idea of borrowing from our future to live for today that seems to be the current m.o. And now apparently little in the way of an anchor for US currency (or other central bank nations, for that matter) since removal from the Gold standard, and recently the demise of Bretton Woods as other nations seek ways around being forced to use US currency.
> If the Time Value of Money has disappeared, then I suggest it is the money that is not worth the time.
What a baffling statement. "If my money can't spontaneously create new money, then why should I try to earn any?" If anything, lowered time-value increases the importance of trading time for cash. And value being too stable is the opposite of being debauched.
Money is a tool we use to facilitate trade. Price assignation has been distorted by "corrective action." Traditionally, bonds would be purchased as a hedge/guarantee of future value, and not to be charged a loss of that value instead.
Anecdotally, I am slowly raising my service prices as my costs rise. To me, this is evidence that my dollar (I'm in the US) is not going as far as it used to. And yet costs in a healthy financial system should normally be driven down, by typical Austrian Economic thinking.
As I posted elsewhere, my observations are for a different time scale than bonds are usually measured against. Sorry for the confusion. :)
I have been spending too much time thinking macro...
"Anecdotally, I am slowly raising my service prices as my costs rise. To me, this is evidence that my dollar (I'm in the US) is not going as far as it used to. And yet costs in a healthy financial system should normally be driven down, by typical Austrian Economic thinking"
I don't think that's correct. You're referring to competition and efficiencies, not inflation.
"The Austrian school believes any increase in the money supply not supported by an increase in the production of goods and services leads to an increase in prices"
Inflation was nearly that high, so while the nominal rate was high, in real terms it was more in line with historical returns. Mortgage rates were often in double digits too.
But during that time inflation was in the double digits, and peaked at 14.8%. There was a real risk that inflation would go to 20%, which would wipe you out.
The 1973 oil crisis (and paying for the Vietnam War, etc) had kicked off a cycle of inflation that didn't really end until after the early 1980's when Paul Volcker (Federal Reserve Chairman) shrunk the money supply and raised interest rates. The prime rate hit 21% in 1982.
Dad was getting phone calls just begging him to refinance his 3.5% mortgage to current rates. "We have a low-low 18.5%!" Nope.
Variable rate mortgages still are a thing. And it's not like there's anything really wrong with them. You are getting a better rate (compared to the newly issued fixed rates), but also getting some rate exposure over the duration of your mortgage. This exposure could help you, or hurt you, but I would hardly call it a bad thing.
The problem is that most people don't understand these things and are stupid, and decide to buy a house and sign all the paperwork without reading it.
> This exposure could help you, or hurt you, but I would hardly call it a bad thing.
The problem is the amount it can help you and the amount it can hurt you are disproportionate; if the rates fall enough to significantly help you, you could likely have a similar reduction by refinancing a fixed rate mortgage. But, if rates go up, you can't refinance to get a better rate, and you may have trouble selling as you may have planned, because higher interest rates put downward pressure on prices.
For me, it seemed like the risk was not worth the reward; especially given I was borrowing in 2009, and rates had significantly more room to go up than to go down. In the 1980s 20+% interest rate climate, I may have chosen differently.
Can you really just refinance a fixed rate mortgage that's now priced at an above-market interest rate? Surely the bank has you on the hook to pay that higher interest rate for the remainder of your loan term, they're not going to accept an early termination without some kind of penalty. After all, they've presumably backed your loan with some kind of equally long-term security.
If your original lender were to refuse you could refinance with a different one. Your lender knows this and therefore will let you refinance to keep your business (I'm actually doing this now).
You do have to pay loan original fees again though which can be 1-2% of the balance of the loan so you have to compute when it actually pays off for you and whether it's worth it.
You might have to pay a fee to close out the loan early, but mostly the fees are reasonable. If your loan was originated after 2014, prepayment penalties are very limited [1]
My lender had a program where you paid a nominal amount (originally $500, but later $1000) and they'll adjust your rate to their then current rate. If you do a full refi, my understanding is that's going to cost in the neighborhood of $3000, although many lenders will roll that into the loan, or otherwise hide it.
So since it seems like under this system, the lender carries most of the downside risk on interest rate movements while the borrower gets the upside, the lenders must be covering this with a greater spread between their cost of borrowing and the fixed interest rates they charge?
Usually yes; the rate for fixed mortgages tend to be higher than adjustable. Looking at rates today, I'm seeing about 3.75% for a 30-year fixed; 3.125% for 15-year fixed, and 4.25% for a 5/1 ARM; but it's more typical in my experience for an ARM to come in near or below the 15-year fixed rates.
That still feels sleazy and racketish. I can understand doing that when you take on a new customer, but charging you thousands of dollars just to change the exact same loan to one with a different rate? [1]
Reminds me of the time I bought a package at a pawn shop, but didn't want one of the items in it. They said that to get a discount, I'd have to buy the whole thing as is then pawn back the unwanted item. So far, so good, but then I had to give my ID and attest that I didn't steal that one item ... even though they knew it never came from me to begin with!
[1] The way you said it, thousands sound like the typical case and $500 is a special deal.
If you do a full re-fi; the new lender is going to run your credit, do an appraisal of your home, record the new loan on the title, do a title search, purchase title insurance, pay the broker's commission, etc; that all costs money, and that's where the thousands come from.
Just adjusting the rate in their systems certainly doesn't cost the lender nearly $500 or $1000, but it was still a win-win. They got some money to offset the lower rate, and got to keep servicing the loan, and I got to pay less interest, it's been a while, but I seem to recall my break even was about 3 years each time. I would certainly consider the availability and price of rate modification when considering lenders in the future.
> After all, they've presumably backed your loan with some kind of equally long-term security.
See, this is what banks are explicitly NOT in the business of doing. They are in the business of borrowing short and lending long, with a rate spread to make money in the process.
I have had a number of mortgages in the last 10 years in the US (refinanced multiple times), and none of them had any prepayment penalties. I suspect if I looked for one that does I might find it and it might have a slightly lower rate. Maybe. That depends on whether the bank planned to keep it on the books or sell it on; it's easier to sell on standardized mortgages into an MBS than weird ones with bespoke terms.
They are in the business of borrowing short and lending long, with a rate spread to make money in the process.
See that makes sense with variable rates. However if you offer a 30-year fixed rate at 4% because you know that you can currently borrow short at 2.5%, what happens in 20 years time when no-one is willing to lend short to you for less than 6%?
1) The loan is still on your books. In that case, you are in the same situation as an individual who has invested money in a 4% bond and can't withdraw it from there while at the same time paying 6% on a car (or house, or whatever) loan. It's annoying, for sure, but whether it's a serious problem depends on your net assets (which you might draw down to make up the difference) and your net income at that point (which will depend on whether you are still managing to make loans at higher than 6%). Also, 20 * 1.5 - 10 * 2 = 10, so I think you you still come out positive in this scenario, subject to some _really_ simplifying assumptions like the rates being 2.5 and 4 for 2 years and then jumping to 6 and 4, and ignoring the fact that money now is more valuable than money later, etc. But yes, if you keep the loan on your books you do run the risk that rates will go up and the money will not be optimally invested; you presumably try to model that risk and price it into your rates.
2) You sold the loan on to investors in the form of bonds. In that case you really don't care that much, as the loan originator. The investors who bought a 3.25% (or whatever; some loan management fees come off the top) bond now have the problem of having a bond that is paying likely below-inflation rates, and can't be sold, except at a loss, because of that. If the question is why investors would buy such a bond now, it's because they need something to invest in and pickings are pretty slim if they want a risk profile better than stocks (and we can argue whether morgage-backed securities give you that) and they are betting rates won't go up that much.
Now you could ask why people generally buy fixed-yield bonds at all, which is really the same question. My guess would be that partly this is a bet that rates won't rise (partly driven by central banks' commitment to macro stability and therefore not having too-large changes in interest rates). And maybe partly an issue of what time horizon the bond purchasers are operating on...
fixed yield bonds/mortgages also provide an interesting hedge in the current climate against
1) Recession
2) Negative interest rates.
in theory one could make a bet that a recession will occur in X months forcing a rate cut/stock decline and use leverage on fixed rate investments to make an above average return.
Agree 100%! But in practice, it doesn’t work like that. In a world where the safe, conservative option, taken by responsible borrowers, is the fixed-rate, then the variable rate takers are dominated by the people who are trying to stretch their finances to the breaking point, and that’s why you should worry when you see variable rate mortgages becoming more common.
Fixed rate mortgages are a uniquely US thing I think - I imagine made possible by government entities securing them. Rest of the world is predominantly on variable rate mortgages - why would a rational lending entity take on the risk of a fixed rate?
AFAIK it's actually the other way around. Banks, hedge funds and other institutions regularly trade "swaps" - instruments that swap variable interest rate for some fixed interest rate - the variable rate is usually "FED rate" or some well-known benchmark, whereas the fixed rate is set to be such that the net present value is zero - so that you can establish such contract without any immediate exchange of money.
If anything, it's a huge anomaly that this facility isn't routinely available to retail customers, and an indication of lack of competition within the banking sector in many countries.
