Of all the developments in financial markets last week, surely the most telling came out of Germany. Berlin successfully auctioned off €4.173 billion worth of two-year notes at a negative yield of 0.06 per cent.
This means that investors are actually paying the German government to lend it money. This gives substance to the expression that the “return of capital is the new return on capital”. In other words, getting your money back is as good as it gets these days.
This happened at the same time as the financial markets gave up on Spain. Despite the fact that the eurozone bailout for Spanish banks was sanctioned last week, the markets are fleeing Spain and its bond yields ended the week above 7 per cent.
The reason 7 per cent is important is that, as the yield moves above that mark, the chance of the bonds being downgraded increases. Now the average bond investor – think a typical pension fund – doesn’t like risk. It doesn’t see the higher return as an opportunity to make more money, it sees the higher return as tantamount to higher risk. Based on the return of capital, rather than the return on capital idea, these guys don’t like risk, but more than that they are debarred from taking risks.
If a sovereign bond is downgraded, many bond funds are prevented from holding them because their legal structure explicitly says they can only hold AAA assets or something similar. So the risk for Spain, as it heads past 7 per cent, is that its bread and butter supporters will fall away. This seems highly likely in the weeks ahead.
All of which makes a mockery of the notion of a successful monetary union when one big country is being paid to hold other people’s money and another big country, Spain, is being squeezed.
Obviously the background noise to all this are the shapes being thrown in Brussels by the Finns, Dutch and Germans about the extent of “peripheraid” that they face. Peripheraid is the likely permanent infusions of money from the north of Europe to the south and west for years to come.
But it is important to gain a bit of altitude from the machinations of European politics to see what is happening. The issue is not so much about what is happening, but why.
Look around the world and you see yields on all major bond markets falling rapidly. This means that investors think the deleveraging cycle is nowhere near over, and a combination of no inflation and hardly any growth is going to predominate.
So how do we square this with the knowledge that the central banks of the world have rarely printed more money? Surely inflation must take off. After all, in the US there are entire political movements based on the end of the dollar or the prospects of an inflationary explosion – and the notion that the Federal Reserve is some sort of anti-patriotic conspiracy to impoverish the average, hard-working American through inflation.
But as Irish-American commentator Bill Bonner noted last week: “The ultra-low yield on the ten-year T-note is a polite ‘FU’ to inflationistas everywhere, and a bet on a continuing and painful deflationary deleveraging cycle.”
This cycle is most evident in Ireland, where huge debts inherited in the boom are fixed while after-tax income is falling for many – and has been eliminated completely for those who have lost their jobs. If, in addition, companies are cutting their prices to compete, they face the situation where their revenues are falling but their debts are fixed.
If they move to improve their balance sheet by selling an asset, this makes sense so long as no one else does this too. But as we see with the case of Spanish bonds, if everyone sells at the same time, you get the paradox of deleveraging. This is where what is good for the individual is not good for the collective. If we all decide to sell, the price of assets falls more, and the very process of trying to improve the balance sheet actually makes it worse.
We can see this deflationary cycle very clearly when we see the fall in money supply relative to GDP in major economies. When there is loads of credit around, the money supply expands relative to GDP; it leads the cycle and where it goes, the economy will follow.
Now in the US in particular we are seeing a collapse in money supply relative to GDP. This means that, despite the central banks making loads of money available to the banks, these banks are not lending this money out.
In economics, this is termed the decline in the velocity of money. It also means that monetary policy worldwide isn’t working because there is a liquidity trap. People and companies are still paying debt, they don’t want to borrow and banks are still dealing with bad debts, so they don’t want to lend.
All this means is that, for the global economy to grow, some big shift in demand has to occur. More and more, it is looking as if the governments are going to have to engineer demand.
I know that this is unpalatable to many who believe that the governments are already big enough and create waste. I have some sympathy with that view, but the only other way the crisis is going to be fixed, in Europe at least, is for the ECB to buy up all the debt of Spain with money that it prints. Can you imagine this being accepted by the Germans or the increasingly belligerent Finns?
