Central Bank Victory and Negative Bond Rates

This article was first published by me on Talkmarkets:  http://www.talkmarkets.com/content/global-markets/central-bank-victory-and-negative-bond-rates?post=100707&uid=4798

Before discussing negative bond rates, and Martin Armstrong's article, it is becoming clear that the central banks in Europe, the USA and Japan are victorious in their plan to stabilize the world financial system.

All I hear about is people saying the Fed is a failure and the Fed has no control of things and collapse is imminent. They are usually talking about collapse of the bond market. I don't see it. That doesn't mean the central banks have not hurt people in order to prevail. Saving the economy was not the mandate of the central banks. If you want the economy first, you probably would have to ban or take over central banks. And even then you may not get what you want. 

I don't see negative bonds being the endgame of the financial system as Addison Quale says.  I don't see negative bond yields as being the precursor of financial collapse. In fact, as long as demand is high for negative yielding bonds, the central bank leaders look like geniuses.

That does not mean that their genius helps out the real economy that much. It does help, some, by providing stability, but robust growth is no longer important to the central banks. Growth must remain slow, as you can't disrupt the bonds, the value of bonds in the world. Those values will continue to increase and yields will continue to diminish. I suppose if this slow growth plan ends up killing the real economy, then it could turn into chaos.

But the central banks have engineered just enough growth to stabilize the banks and keep the economy growing a bit. This infuriates market monetarists, and people who feel disenfranchised and seniors who cannot get a return on their investments. It is a new world now, and those people who desire real robust growth don't matter so much. The Fed and central banks have lost one power, the ability to raise interest rates in the face of so much bond collateral in the derivatives markets.

This new system hurts a lot of people. Genius can be unfair, and it has proven to be very hurtful to many on mainstreet.  But, the economies seem to be muddling through.

And proving the above statement, Stephen Williamson once said at his blog that he went to Switzerland, and the economy seemed to be fine, even with negative long bonds. 

I once said to Scott Sumner:

...the Fed is done, the Fed has its demand for bonds, so it is resting and ignoring NGDP and ignoring helicopter money and ignoring things that could improve interest rates, all because the bonds cannot be disturbed as to value. Too much is riding on their stability now.
I still hold out hope that the central banks could carefully dole out helicopter money in such a way as to limit the inflation that would occur to their targets, saving the bond values for the most part.

The Fed, then, has saved the banks and the elite, thrown the middle class and poor a bone, a well chewed upon bone, and has made bond yields untouchable to the upside. The Fed simply has nothing more to do. Greenspan's plan is now fully in place. Bank risk is minimized because derivatives take away risk for banks, as long as the collateral remains stable. 

There are just a few details to iron out in the future, perhaps cashless societies and perhaps a global currency. The system has dreadful potential consequences for people, but it is firmly in charge.

Are there weaknesses in the system going forward?  Yes, global shocks to the real economy, and a shortage of pristine collateral could undermine the stability of the new system. A nuclear war wouldn't help much either.


I take issue with Martin Armstrong's view of negative Euro bond rates. As most people know, German 10 year bond yields have crossed into negative territory, joining Switzerland and Scandinavian nations in negative long bond territory.

Mr Armstrong has said that negative rated bonds are not eligible for the ECB purchasing program. He is absolutely correct about that. But there are two issues in his article that we need to look at for clarity:

1. He says that the bonds will crash, since the central bank cannot pick up the demand for the bonds. He likens it to World War 2 in America when he says:  "This is similar to the US bonds during World War II when the government ordered the central bank to support the government bonds at par. When that directive ended in 1951, the bond market crashed."

But, with such a shortage as exists today for Euro bonds, that crash seems unlikely.  The ECB is likely confident that bond demand will continue even though rates are negative. Higher and higher quality bonds are being required as collateral in the derivatives markets the world over. So there is plenty of demand for bonds, even negative yielding ones.

The ECB is clever. It is smart enough not to buy bonds with negative rates, but knows investors must buy those bonds as much needed collateral, resulting in reduction of government debt!

2. Mr Armstrong goes on to say that negative bonds are a bet against the currency, against the Euro. This currency collapse theory is plausible, I suppose, but seems to me to be pretty unlikely. The Yen was supposed to collapse. It didn't. The dollar was supposed to collapse. It didn't. The Euro has already collapsed some, but appears to be stabilizing. Bond yields are declining as the Euro is stabilizing.

So, all in all, the system is what it is, and people will not like it, and they have good reasons and I sympathize with them.

But the question remains, how negative can yields go before people want Fed and central bank heads on a stick? So far, the Fed has been able to reap few enemies, as most people don't care about economics. But could it one day be everyone against the Fed? That would depend on continued prosperity for at least most of us. And the Fed seems to be pulling that trick off so far. We are not yet negative in the long bond as they are in Europe.

And negative bond yields do alleviate government debt, allowing government to spend a little on society. I am sure that the central banks are feeling victorious about all of this outworking of events.

And I, as a result, am Comfortably Numb.


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