The mortgage market is giant. I don't think there is enough liquidity to remove all the risk off of bank's books from private investors. This is where the government comes in I believe. Freddie Mac/Fannie Mae buy all the loans off of the banks. Many of these are later sold to investors who want to bet on rates - but I imagine Freddie/Fannie still has huge exposure to interest rate moves.
Fixed rates are the default in Germany. You would have a hard time trying to find a bank offering a variable rate to a normal customer. They have them, but they are surely not standard and fortunately not offered aggressively. I am unaware of any such regulation, but there probably is one.
In US lingo, that would be referred to as an adjustable rate, like "5/1 ARM" (fixed for five years, then adjusts each [one] year). When they say "fixed" in the US, they mean fixed for the full term.
I'm honestly surprised that became the standard, it seems like a lot of risks for the banks for what they're getting. I think it has something to do with Fannie Mae and Freddie Mac preferring to buy some mortgages and absorb the risk?
Germany has 5, 10, 15 and 20 year mortgages as the „default“. With the longer ones having a legal exit option (only for the Customer) at the 10 year mark. So in case the interest goes down, you can always refinance after 10 years. Independent of your Bank agreeing to it.
Having personally just purchased a home in the US I can say that a 400 bps increase in a variable interest rate would effectively double my housing cost, and place my home underwater as the Total Cost of Ownership would more than double over 30 years. If the interest rates increased by 600 bps to the maximum of the last 30 years I'd unavoidably default and declare bankruptcy.
On a per consumer level a variable rate is much higher risk, even in countries with highly variable inflation rates some fixed form of incomes will not inflate uniformly with the economy and a variable rate would increase the rate of defaults. On the other hand the loan terms and risks are determined once at loan origination where it's quite feasible for a financial institution to hedge out any long term inflationary risk.
Oh yes, it's a big risk. I think this is at least one reason why policy makers are so hesitant to raise rates. Especially in places like the UK, where many home owners are highly leveraged assuming a low interest rate, yet only have 3-5 year fixed rates. I wouldn't be surprised if there were a large increase in defaults if the interest rates went up here. It would probably bring home prices down to more reasonable levels as well.
Interesting how mortages vary so wildly between countries. Here in Denmark the variable loans are all below zero.
You still pay something as the loan has a management fee on top of the interest, so you can end up paying approx 0.6% in interest in the variable loan that can change every 5 years. The mortage loan can only cover up to 80% of the value of the house, with rest being 5% cash and 15% a more normal, higher-interest bank loan.
How much you can loan is based on a multiplier of your household income typically.
The 30-year fixed loan is 2% effective interest. And you can also not pay any interest for up to 10 years.
The only reason anyone can get a 30-year fixed-rate is that the government makes it so, by guaranteeing and eventually taking over Fannie Mae and Freddy Mac.
Boomers often cite the 1970s inflation spike as a terrible time, but the wage inflation eroded their debt, leaving them with high disposable income and the ability to refuse to work if not sufficiently compensated.
The establishment have not made the same mistake again. When you have people in perpetual debt you have them under perpetual control.
Credit can be created at will, but if you accidentally let financial independence break out, it's not easy to put back in the bottle. You have to wait for the next generation.
I’m curious what they said in the phone calls? I’m not sure what they could possibly do to sound compelling apart from perhaps just hoping your dad was aggressively financially illiterate?
Hello, uh, Mr. Doopler, I see that your current rate is 3.5% on your house. Did you know that at Bank Super Cool we're offering rates as high as 29.7%, and as you know, bigger is always better. PLUS if you refinance today, we're giving away FREE POPTARTS! Whaddya say, Mr. Doopler?
Not sure why you're getting downvoted. They absolutely do that. If you were in person, they would even show you a great chart with their returns and the normal returns so you can see how how much better than the average they are!
Lower your interest rate mortgage calls are very poorly targeted. The companies that do this get lists of people with mortgages, which is easy because mortgages need to be publicly recorded to be effective, and call all of those people without any attempt to narrow the field; or maybe they just call everyone they can. They usually call and offer "new lower rates" when the rates have gone down in the last few months, but they probably don't work very hard to estimate the original rate (it's not public record, but you could probably make a good guess based on the lender and the date it was recorded).
I had a mortgage originated in 2009, and then rate adjusted down several times to something in the 3.x range -- and would get calls and mailers promising "historically low" rates of 4.x; which I always found very amusing.
Well, if they didn't call, their chance of getting a refinance sale was 0.0% Then, as now, sales is a numbers game.
Dad was very financially literate and would hang up on them after a short "no thank you". If for no other reason than they interrupted the family dinner.
If a precipitous rise in oil prices caused inflation, why did Paul Volcker cure it, and not the equally-precipitous fall in oil prices that occurred simultaneously with his attempt?
That is, second attempt -- his first attempt, when oil prices were still high, didn't work.
I may be wrong but I think when you say risk free you just mean there’s no risk of it not paying out. Inflation is a separate potential threat, for which there are inflation protected treasury assets?
The risk is that it pays out, but what it pays out is less value than you paid in, due to inflation. It's effectively less money you're getting out, even though the number is the same. Sometimes inflation is so high that you would effectively get nothing back. You can't call that 'risk free.'
You also risk that the bond is not honoured - that's a really low risk for the US Government, but it's also not 'risk free.'
Yes, "risk free" has a technical meaning which doesn't include inflation risk. But it may be misleading when used in a non-technical context. Even if we assume for the sake of the argument that there is no default risk at all in government bonds you have risks linked to inflation and changes in interest rates (they affect the value of your investment before maturity and your ability to reinvest the coupons received according to the initial expectations).
In the early '90s you could buy CDs in the 10 and 12% range! I had a passbook savings account that paid 5%.
I manage a pretty decent sized portfolio and have given up on bond funds. They're all screwed up because of the inversion. For the past 24 months all non-equity capital has been in shorter duration CDs, a money market fund that was until recently paying about 2.4%, and some individual corporate and muni bonds that I bought in the secondary market. A lot of lower rated bonds still have decent coupons and I haven't had any default. I assume these bonds arrived on the market because some pension fund had to dump them when the rating dropped. I'm okay with AA, A, BBB because after 2008/9 I realize pretty much that bonds are all unsafe junk, too, and provided very little backstop to my portfolio when the crash came. Money Markets nearly broke the buck back then, actually some did. Thus, the point of having bonds in a portfolio is no longer valid, all the asset allocation books need to be rewritten. I currently own a lot of student loan debt, auto notes, corporate and school district notes, etc. It's still diversified, but they are all risk assets.
As other have mentioned, it's not "risk free" in a way that makes it "insane".
You could buy a 10-year bond paying 8% in 1970. That's a high yield by 21st-century standards but it performed quite poorly [1]: when you got your principal back ten years later it was worth less than half as much due to inflation (and not even by reinvesting the interests received would you break even).
> That’s more than double the long term stock market return, and it’s (basically) risk free.
You're comparing nominal and real numbers here. The nominal rate was more than double the long term _real_ stock market return, but the corresponding real rate was 4.5%, as the inflation rate was 13.5% in 1980. That's a more accurate and much less eye-popping number.
I didn't read the whole article (out of free articles on bloomberg and I'm not going to jump through hoops to get around the paywall), but it seems like the premise of the article doesn't match the title here.
It's not that TVM has disappeared, it's that people's evaluation of market risk has changed. It has always been the case that people are willing to accept a lower return for lower risk, and that will always continue to be true for rational people. Government bonds used to be the second lowest risk option- the absolute lowest risk used to be cash in a mattress (or a safe/bank vault), which returned zero percent (or just slightly below zero if you have to pay for storage). If a bond yield is negative it's not that TVM is suddenly wrong, it's that enough people seem to think that bonds are lower risk than holding cash.
Another option is that enough people think that the only alternative to stocks is bonds, and they forgot all about cash, causing bond yields to dip below cash yields. I doubt that enough people are dumb enough to forget about the cash option, so I don't really think this is the case.
I personally think it's silly to think a government bond would be lower risk than keeping my money in a safe, but think about the market movers (investment funds). You can't keep a billion dollars at your house, so you probably have to keep it at the bank. A negative bond yield indicates that you think the government is less likely to disappear than a bank, which at least makes some sense.
Cash in a safe appreciates or depreciates relative to the current deflationary or inflationary environment. Imagine if you had $5,000 right about when Nixon ended convertibility of US dollars to gold† and announced wage/price controls. Back then that could have bought you a decent piece of land or a good chunk of a house depending on where we're talking about. How far does $5,000 go now? Wouldn't get you in the door of a university for a year.
A follow on point is. Who says what that CPI is? Looks like it is near enough the same people who control the money supply. That's an actual problem.
For money to have a positive time-value it means that people prefer having any amount of money now over having the same amount of money later, all else equal. It is very hard to argue that this is not the case, because if you have the money now, you can have it later (by not spending it), but also you can spend it now, whereas if you don't have it now and only have it later, you have it later but you can't spend it now. Therefore having it now is always a better alternative, again, all else equal. Negative interest rates can be explained by other reasons that do not imply money having no time-value.