Looking at historically low bond yields and capital flight from the periphery, as well as the liquidity trap everywhere and the paradox of deleveraging, I am at a loss as to how growth will be kick-started otherwise.
“The reason 7 per cent is important is that, as the yield moves above that mark, the chance of the bonds being downgraded increases.” David it needs to be put in “layman’s” language – the reason 7 per cent is important is that a quick calculation on debt appreciation = (70/7 per cent) = 10 yrs to double the debt i.e at these rates the debt will be doubled in 10years! So if one cant pay the debt now they dont have a chance in paying double the debt. This is why 7 percent number is bandied about so much… Read more »
Spain 10 year at 7.47% this morning.IMf will no longer lend to Greece.
Several Spanish regions request aid.
The sooner this “crisis” blows up the better , so we can see what we are facing.
Has anything been so badly managed in History ?
subscribe.
Surely one can put it like this:
When % growth rate + % rate of inflation < % rate paid on govt debt = inward spiral
A long crises which has caused a psychological shift in the population creating fear of spending, risking and investing; youth unemployment of 50% in Greece and spain; a lack of leadership…the writing is on the wall…this is a Weimar Republic. Social unrest will follow; and strongmen will emerge who will order the banks to lend and shake the people up. This is the future. The Anglo-American model has failed, we need to give up some democracy and implement “dirigisme”. I just hope it will be an FDR that emerges rather than something else. But its coming…Choose your propaganda bogeyman… the… Read more »
David,
Try this proposal for creating some new and necessary stimulus to offset some of the debt deleveraging process. I cannot see any other way forward other than a massive contraction in the money supply and a deflationary spiral.
http://sustento.org.nz/wp-content/uploads/2012/07/NZ-Investor-Piece-Monetary-Dialysis.pdf
Be interested in your thoughts.
Best
Raf
Von Mises is correct There is only one end to a boom, a corresponding bust. The longer things are held up the bigger the fall. 1.Borrowing more money to stimulate is all the central bankers know. It no longer works. 2.Debts must be paid off. can’t happen, not enough money. Even if the debt is monetized by the central bank it is still there and just grown larger. 3.Default is the only answer. Burn the banking bondholders, shareholders etc. Everyone takes the hit who is owed. Those who can’t pay sell the assets to liquidate what they can. 2 and… Read more »
Everything has been wasted bar the lenders. I think the very fact that negative yields are accepted speaks volumes. As matter of interest, Minus 7% means you get less than 50% of your money back in 10 years AS Plus 7% means you get double your money back. Reductio ad absurdum for David’s argument means that all money flows to Germany, Netherlands and Finland etc. The rest have no money. Now, anyone doing 101 Economics says we need some means of exchange before we can buy goods and services. Exactly who does Germany etc expect to be trading with shortly?… Read more »
The UK created 200,000 private sector jobs in the last quarter, as ever it will be a saviour for the land of the peasant Paddy.
http://www.independent.ie Shane Ross has an excellent peace on BOI director Joe Walsh.
Willie Mc Ateer has been arrested ! LOL.
Sub Atomic Economic Particles From the above the most important statement is , in my humble opinion : ‘this is termed the decline in the velocity of money. It also means that monetary policy worldwide isn’t working because there is a liquidity trap.’ I am reminded that Higgs Bosom believed that matter existed elsewhere that could not be detected . This was verified recently by colliding two sub atomic particles and measuring their impact and subsequently their weight. Science has identified Atoms when Economics has failed to do so not to mention sub atomic particles . What David is revealing… Read more »
The Demise of Economics
What can this Science serve to us any more? Has it reached its Nadar?
What will Galbraith think in his grave ?
Can Economics not predict any more ? Why look at the clouds when it can see the heavens?