> if you have the money now, you can have it later (by not spending it)
I think this is where your argument breaks down. As pointed out by many other comments, there is non-zero cost and/or risk to ensuring that if you have money now, that you will still have it later. Matresses burn, stashes get stolen, vaults or insurance cost money. FDIC is limited.
No, it isn't that TVM is disappearing. I will always prefer to have a good thing now rather than wait until the future. I will also always prefer to have more of a good thing rather than less. Those two reasons together are why we expect positive interest rates, because I am trading having a good thing now for having more of a good thing later. However, assuming that the interest rate must be positive assumes that you can make decisions with certainty. This leads to another common thing we need to talk about- risk preferences. Being risk averse means someone will forgo some amount of good things to have a better chance of not losing even more. Overall, the market is risk averse, risk seeking behavior doesn't survive in a significant amount (for every successful YOLO investor there are dozens of bankrupted investors).
If I have money, I have to do something with it (not doing anything with it means saving it, which is still doing something). I can stick it in a bank account or mattress, give it away, buy things now (food, stocks, gold)- I may sell in the future- or buy bonds (which are also things, but we're considering them separately than for this). I am trying to figure out how to get the most happiness now, but I might forgo some happiness now to ensure that I have more happiness in the future. The future presents risk. A stock or gold might go down, a bank or government might default. My mattress might get stolen. All of these things could happen regardless of inflation. We assume that inflation rises, and we assume that a government bond is pretty safe for most countries. You might buy an inflation protected bond, but the basic treasury bond just gives you a fixed percentage each period and then your money back at maturity. Negative yields can happen on T-bonds or TIPS- this discussion about TVM isn't about inflation or how CPI is calculated. This discussion really isn't about inflation.
If a person is paying more than the total value of the bond (the bond value plus all payouts), this isn't an indicator that TVM is broken or no longer true. What it does say is that your evaluation of the risk has changed. I am willing to accept a negative yield because I've calculated that all the options that have a better yield are too risky. I'd rather take a guaranteed loss of a little money instead of risking more, even if the higher risk might come with a better average return. Buying negative yield is saying that it's not worth trying to keep up with inflation, because trying to keep up with inflation is too risky. It's saying that holding cash with zero yield (and negative inflation-adjusted yield) is more risky, because I don't think I can store that cash safely, or that I would need to pay the amount of the negative yield to store the cash safely.
Again, TVM isn't broken. You will always need to compensate me more in the future to forgo something in the present, assuming that risk is equal for the payout in each time period. You will also always need to offer me a higher average return to take on risk. The perceived risk of the deal is what changed, not the logic behind decision making.
A follow on point is this: Bloomberg authors get paid more if their articles move markets (they have a funky way of deciding this bonus). Don't go thinking that Adam Smith is wrong just because a guy with a journalism degree interviewed a few investors.
I'm sure this is a hugely ignorant question, so I'm asking honestly...
> Some funds track government bond indexes, meaning they must buy the bonds regardless of the yield.
Well, that looks like the problem, to me. How about don't do that? Just choose to invest in literally anything else that doesn't have a known negative ROI.
No. The investment vehicle should (strive to) attain it's stated goal. If I invest in a fund that tracks bonds, then I expect it to track bonds. I didn't invest in a fund that said it would give me zero percent yield, I invested in a fund that said it would track bonds.
If you want a fund that invests in literally anything that doesn't have a known negative ROI then you need a different fund.
If funds try to do what they think investors want rather than what they said they'd do, then they can get in serious trouble.
1) The funds themselves are specifically designed for people who want their money in government bonds. If that doesn't make sense for you as an investor now, then yes, you should get out of the fund, but the fund is still chartered to cater to whichever (insane) people still wish to be in government bonds in a negative rate era.
2) It's not necessarily bad to have bought into the fund. To the extent that interest rates go down, that means the value of the bonds, and therefore of your shares in the fund, goes up. So you could at least pocket that (one-time) return and move your money into a 0-yielding savings account.
There are often regulations or other structures that govern what kind of assets a pension fund must buy. For example, California's pension fund has a 20 percent fixed income investment target (note CA pension is has somewhat more flexibility than others in what they can do)
People invest in bonds because they are safer than stocks. Government, municipal, and corporate bonds pay interest relative to interest rates set by the central bank and how risky they are perceived. Across the bond categories, there will always be funds (ETFs & Mutual funds) backed by these categories of bonds for investors to purchase and their value proposition is that they behave like the underlying asset. It's much more convenient for people to buy shares of a mutual fund or an ETF than to buy individual bonds at an auction, so it's an attractive product for them to offer and take a small management fee on top of.
> Just choose to invest in literally anything else that doesn't have a known negative ROI.
A fund manager who is responsible for creating a product that matches government bonds can't buy something else because it would no longer be what it is intended to be: a product which behaves according to how the underlying asset behaves.
Investors however, will buy other (riskier) products because it doesn't make sense to buy something with zero or negative interest, which puts more money into less safe hands, hence the talk about bubbles. If the only thing that is offering any return is a ponzi scheme and everyone is invested in it because nothing else is offering return, then it's going to end badly for a lot of people.
Because the private markets aren't offering many assets that compare well against these bonds if you take into account returns, risk and liquidity.
BTW this is normal. Historically, negative real returns on stores of value were the norm. Before financial systems existed, almost all investments had negative returns if you didn’t put work and energy into them. To store value, you had to accumulate stuff, buildings or land. Most options either had high maintenance costs, were subject to risk of damage from natural causes and theft, were very volatile or required hard labor to get production out of.
Even in societies with financial systems, getting low risk, hassle free, liquid, positive real returns has been difficult for most of history. This just reflects the natural laws of thermodynamics that tell us that everything tends to decay without a constant supply of work and energy. In general, most things require maintenance to keep their worth.
The 20th century was probably the most notable exception. Because of unprecedented demographic and technological growth, positive risk free real returns were easy to find. The recency effect probably explains some of the confusion people have about this. It is possible that under favorable conditions, wealth can have positive returns and even compound into very good long run returns but it is not a guarantee and there is nothing natural about it. It may not continue forever, particularly amidst an aging and retiring population in a world no longer as rich in easy to exploit natural resources.
While people are used to get negative returns on short term purchases, you buy fresh vegetables at the supermarket, even if they degrade over time, many can’t seem to accept the normalcy of negative returns on longer term assets. In nature, squirrels’ nut caches have a certain percentage of losses from theft and spoilage. Real returns tending towards the negative is natural even if they can seem unusual for humans just out of the 20th century.
> This just reflects the natural laws of thermodynamics that tell us that everything tends to decay without a constant supply of work and energy.
"Decay" is very subjective. The laws of thermodynamics only tell us that entropy (an objective quantity) must increase over time, but it does not tell us how it increases or whether this increase is desirable or not. Life itself exists only because the combination of life + the environment creates more entropy than just a lifeless environment. Yet few would describe life as a "decay" of physical elements into self-replicating structures.
This is not to say that the phenomena you describe doesn't exist, it's just to say that the laws of physics at the scale of statistical mechanics are far removed from high-level processes at the scale of human society.
>BTW this is normal. Historically, negative real returns on stores of value were the norm. Before financial systems existed, almost all investments had negative returns if you didn’t put work and energy into them
Citation needed? Government bonds historically paid something like 4%; here's the German government's from the 19th century, over a a time of low inflation and income taxes:
Related story - my first job out of school was in investment banking. My desk worked on some esoteric securitization products (basically bonds backed by aircraft and shipping container leases) where all issuance had basically disappeared when I started, which was right after the 2008-9 crisis. These products generally were in the A/BBB area, and generally had traded like high yield bonds before the crisis. When I first started, we struggled to find investors and were generally seeing 6-8% yields on some small deals. By the time I left three years later, yields were getting down to the 4% area, issuance sizes had tripled and new paper was routinely 3-4x oversubscribed. I have some friends who still work there and tell me not only have yields kept coming down, but lower quality leases are being thrown into securitization pools. I 100% agree on all the comments here saying the big story is lower rates driving people into riskier investments. When the next crisis hits, people will talk about how negative rates forced people to reach for junk companies and questionable securitization paper.
Yes, but... isn’t this basically a bunch or rich folks saying “I was forced to take risks with my money because treasury bonds barely pay anything!”
My gut response is that, yes, if you’re buying risk-free treasuries, why should you get a return above inflation at all? Rewards and risks should be commensurate.
Because the return on a bond is not just based on the expected risk, but also on the time value of money (generally we prefer consumption now rather than in the future).
The time value of money is the expected risk of inflation. For example, if a lender lends someone $100, then the interest rate is a combination of the risk of not being paid back, and the return that could have been had if the same $100 were invested elsewhere (with the same risk profile of the original investment).
Wrong. The time value of money is the "time preference of money" i.e. if you have 1000$, you prefer buying a new iPhone with it today than wait for it for 10 years. You get old, you might even die, future is uncertain, and the time is wasted waiting meanwhile.
Exactly, and the world is awash in goods. The only returns are in some real estate markets, where inflation is called appreciation and is underwritten by “greater fools.”
> The time value of money is the expected risk of inflation.