It’s actually hilarious now seeing the way it’s going for Greece! http://www.rte.ie/news/2012/0723/imf-reacts-to-reports-of-extra-50bn-for-greece-business.html ********************************************** A German conservative was quoted today as saying that Greece should start paying half of its pensions and state salaries in drachmas as part of a gradual exit from the euro zone. Alexander Dobrindt, general secretary of the Christian Social Union (CSU), the Bavaria-based sister party of Chancellor Angela Merkel’s Christian Democrats (CDU), has long argued that Greece would be better off outside the euro zone. “With Greece we have reached the end of the road. There must not be any further aid. A country which does… Read more »
Dear DMcW, Just a quibble with my favorite economist, ‘This means that investors are actually paying the German government to lend it money. This gives substance to the expression that the “return of capital is the new return on capital”. In other words, getting your money back is as good as it gets these days’ 4 billion euros is not a lot in today’s financial markets, what it means is that some Italians. Greeks, Spanish, Irish, etc are betting the euro will not last 2 years. They believe that having their money in a German bond, will provide them with… Read more »
Government Engineered Demand (GED) is feared by many because they seem to benefit the administrators, coordinators, policy makers, strategists etc more than the final end user. They are perceived as inefficient and ill conceived. Just look at the stupid endeavor for 2,5bn to build more roads and unblock what was never blocked. GED works. But it’s how you work it is the key. PPP down to community/ small company level is the key. No g=big operators and no project over 6 months long with an average time of 3 months. We need fast returns and lots of small ones. None… Read more »
so it looks like its Greece for the holiday again, cheep Ozo and so…
“If we all decide to sell, the price of assets falls more, and the very process of trying to improve the balance sheet actually makes it worse.” When trust and confidence in a currency is lost is when hyperinflation occurs. Despite the loss of economic activity we still have positive inflation reported. as nations abondon(sell) the US dollar as the major reserve currency the US dollar will fall in value against other currencies and inflation in the US will increase. This will give the US a trade advantage and other currencies will attempt to devalue to compete. At present this… Read more »
My difficulty with this argument is that as far as I can see, looking at the last 20 years in the Republic, US, UK, Greece, Spain, Iceland, and various other countries, governments efforts to increase demand simply result in the problem getting worse. We’ve watched trillions of $€$ build the greatest pile of malinvestment in recent times. So we can print and spend a further $€£15trillion, over the next X years, and where will it go? Why do we believe that it will go into functions that create things that others want – which has been the basis of all… Read more »
Dammed Cyclist, spoiled my drive yesterday one cyclist really got to me his out fit was splashed with a bank logo he should be careful cycling with such profanities pasted to his Lycra top, imagine cycling with HSBC plastered on you back, a bit like dancing in a bull infested field all dressed in RED.
Italy has a municipal budget problem. Italian cities are stretched.
http://globaleconomicanalysis.blogspot.ie/2012/07/ten-major-italy-cities-at-risk-of-crash.html
This means more austerity, and more rationalization of urban politics in Italy (which is often loaded with corruption).
We are also edging towards a full Spanish bailout. This is going to be very very expensive. Spain is still in a dire situation. The Spanish government will have to do something urgently considering the state of the Spanish labour market. The unemployment problem is reaching crisis point.