I don't think that's the only source of time value of money.
For example, I'm fairly certain I can buy a car for the same price a year from now, but I am willing to pay a huge premium to have the car now so I don't have to ride the bus for two hours a day while I save up the cash to pay for it.
That is a preference for present consumption over future consumption that has nothing to do with inflation.
Consumption and investment are the same thing in a generalized model when comparing returns and figuring out how much interest to charge to keep up with inflation.
But those two possible uses of money have different profiles. You would have to price in how much it is worth to you to use the car vs the bus, subtract the amortization of the car - and together that's the target rate/yield that you should ask for your money plus risk of default.
According the Planet Money's Giant Pool of Money, which I've come to realize is a superb postmortem on the 2008 financial crisis, this is exactly what happened:
Adam Davidson: All right. Here's one of his speeches that really drove that army of investment managers crazy.
Alan Greenspan: The FOMC stands prepared to maintain a highly accommodative stance of policy for as long as needed to promote satisfactory economic performance.
Adam Davidson: You might not believe me, but that little statement, that is central banker's speak for, hey, global pool of money, screw you.
Alex Blumberg: Come on, that's not what he said.
Adam Davidson: It is. I speak central banker. Believe me, that's what he said. What he is technically saying is he's going to keep the fed funds rate-- that's when you hear, the fed interest rate-- at the absurdly low level of 1%.
And that sends a message to every investor in the world, you are not going to make any money at all on US Treasury bonds for a very long time. Go somewhere else. We can't help you.
To the question: why should you get a return above inflation at all?
I guess one way of looking at it is: do you want to treat low-risk returns for conservative investors as a sort of public utility guaranteed by the government? Or do you want to put it in the hands of private industry?
If the US can sell treasuries at rates not much above inflation, then it is because they are not loaning enough -- is there really no bridges or other infrastructure that could benefit the economy if they are built?
I would say most of the solidly profitable infrastructure projects, in the US are gone, combined with pretty much all the state legislatures and Congress being taxation adverse.
We're running our governments like businesses and you're not going to find any nimble or disruptive startups in the mix.
Check out the price tags on most infrastructure projects these days. As badly needed as they are, the US government currently doesn’t have re ability to execute them for less than the mid-horizon returns, if that.
Much of the infrastructure we need is self-financing. Eg bike lanes, transit etc. increase tax base and keep money in the local economy, while increasing foot traffic and retail sales. There’s no reason curing the 20th century’s car hangover shouldn’t be profitable.
If this were true, they would be easier to get done. Borrowing money to finance is fine, but a lot of these projects have to borrow a vet long way in the future, and the longer the term of the loan, the more interest rates eat into the real return from the project.
Secondarily, many prospective borrowers of these projects are already in debt, and have cash flows which are not growing fast enough to borrow more.
why should a gov't project need to have any real returns? Social returns is enough. If the city is nicer to live in, if the businesses thrive because of increaed foot traffic, lower car accident rates, cleaner air etc.
The city has to pay the money back at some point. This either requires higher tax rates, reduced services, or a larger pool of money to tax. The first two are quite unpopular.
No good reason- but like I said, check out the price tag; a mile of subway development in the U.S. can cost billions (with a B!) of dollars. Additional foot traffic along that mile couldn't get you that much back.
That "postmortem" explains nothing at all about how real estate factored in. I'd have to be in-the-know enough to understand that people overinvested in real estate partly because they could get loans easily from low interest rates. But even then, doesn't cover how financial markets were repackaging mortgages and hiding or miscalculating the risk.
If you listen to the episode, or even scan the transcript, you'll find that all of this covered. For a one hour show, it does an amazing job of putting everything together.
What I´ve never understood in all these arguments, is why do economists think that the laws of supply and demand supposedly (given that from this article it´s clear that they´re not), suspended for debt?
If for whatever reason (and having a moderately stable currency is the answer there) there is more demand for bonds than supply, then the price will fall. This has nothing to do with economic reality and everything to do with market pricing mechanisms. Whether it´s good in the long term for the government to increase its lending this way, is a completely separate question.
I can't possibly imagine where you have read/heard that any self respecting Economist thinks that yields (interests, cost of credit/capital) are somehow exempt from supply-and-demand.
And so we circle back around to, "All socialism is evil except the parts that benefit me."
Which isn't to say that I think the government should do what it do out of spite. Is there any chance of... I dunno, cutting off the public handout and then regulating the private vacuum-fillers sufficiently? Or does the implied drug analogy here reach its logical conclusion (on the black market)?
This is the market signaling that it no longer perceives any value in the maturity value of these bonds. They aren't being purchased for their maturity value; they're liquid assets, traded like any other in a market awash with ultra wealthy institutional investors between whom these securities flow like any other asset.
Isn't inflation simply another cost? As long as the value of these bonds (their low risk, as opposed to their maturity value) is greater than whatever cost you care to consider (inflation, negative interest, opportunity cost, etc.) they will be valued instruments. There is no "what should happen" or what is "supposed" to happen; those are fictions in the minds of spectators and until you're prepared to anger some powerful people and institutions they will remain fictions.
> My gut response is that, yes, if you’re buying risk-free treasuries, why should you get a return above inflation at all? Rewards and risks should be commensurate.
The parent has some sort of ad hoc economic theory ("gut response"), and I am asking them to expand on what the theory entails. "Supposed to happen" means it would be predicted by this theory of theirs.
US Treasuries may be the closest thing to 'risk-free' that there is, but isn't 100% risk-free. If the investor does not hold the bond to maturity, then he/she is open to interest rate risk (the risk that rates have changed, and so has the bond's value).
Even if the investor plans to hold the bond to maturity, then the investor is agreeing to lock up that money until maturity. This carries the risk that the investor won't be able to take advantage of an investment opportunity before then. Or, if he decides to sell at that moment, he must accept interest rate risk.
The investor should be compensated for these risks, however small they might be, and that - in my opinion - is why treasuries should yield more than inflation.
that's not what risk means. no investment considers early exit because of difficulty as a risk. even legislation call that "investor profile" or something meaningless or another.
By selling a bond before maturity, you're open to price fluctuations of the bond. It's not that the investor is exiting early, it's that by exiting early he is no long guaranteed the yield of the bond when he purchased it. Thurs, the yield is not "risk-free", and the risk is that the price moved in the market.
I was right there with you until the last three words. Investors ought to be compensated, but there’s no particular reason that compensation should be greater than the inflation rate.
“Rich folks” include pension funds, insurance companies, and sovereign wealth funds.
The whole thing seems to me like central bankers confusing cause and effect and trying to squeeze a complex system in to linear regressions. Lots and lots of unpredicted consequences to artificially low interest rates, including effects that do the precise opposite of what was predicted.
Not necessarily. With these things there is usually a big belief aggregation going on (some central bankers think this, some that), and we end up with a silly compromise. See Japan, see all the idiotic austerity programs.
So it is very possible that the central bank is not doing enough.
Owning negative yield bonds not only you don’t make a return above inflation, but you have to pay for the privilege of owning them.
Why do you think that it’s a good thing?
Why is it that when we see the unintended yet predictable and easily understood consequences of a policy, in this case monetary policy, all the blame goes to those whose decisions were influenced by that ill-advised policy in that predictable and easily understood way? This doesn't strike me as a good way to avoid bad policy in the future.
The west's current monetary policy very much hurts retirees living on dwindling fixed incomes. There ought to be at least some reward associated with savings, even without taking a risk to the principal.
Returns need to be associated with value creation. As the world has become more wealthy simply having assets and lending them out stopped creating significant value, thus lowering returns.
My completely unsecured credit card only charges 10%, and that’s before inflation.
> “I was forced to take risks with my money because treasury bonds barely pay anything!”
... is the system working as intended, because the policy rationale behind issuing lots of government bonds is precisely to make investors seek higher risks.
When downturns (like 2008) happen, this is investors fleeing to safe, money-like assets and and so wonks recommend that governments flood the markets with bonds, printed money, whatever to make that unprofitable.
The problem is with trying to fix the economy with policy levers. You can force people towards riskier investments (especially if they can be disguised as safe ones). But investment that is actually productive on average requires conditions where people on the ground can actually build useful stuff at a profit.
But that's an anathema to macro-economists (who want to advise on how use those levers) and also to politicians (who want to be seen to be "doing something").
Every state, city, country has a lot of favored sectors and grant opportunities, it's then up to investors to come up with projects that actually turn a profit.
VC/startup investors do this by simply doing a semi-blind search, funding everything they think is at least minimally sound.
If investors are still unable to turn a profit they are not taking on enough risk. (They are not thinking big enough.) And that might be okay. There's no moral imperative to keep every investment fund alive, every investor happy. And the only difference between business as usual periods and now is that the numbers are now scary (negative yields!).
But the fundamentals haven't changed.
Negative yields just mean that too many investors are risk averse, too many people (pension funds, passive funds, low-risk funds, inflation tracking funds, basic savings accounts) just want to park money. And that's okay. Eventually one of the following will happen: the fund managers will take on more risk, the people behind the funds will use the money for something else (eg spend it), or the people behind the funds will pester Congress to spend more and finance it all from debt.
It's not just rich folks. Via pensions funds, this is also about a lot of teachers, social workers, government employees and normal folk.
Pensions were funded (or not) based on assumptions about yields. If actual yields are not hitting those assumptions (and they're not), it's not the rich that'll be eating cat food in their retirement.
(Of course, fixing the funding shortfall by making risky bets on exotic high-yield investments is uh...what's the word? Oh yeah, terrible! But let's not pretend this is strictly a problem for the 1%.)
> When the next crisis hits, people will talk about how negative rates forced people to reach for junk companies and questionable securitization paper.
> negative rates forced people to reach for junk companies
Negative rates don’t force junky investment decisions. Inflation does.
Inflation is low. Investors choosing junk yielding 4% are not being forced to do so by negative yields (or, in America, low yields). They’re choosing to reach for yield.
> lower quality leases are being thrown into securitization pools
Shocked, shocked, do you hear me!
Not to snark at this poster, but in general,
if we learn anything from experience in markets, we learn:
People want higher returns without higher risks, and
other people can profit from convincing buyers that the returns are higher, or the risks are lower.
Also, money is more nimble than legislation. While
Congress is trying to outlaw the most recently
exposed scam or malfeasance, people are inventing the
next several workarounds to existing or upcoming law.
Reimbursement for work is on a slow decline, and has been for a while (in radiology at least). Hardware vendors and conference talks are often centred around a theme of ‘doing more with less’.
This link is an example and discusses revenue declining but the development of new tools might help to get more value out of imaging.
https://www.alliancehealthcareservices-us.com/12-imaging-mar...
The average multiple on a healthcare services business is 10x and HCIT assets are trading on revenue multiples. It works exactly like this everywhere. Livongo, Health Catalyst and Phreesia just went public at multiples that didn’t exist 5 years ago
> People want higher returns without higher risks, and other people can profit from convincing buyers that the returns are higher, or the risks are lower.
That does happen, but what may be even more common (and more important is a slightly different form:
People want high returns, and are willing to accept risks, but are required by law to invest in safe securities, and are happy to pay high fees for people who can find a way around this.
A huge driver of this isn't scams or outright fraud, but "regulatory arbitrage". Not saying it's fine, but if your mental model is "how can we protect unsophisticated mom and pop investors from these predators selling exotic asset backed securities", well, they're not the ones buying them. The bigger question is, how can we (or should we?) stop pension funds from knowingly seeking higher risk/higher return investments as part of their ongoing effort to try and reduce their massive unfunded liabilities.
You speak as if there is something that can done about it.
There is no way for the government to push rates, especially on exotic collateralized products like you describe. The Fed can play around at the low end and set an overnight rate, but not much else. Historically, the Fed has tried and failed over and over to affect the long end. And it certainly doesn't have the stock to dump long bonds to drive yields up.
Right now, the yield curve is inverted showing how little they actually effect rates. Long run rates are set in the global market.
They don't really have a mechanism, and rates are set in the global market - return on capital is mostly a global issue now and something the fed has no control over.
They can target the overnight rate and buy and sell short term funds because they are the majority player there, but even then the actual Fed Funds rate doesn't always equal the target they are trying to set (and not by a few points either).
On the long end they are more constrained. They can print a ton of money to cause inflation, but going the other way just isn't as easy. They aren't the major player there either. Long term treasuries compete with every other debt instrument out there government and private. Those rates are global for the most part
Just look at the late 90s when the Fed tried to push long term rates up and failed horribly. All they did is invert the curve. It is a repeating scenario.
This same conversation comes up about once a decade it seems.
They can, they just don't have a direct tool for doing it. Long term rates are just an aggregation of short term rates over a given time span. So they can adjust long term rates via promises and hints that they will keep short term rates low for a long time.
There is a ton of interesting monetary theory about how the Fed can do this and issues they run into.
long term rates are more than short term rates added together. while related, short term rates are much more driven by central bank reserve and regulatory policy, and long term rates much more driven bvy return and inflation expectations.
In a real dollar sense, the fed has zero ways to affect long term rates.
Sure there are other factors that affect long term rates. But if the Fed came out tomorrow and said "We promise to keep interest rates at 0 for the next 10 years" long term rates would drop considerably wouldn't you agree?
Not at all. Inflation expectations would soar. A few years ago and there talk was that keeping the overnight rate would lead to huge inflation issues. Now a strange narrative is appearing that nominal interest rates are simultaneously too and inflation going higher.
And there is no way they would be to keep that rate. They can say whatever they want, but that doesn't mean the overnight rate has to oblige them either. They only set a target, the actual rate is still determined in the bank to bank market and historically it does diverge, sometimes strongly.
I'm curious, why can't they manipulate it directly? It seems like if a central bank bought enough long-term bonds, supply would drop enough to raise the price?
The opposite. If they buy every long term bond that means that companies (and the Treasury too), can put them up for any price, let's say zero coupon payment, that's a zero yield bond.
No, to drive up rates would mean to restrict the buyers from buying (either via restricting the money supply - that means a combination of raising the overnight repo rate [FFR - Federal Funds Rate], raising reserve requirements, decreasing interest payment on reserves).
But such a move means slowing down regular lending, VISA/MasterCard and the banks would have to increase consumer facing prices of credit, etc. It would slow down wage growth.
And we are not seeing wage growth, we're not seeing inflation.
To stimulate spending/consumption all the Fed can do is absorb more and more risk (buy bonds/assets - quantitative easing, keepr rates low, encourage lending, encourage the starting of new projects).
Why people are not starting new projects?
Well, for example look at NIMBYs, look at how Congress doesn't want to force mandate better EPA regulations, look at how municipal fiber plans were stopped thanks to Comcast lobbying, etc.
Basically a lot of money goes into "rent" instead of innovation. (Asset bubbles.)
Unilaterally pushing up nominal interest rates is trivially achieved by rising inflation by devaluing currency by printing lots of it and spending it on pretty much anything. It would pretty much instantly hike up the nominal yields on pretty much everything USD-denominated to match the (now) higher inflation.
It doesn't mean that it's a good thing to do as it has all kinds of other effects, but in general the governments have the ability to do this should they choose to, it's just that they keep pinky-swearing that they won't do it, making legislation that makes it tricky to do without consensus (but they can repeal that if both parties agree that it's the way to go) etc.
> Right now, the yield curve is inverted showing how little they actually effect rates. Long run rates are set in the global market.
The fed causes the inversions every time by pushing up the short term rates until they are near or above long term... It is ridiculously obvious if you just look at a plot of this.
And it possibly still can. There is mentioned in that link of the theory being controversial due to automation, where there ends up being less workers and more production.
napkin math. Say we start with economy size A and a year later we have A+P. The profit rate is P/A. Whole economy-wise the P comes from people doing/producing something. Next year same people doing the same would produce the same P. Thus profit rate fell - it is now P/(A+P). As a result we can see that the profit rate can be increased by increasing output - ie. P(next year) > P(this year) due to productivity increase (thus automation) and/or labor force growth (population growth).
I once saw a graph of oil production/consumption over the last 100-150 years. Interestingly the curve is a smooth exponential right up until the late 1960's and then it gets ugly jaggy linear.
Say what you will but I think that's really significant.
Interesting, thanks. Can you expand on the link between government-issued bond interest rates going negative and the tendency for profits to decrease over time in a capitalist system?
Also, the ratio of theoretical to empirical content on that page is ridiculous given the topic is supposedly an empirical phenomenon requiring explanation. What is there is extremely weak as well. Is there better evidence this phenomenon exists?
This fundamental issue with the economy is driven by a couple of factors. Increases in inequality and wealth concentration means there is more money to loan, and an aging population means there are less young people to borrow the wealthy's money.
We have a couple of levers to increase the interest rate. We could reduce inequality to reduce the supply of loan-able funds, we could allow large amounts of immigration to drive up the demand for loan-able funds, or we could keep interest rates high enough that we have a permanently high unemployment.
However I do have a strong worry that natural interest rates are too low for our current inflation. This gives the fed very little room to deal with the next crises. They should probably be targeting an inflation rate closer to 3-4% so we don't run into zero lower bound problems.
Wouldn't it be better to have interest rates match the natural interest rate? People paying for loans can't afford the rate payment, so these payments should be lowered to reflect the ability to pay back the loan (including into negative territory). If you're the U.S. Government, you're essentially telling capital surplus holders, "You can keep you large hordes of money here, but it'll cost you 1% a year."
And if you want to take out a loan, it'll still be a risk, since you'll need to make the principle payments, but you'd get a tailwind on the interest paid to you.
I'd be happy to learn where I'm wrong if you have any insight.
Yeah it's always great to have the interest rates match the natural interest rate.
Btw the definition of the natural interest rate is "The natural rate of interest, sometimes called the neutral rate of interest[1], is the interest rate that supports the economy at full employment/maximum output while keeping inflation constant"
I'm not any kind of economist, but to me this seems like asking whether the sky really ought to be blue. Reducing the impact of debt (and by extension interest rates) on the economy is every bit as simple as undertaking a massive transforming project to change the color of the sky.
Yes, anything that requires government action is very hard in practice. But rhetorically, we discount that when talking about whether some government action would be a good idea or not.
Who's "we"? I think it's completely reasonable to consider how practical something of this magnitude is. You're not passing a single law; you're talking about fundamentally changing the entire nature of the (US? world?) economy in ways that I find difficult to even comprehend. I'm not even sure any amount of government action would be sufficient to bring it about.
Sorry, I must have given the wrong impression. To be clearer, I was hinting at either more government spending, universal basic income, or "helicopter money," as alternatives to attempting to stimulate the economy by encouraging more loans. These have precedents and it's not particularly difficult for a government to be efficient at giving people money.
Living in Japan, I feel like they've naturally developed the culture of changing the color of the sky. I mean to say they always find ways of getting the people to blow cash to keep money circulating. Most companies here have like 3x more staff helping me or standing around than in Canada. Consumerism and state marketing is big too.
This is why you have to do it every year. Which is exactly what a progressive taxation system does (or would do if it was a little more progressive than current systems)
I imagine you would have to "do it" every week to have the claimed effect...
With online banking, etc perhaps once a day.
EDIT:
Actually, if the funds are transferred electronically it would take as long as an ACH transfer takes to get to the new account. The funds are tied up during that but then immediately available to the banking system again.
Value lives outside, but the money represented by the value lives on accounts, in databases.
Even cash is just something tracked by central banks as liability (negative account value - because when someone deposits cash they increase one account, and if the bank then deposits that electronic money at the central bank the total money supply must not change, hence cash is tracked separately).
I think its driving people into riskier investments that still look like a traditional cash instrument from a bank - instead of looking at say equity / income funds.
The whole world economy makes no sense. The finance and tech industries in particular are a mess; there seems to be no correlation between value creation and profit.
Whenever I hear successful entrepreneurs bash cryptocurrencies, I wonder how they can simultaneously hold the following 3 thoughts inside their heads:
- My company became successful in the last 10 years because it added value to the economy.
- Cryptocurrencies became successful in the last 10 years in spite of subtracting value from the economy; they are the exception to an otherwise efficient market.
- Capitalism works.
If cryptocurrencies were an exception to an otherwise highly efficient and meritocratic economy, could we say the same about bonds which have negative yields?
Maybe the following thoughts are more logically consistent:
- My company became successful in the last 10 years because I exploited a vulnerability in the economy.
- Cryptocurrencies became successful in the last 10 years because they exploited a vulnerability in the economy.
- Capitalism doesn't work because it's vulnerable to hacks.
Also, to explain the current bonds situation:
- Bonds can have positive value in spite of negative yields because some investors believe that the vulnerabilities in the economy can be patched (e.g. it's possible to increase interest rates) and that bonds will eventually return to positive yields.
Cryptocurrencies add value to the economy. At the very least, it is a way for people to hold value into the future and plays a similar role to gold. Other cryptocurrencies can be used to buy/sell stuff.
The interesting part of this story will be looking back on it in ten years. We are either looking at a situation that is surprising but healthy, or a situation that is verging on being a crisis a very long time coming. So far so good, but I don't like it.
There are lots of smart people worried about a sub 0 percent interest rate, or worry about stagnation. Not to mention my peers in every Industry talking about slowdowns or unprofitable years due to tariffs.
The only people who seem to be enjoying it are exploiting the bubble with high wages and investing companies.
And if you didn't take the investment, your competitors destroyed you.
The biggest risk with TARP was inflation. You throw that much money into the economy and normally inflation goes up. Some assets have gone up, but generally inflation is low.
So one of two things will likely happen:
1. Economy will go into recession, feds can’t drop interest rates much more (they are already low), so recession hits hard.
2. Inflation skyrockets and the fed starts cranking up interest rates in an effort to control it. Economy stops growing but inflation continues (hi 1970’s!). People bitch because their paycheck stays the same but he price of milk doubles.
Land prices are not included in inflation stats. The cost of carry is, as mortgage payments, however that is simply the cost of money. And rates are at all time lows.
The difference between 7% rates where your mortgage takes up most 50% of your wages and 2% rates where your mortgage takes up 50% of your wages is that it's far harder to pay off your mortgage in the latter case.
You cannot attain financial freedom. This means ultimately you cannot refuse to work, even if compensation is poor (low wages, stuck low).
There is inflation. It's being used to force us to work, and the precariat cannot bargain for more of their surplus value.
As I understand it, housing is included as rent or "imputed rent". But, this is the price people actually pay for housing and home owners have it locked in whenever they bought, which could be decades ago. So, inflation lags the market rate for housing.
Or in other words, many people aren't paying market rate and it brings the average down. This isn't what you experience if you need a place now, or bought recently. Inflation is an average and most people aren't average. (Just like nobody has 2.2 kids or whatever.)
No that's just the price it would cost you to rent it back to yourself. It's not the land price. So even if it tracked rent, by being marked to market, it still wouldn't reflect the additional money creation forcing land prices up.
* companies are seeing record profits
* profits are paid out to shareholders
* or used to buy back shares
* but not reinvested
* ROI on capital is high
* ROI on work is low
* governments are not investing
* nations have high depts
Apple and the likes are stashing enough cash on island to fund Apollo over and over again.
Take Musk away, who is investing in expensive, risky stuff with actual potential to change things?
I firmly believe that the tax evasion schemes we are suffering from today are making capitalism less innovative. Usually, you would have to invest your profits in growth or the tax man would take it away (and spend it). Now you can just park it on an island and use it as security to lend money against, which you can use to buy back shares.
Yup. This is happening because rich people broke capitalism when they gamed the system and destroyed oversight by buying governments. When less than 1% of the planet controls 80% of the financial resources there's not much left to move. We're essentially in a neo-fuedal state in the US. Essentially you can point the blame at Reagan for destroying collective bargaining and SCOTUS for continually rolling in favor of corporations since Robert Bork. The natural correction based on history is the blood of the wealthy and then spreading their resources. Some of the wealthy have realized this and started trying to sound the alarm but it's falling in deaf ears. It's things like Jeff Bezos thinking space is the only way to spend his considerable wealth instead of someone like Bill Gates trying to make massive societal changes and improvements. Leave it to a guy with the money to literally wipe out world hunger to think space ships are the only way he could spend his money.
> Take Musk away, who is investing in expensive, risky stuff with actual potential to change things?
Your point is mostly valid, however there are others.
Gates & Buffett will ultimately pour a collective ~$300 billion into education and health. That includes attempting to wipe out various diseases entirely and eg inventing new ways to deliver vaccines cheaply - just about as important to humanity as most anything else we could be doing. Gates is also putting billions into new high-risk energy technology over time, far more than Musk put into starting SpaceX and Tesla.
Jeff Bezos will probably put tens of billions into space over decades, ultimately far exceeding the investment scale of Musk in that arena (whether he'll have results worthy of that investment, is yet to be decided).
Paul Allen - his estate now - has and will put considerable resources into researching the brain over time. Beyond that he put hundreds of millions of dollars to work in other high- risk scentific endeavours that may yield large results over time.[1]
Eli Broad has poured immense resources into the Broad Institute (a billion dollars inflation adjusted), a partnership between Harvard and MIT that has already made a huge impact by blazing the path re CRISPR. The Broad Institute is one of the premiere scientific institutes on the planet.
Larry Page is putting resources into flying vehicles. Not a huge amount of money based on his $55b net worth; non the less an interesting technology pursuit that could make a dent in our transportation systems.
Sergey Brin - on a personal mission - is attempting to combat Parkinson's, which afflicts 10 million people around the world. If his funding makes a difference in curing Parkinson's, it'll be a big deal and it's certainly a high-risk pursuit.
Sean Parker has been funding some of the first attempts at getting into trials with CRISPR. The definition of high-risk with the potential to change everything, not to mention very expensive.
MacKenzie Bezos, in her declaration in relation to the Giving Pledge, has said she'll give until the $40 billion is gone. Who knows what good she may accomplish, probably in areas of education, health, equality. She seems to be a very smart woman, so I would suspect she'll do something meaningful. That type of investing is typically high-risk and with the potential to change things.
Gordon Moore has spent his retirement figuring out ways to give away his (formerly) $20 billion fortune.[2] Including pushing $1.4 billion into science grants and $1.5 billion into environmental conservation efforts (I consider that arena to be high-impact, even if it's not as sexy as a starship). He has put $200 million into the Thirty Meter Telescope.
1. Advances in fundamental science are what ultimately dictate the growth rate of an economy. For example when you discover quantum mechanics you can make lasers, circuit boards and therefore computers which boosts everything enormously.
2. The more science you have done the harder it is to do more. You can only discover a truth once. For example discovering new elements is extremely hard now compared to when Hennig Brand discovered phospherous in his urine.
Consequences:
1. When a society gets the scientific method right it goes through an S shape curve (logistic curve), where science accelerates for a while and then plateuas out.
2. When you hit the plateau of the curve the maximum growth rate of the economy becomes very limited, it's just not possible to have new ideas which are worth developing very fast.
3. Human labour still provides a surplus so what you get is more and more resources piling up with nowhere to invest them. Look at Apple's $245bn cash pile, if they had new ideas they would put that money to use.
This will cause bond yields to fall to almost nothing and loads of money to be pumped into any startup with a vague hope of accomplishing something.
If we are in this situation it would also mean that the 08 crisis is not needed to explain the slowing growth in the world, things are slowing because we don't have many new ideas.
Common objections:
1. But what about X invention that happened in the last few years? Invention still happens on the plateau, just slower, NN's, crispr, exoplanets, smartphones are cool, they're not relativity, quantum mechanics, electrification, aeroplanes etc.
2. Scientific progress is exponential! : Accurately fitting a curve to a logistic curve gives you an exponential up until it shifts on you and starts slowing.
3. China and India are still growing strong. : Essentially they are still deploying the previous discoveries. China's growth is slowing over time precisely as it has less and less discoveries to deploy.
More to read:
DOE finds it can't get supercomputers like it used to.
This is false. There is a LOT of work to be done. A lot of houses can be made out of better material. A lot more books can be produced. A lot of drainage and clean energy systems can be built.
But why aren't they? Surely not because the science of it doesn't exit.
It's because the printing of money has inflated the bare necessities of humans. Housing, food, education have become crazy expensive. Heck, even a simple iPhone cable is expensive.
This is an optimistic invention driven growth curve hypothesis. There is an alternative pessimistic version. Where challenges like climate change, growing infertility rates, anti biotic resistant bacteria, require reactionary invention.
In other news, the S&P 500 and Nasdaq closed at record highs on Friday. The obvious explanation for both is there's a lot of money looking for somewhere to park, driving asset prices up and bond yields down.
There's either something not captured in inflation numbers, or most of the stimulus money just got invested and not spent.
There are two sides to every trade. When I buy into S&P, along with others, forcing the price up, someone else is selling and gets my money. What do they do with it? I can't know.
It's not going into a bank account called "S&P", where it's parked, it's a transitory snapshot of a transaction.
yes. I still find myself looking around from time to time wondering how it's all gonna end... feels like something should pop eventually, but what? or why?
>There's either something not captured in inflation numbers
My pet theory is that real inflation is higher than the official one, and is around 4-5%. The cause of the inflation is a gradual loss of quality basically everywhere except high-tech.
When the official inflation rate is calculated the basic assumption is that each item (which price is compared YoY) is exactly the same as it was last year. In another words, it assumes that its quality remains constant.
However, it's not always true (I believe it rarely is). Sometimes quality goes up (e.g. due to the Moore's Law in high tech). Sometimes quality goes down (e.g. due to cheaper food ingredients). When quality goes down but price stays the same, the official inflation would be 0%, but the real inflation would be greater than 0%.
I'm not aware if there is any way to account the change of quality in the inflation calculations. I suspect it's just not possible and therefore any published price-based inflation rates are bogus.
This story somewhat reminds me of The Giant Pool of Money[1], a landmark This American Life story on the origins of the 2008 financial crisis (remarkably) reported in the early-middle stages of the crisis (May 2008). One of the things it points to as fueling the sub-prime mortgage crisis was an impossible-to-meet demand for mortgages to be bundled in to CDOs which lead to mortgage lenders lowering their standards to increase supply to try to meet the demand. Why was the demand so high? During the early-to-mid 2000s the global money supply had basically doubled (the titular Giant Pool of Money) and that new cash needed somewhere "safe" to be parked and CDOs were the highest-yielding "safe" investments.
That pool of money hasn't gone away and the lesson investors seem to have learned from the financial crisis is that the only truly safe investments are government bonds issued by major governments. The demand that drove mortgage lenders to make (in hindsight) irrational decisions to increase supply seems to have shifted over to those government bonds. Because the supply of bonds is fixed by politicians the market is responding as it needs to match demand with supply: lowering rates (effectively increasing the "price" of the bond), even below 0, to lower demand to meet the available supply.
Government rates are set by the market at auction. The government does not set the rate of their own bonds, they just offer to sell a certain amount, and the auction determines the rate.
In the US, the Federal Reserve sets the Federal Funds rate, which is (supposed to be) determined independent of the federal government.
The reason rates are low is because there is a lot of demand, and participants are bidding down the price as they compete to acquire the bonds.
So can someone explain to me how these high-yield savings accounts are playing into this?
I read somewhere that these savings accounts are basically loss leaders and don't actually matter much cost wise to the banks offering them, but if I can park my cash in a 2.4% APR savings account, why would I ever buy a 6 month treasure note that's at ~2%?
I don't if/how the banks make money with high-yield accounts, but you might be better off with treasury bills if:
1. You're in a high income tax state -- interest is taxed as income but t-bill yields are exempt from state taxes.
2. You have more than the $250k FDIC limit (although that limit is per bank, so you can safely exceed it by opening accounts with multiple institutions).
3. You expect interest rates will decrease in the future and want to lock in your rate for a certain amount of time (of course, a high-yield CD would do the same thing, potentially at a better rate).
In other words, billionaires/oligarchs have sequestered so much cash that it has outrun investment opportunities. What does that tell you about the theory that tax reduction spurs investment?
It's more like a heart attack. There's plenty of blood, but the circulation to the heart itself (the people, ie demand side) has stopped. The doctor is pumping ever more blood into the patient without fixing the clogging to the heart itself.
Helicopter money which deletes loans (meaning it would not punish people who did not borrow) would be a far better strategy in this case, and lead to both inflation and deleveraging at the same time, something which is impossible with other methods.
I guess it's not a penalty if you are able to invest the money you get from the helicopter drop in assets, or a sweet gaming rig, while other people are just paying down debt?
On the theory that everyone gets cash, and for those with debt, the cash goes to the debt first, sure. But If I'm reading the proposal correctly, the argument is to just drop money into the debts. Suckers who lived responsible lives up front are left in the dust. This seems ... not healthy for society in the long term.
The overall statement is a fallacy, correlation does not imply causation. There are plenty of good investment opportunities out there, the truth is that you need to find them yourself. The next big companies in the world are purely in their "unfunded idea" stage.
Also the whole tax reduction statement is mostly an opinion. From what I've seen, most companies are almost purely motivated by the risk-adjusted post-tax profit that can be obtained from the investment. Every idea on the drawing board is effectively evaluated meticulously on this basis. If that number isn't to their liking then the research/project simply never gets funded. The company might opt to simply do share buybacks or pay a higher than normal dividend. Plus the overall argument is mostly junk because the United States heavily reduces taxes for companies that perform R&D through the R&D tax credit.
1. “Plenty of good investment opportunities” does not treat their aggregate value compared to cash removed from the economy. I reiterate, in plain English. There is more of that cash, way more, than realistic investment opportunities. Don’t believe me? Look at the crazy vanity projects, either started or under consideration. Settlements on Mars. $500B Saudi cities.
2. “From what I've seen, most companies are almost purely motivated by the risk-adjusted post-tax profit that can be obtained from the investment. Every idea on the drawing board is effectively evaluated meticulously on this basis.” I couldn’t agree with you more, at least when it is done rationally. And precisely because taxation is MULTIPLICATIVE, tax rates have little effect on investment decisions. Look at the 1950’s. Indeed, I suspect, (paradoxically?) that high tax rates encourage investment. The investment cost is effectively discounted by the tax rate.
> More than a decade on from the credit crisis, inflation is still scarce, with wages increasing only modestly despite large drops in unemployment. The ECB, for example, isn’t expected to get to its close-to-2% inflation target over the next decade, according to a market-derived measure.
I find it baffling how everyone talks as if inflation is some incomprehensible force of nature out of anyone's control, even though it's actually trivial to cause inflation by printing money and buying assets.
> Why does it seem like nobody (with the relevant authority) is willing to do anything but stand around in paralysis worrying?
Maybe because those relevant authorities are more and more not very good at their jobs. It happened a bunch under Bush and his happening way more under our current POTUS. Unqualified people are being put in charge of large portions of our government, and there has to be some consequence. This might just be it.
> I find it baffling how everyone talks as if inflation is some incomprehensible force of nature out of anyone's control, even though it's actually trivial to cause inflation by printing money and buying assets.
But that is literally the mystery about the contemporary economy. The Fed has been printing money like mad with "quantitative easing", with extremely low interest rates, and Congress helping them along with massive tax cuts, but this is having basically 0 impact on inflation rates. We're printing money like mad and it's seemingly having no effect on prices.
This is called "QE for people", or "helicopter money", and economists know about this idea. It's still deep in the fringes, but in my opinion we can see this happen within our lives.
Like /u/photojosh mentioned above, it's no good to print money and equally hand over to citizens if most of the citizens don't buy anything :-). Photojosh's comment breaks down how the citizens might be doing it.
"But that is literally the mystery about the contemporary economy. The Fed has been printing money like mad with "quantitative easing", with extremely low interest rates, and Congress helping them along with massive tax cuts, but this is having basically 0 impact on inflation rates."
One conclusion that you might draw is that we are in a massively deflationary environment. So much so that all of the inflation tools running at full-tilt only keep us in place.
Among other things, birth rates in rich, developed countries have been dropping for decades and are below replacement rate in many of them. Does that sound inflationary to you ?
Where's that money going though? It can only drive inflation if it's actually increasing demand, and I don't think that's happening. I think there's a fallacy of aggregation required to call it a mystery, if we disaggregate even slightly I think that argument falls apart.
eg, my anecdotal view is that:
1. the rich just put extra money into investment
2. the upper middle-class are just putting any extra money into paying down their debts: housing and student loans.
3. the lower-middle and lower classes are increasingly precarious; and they're not actually seeing any extra money.
4. big business are just doing stock-buybacks, and any profits are just going back into 1
5. small business are struggling because of 2 and 3
Contention: The cultural assumption that saving ought to be rewarded is misguided.
Reasoning: When a bank lets you transform production today into future consumption, it's performing a valuable service for you. Storing your value takes work and the bank deserves to be paid for that service. However, historically, they charged a negative price for this service (positive interest rates), because this service allowed them to make even more money letting other people transform their future production into present consumption. But as fewer people need to borrow and as more people want to save, the market clearing price of savings is approaching and in and cases overshooting 0%.
Extrapolation: There's a fair chance this will be a big deal in the history books we write a century from now. Today's bond prices are telling us that the world is changing. We are going from a world of relative growth, where we needed to delay consumption to juice investment, to a world of a relative stasis, where consumption and investment are in equilibrium. Everyone who said interest rates would bounce back to "normal" after the Great Recession has been wrong. This may be the new normal.
I don't pay too much attention to this type of thing but I think it might be related to wages not going up but the cost of living skyrocketing.
For example people in their late 50s and early 60s might have been making let's say $30,000 back in the 1980s and 1990s and now today the same exact type of job pays the same 30k salary except the cost of living is crazy high now compared to back then.
Back then they had money to spare for investments but that same salary today means you're probably in debt.
If that were the case, the people who do take out loans etc should be realizing supernormal returns as they exploit the low-hanging fruit being ignored. Do they?
You have it backwards. There are investors (such as banks and pension funds) who want certain very safe investments (government bonds) but governments are unwilling to supply it. So, if anything, this would be too much savings rather than not enough.
But really, it's not about consumers, but about banks not making as many loans as governments want them to. That suggests a lack of safe investment opportunities.
Maybe, instead of pressuring banks to make investments that they don't want to make, governments could stimulate demand in some other way? There are certainly people who, if you give them money, they will spend it.
Sure, but the point is that money is cheap because government is throwing buckets of it on the table and not because people didn't want money in the first place.
The Fed sets interest rates based on inflation and unemployment (the dual mandate). And what has changed from 20-30 years ago is not that the Fed is extra dovish. If so you would see historically high and accelerating inflation, and incredibly hot job market. So it's not the Fed that has change it's the environment. Due to fundamental changes in the global economy we are living in a world of incredibly low natural interest rates.
To use a car analogy I'm arguing the gas pedal doesn't work as well so the Fed is having to keep their foot to the gas to maintain it's historical speed. Others argue the Fed is has been trying to go faster and that's why their foot is on the gas pedal. The graph seems to support that indeed their foot is on the gas.
Sure, that's quantitative easing. Something that the Fed was not doing in this form before and it's quite controversial whether it has been a success of a failure. In any case, this "temporary" solution is going for over ten years now and the Fed doesn't know how to get out of it.
Uhh, there's a practical human problem with that notion and it is that when you're younger if you don't save for when you're older then you'll be destitute. Social Security alone is pretty hard to live on. As for what the bond market is telling us an alternate thesis (supported by the public statements of Trump and the Fed Chairman) is pretty much they don't want a recession in an election year and have eased interest rates not because it's good for the economy but because it's good for the incumbent. In short it's interest rate policy not the market which is setting the price.
Not sure who you mean by younger. I'm pushing 40, and I've been aware my entire working life that social security would not be there for our generation when we reach retirement age, but we would still be expected to pay into the system to support our elders and/or their elected officials. The only way we're likely to get any kind of return on that investment is if we become disabled.
I agree with you BUT social security can also be seen as a pay as you go system where the young care for the old. The notion that saving must take place is somewhat tied to American individualism.
If we didn't treat things like wellfare as disdainful and something you could actually rely on, we wouldn't need to worry about personal savings as much.
> Contention: The cultural assumption that saving ought to be rewarded is misguided.
This is an odd contention that I don't agree with entirely based on the usage of "rewarded." Interest isn't a reward, it's simply the price of money, and depending on your personal current values/needs/wants (spend now or save now), it can look either like a reward or a punishment.
So this ends up reading only as a topsy-turvy ex-post-facto justification for central bank policy that favors / provides cover for governments that spend more than they earn, which they all do afaik.
I do agree with some elements of your extrapolation though. It is possible that we are going from a world of relative growth to one of stasis. Or, at least, I don't think it's necessarily a bad thing if economies do not "grow", especially not in cases where population growth is slowing or even reversing.
One of the biggest risks with a natural interest rate of 0 is monetary policy loses all effectiveness. We need to either increase inflation or start playing with other forms of juicing the economy like helicopter drops.
Another factor - there are probably a few billion people in Asia in rapidly growing economies who need a hedge against all their savings suddenly becoming worthless due to local instability.
Suppose you are planning your future, and you think there's a small but real (1-5%) chance that sometime over the next decade your local currency will become devalued to zero. Suppose also that you're expecting significant future costs: elder care for your parents, rising costs of living, etc. In those situations, you're likely to have a very high savings rate, and will tolerate guaranteed returns that are near zero (because factoring in the risk of local returns might make them closer to negative double digits).
I'm not a global economist, so I don't know how much this is driving things. But China as a 45% personal savings rate, India is in the 30s, compared to the 6-7% of the US, and anecdotally people have noted significant amounts of foreign investment in "safe" assets. Some of these areas have banks that offer double digit returns for investments, but only on paper - people were talking up the returns from Mongolian savings accounts a few years ago, but then the currency has eroded so quickly that 15-20% returns are actually negative.
Except we don't need banks to store money now. We can use math and computer networks aka cryptocurrency.
Personally I think what's missing is a way to holistically track real world resources and consumption and tie them to digital money that can then be regulated in a fine grained way.
I think that is what is needed to change economics from a society of witch doctors into a technical and practical profession.
Gain via interest is a function of inflation. That is 4% interest in the context of 5% inflation is a 1% loss.
Long to short, in the context of deflation (and associated financial uncertainty) these bonds would be good to have. With the bond curve currently inverted and to many a recession eminent, if the "smart money" is holding these bonds then please sign me up.
Exactly, just because rates/inflation are low doesn't mean you can't have a bubble burst and a recession. It is just that the policy response is more difficult, because there is no room to maneuver on bond rates... nominally the only response is more (unbacked) currency issuance... which will cause inflation even without growth or requiring new loans.
I want to give a shout out to Max Keiser and Stacy Herbert over at “The Keiser Report” on RT at https://www.youtube.com/watch?v=u3ojPk8CQns for pointing me towards this eye-opening Bloomberg article. Even though the Bloomberg article is titled “The Black Hole Engulfing the World's Bond Markets” I decided to editorially change the headline to the more meaningful and less metaphoric “The time value of money has essentially disappeared”. I know this is usually against the spirit of HN but I hope you understand why I did it.
This is what's in the episode.
“In this episode of the Keiser Report, Max and Stacy discuss the mainstream financial press turning to the metaphors and analogies the Keiser Report started using a decade ago about the obvious blackhole of debt that would put central bankers into a quicksand of negative rate policy trap. A full 25% of global sovereign debt is now negative yielding with a whopping 85% of German debt negative. This means that the time value of money has disappeared, hence a fundamental law of monetary physics has been broken. So, what is next? They look at the historical break from gold which had provided an anchor to time value, and how that hurtled us over the debt event horizon and into a negative yielding world. They also look at a recent exchange between a CNBC host and the treasury secretary on bitcoin and the dollar.”
So this still continues because it's seen as short run volatility where the cost of rebalancing and trading out is higher than the expected loss? Or is it seen as a stability measure that protects investments in other asset classes? Or are a lot of investors/managers just asleep at the switch (organizational lagress, internal politics, laziness). Or is it simply market inefficiency?
It is difficult to wrap my head around why price discovery is totally failing here...
I think many people don't understand how negative rates are possible because they are used to having FDIC insurance for their bank account. The issue is that an entity with billions of dollars to protect (such as a pension fund) cannot rely on the FDIC because of the $250K insurance limit. There are not enough banks in the US to spread billions of dollars across, $250K at a time, even if an entity was willing to manage 10's of thousands of bank accounts. A government bond is generally the safest alternative. When demand for the safest level of protection is high, an entity might be willing to pay for the protection because market conditions make them unwilling to accept greater risk. Personally, I believe this is the main reason for very low rates right now. The big fixed income entities expect an economic downturn. It's just a question of how many months away it is.
This really helps me understand the institutional desire to purchase bonds even at a negative rate (especially when combined with legal requirements around holding safe asset classes).
It seems relatively obvious in hindsight, but I was still having a little trouble getting my head around it until I read this.
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