http://globaleconomicanalysis.blogspot.ie/2012/07/full-spanish-bailout-coming-up-yield-on.html
From “The Old Woman Of The Road” to, KING OF THE ROAD Words and Music by Roger Miller Trailer for sale or rent, rooms to let fifty cents No phone, no pool, no pets, I ain’t got no cigarettes Ah but two hours of pushin’ broom buys and eight by twelve four-bit room I’m a man of means by no means, king of the road Third boxcar midnight train, destination Bangor, Maine Old worn out suit and shoes, I don’t pay no union dues I smoke old stogies I have found, short but not too big around I’m a man… Read more »
I’m glad to see some discussion in this article about money creation because it’s an important issue and one which I feel gets to the route of the debt crisis problem. For a start very little money is printed as demonstrated by the green line on the graph at the link below: http://www.sensiblemoney.ie/the-issues/#whats-different-about-this-recession I’d like to note also that while central banks have been recapitalising banks with reserve account money, banks do not lend this money when they make loans. Banks create the money they lend by typing it into the borrower’s account and recording a corresponding debt. They do… Read more »
“but the only other way the crisis is going to be fixed, in Europe at least, is for the ECB to buy up all the debt of Spain with money that it prints” It will never work. Japan has done that for 20 years and they have a 20 year recession, the US is doing it for 4 years and things get progressively worse. David your education betrays you are you were fed propoganda and lies by the banking system who fund the universities to to train the profs to repeat the lies that cloud your mind. Europe has been… Read more »
This seems to be the Krugman arguement on ‘ liquidity Traps ‘ which seems to tie in with Bernake’s policy of one bubble after another
policy .http://www.usatoday.com/USCP/PNI/Business/2012-02-11-APUSBernanke_ST_U.htm
This is actual US economic policy ???
I thik we need to start reading John Mauldin’s newsletter’s a little more closely
Reality is we are generally a richer world than we were 20 years ago and people are more globally aware and more educated and more switched on. So whatever the banksters etc have been doing during this interval may not have been all bad. And the fact we can all waffle on this blog and slag each other is not to be taken for granted. The best analogy of what is happening today was explained to me by a teenager. “You old fogies simply cannot keep up”. We have functionality and capability that allows us to accelerate way beyond our… Read more »
On house hold debt forgiveness, liquidity and David’s and others comments above; I caught a bit of the Andrew Neil show last week, a strange show, the guest documentarian that night had made a short documentary on liquidity, I did not see it, but in the studio with Andrew Neil and the shows long time guest Michael Denzil Xavier Portillo, a strange beast, thank Cod he did not get to be PM, the guest documentarian asked where had the 300 billion gone. The 300 billion he was talking about was the 300 billion that the British exchequer had pumped into… Read more »
The Bloody Rain
Its pouring here in buckets .I wish Davids new book was out .I am looking forward to reading it . He is a good story teller.
For Mr. Tony Brogan some thought for ya, ON GOLD! Yes your thoughts on gold-these are facts maybe,,,, BUT bu but b ut buuut wait a minute the value of most things are played with, food included, states are protecting the paper stuff that is why it has value, a promise to pay, a credit for goods, work done, resources supplied and so… that is why default is the nuclearly option. The value of anything is decided by mankind the problem you are mentioning is more to do with what BONBON continues the repeat repeat repeat… its a policing issue,… Read more »
Zero Hedge present their perspective that Spain is next up for a Troika takeover. http://www.zerohedge.com/news/spain-curve-inversion-all-its-gravitational-glory At this stage the Italian government must be wondering about panic in their bond market, and the Frenh banking system must be worrying about panic in their bank balance sheets. We have the Germans on holidays. The Finns have decided that they will leave rather than incurr more liabilities for the benefit of countries where the regulators lie repeatedly about everything. The Netherlands are trying to get themselves to a position that they can quit, if the bill becomes greater than the value of staying… Read more »
Germany has begun to Wobble
Moody downgrades the Holy Grail and its issues .
Germany’s Oldest Private Bank, Berenberg, Calls for Bank Separation July 24 (EIRNS) — An analyst from the German private Berenberg Bank has come out calling for separation of retail and investment banks along Glass-Steagall lines, according to {Financial Times} Economics editor Patrick Jenkins. Writing in his blog, Jenkins says that the Libor crime of the century has prompted calls to go beyond the Vickers ringfencing to “forcibly splitting up universal banks. The danger and potential expense posed by an investment bank to a retail bank are just too great, the reformers argue. “The latest contribution to the argument comes from… Read more »
German Cabinet Minister Addresses LIBOR Scandal July 24, 2012 (EIRNS)–Finally, a leading German politician is addressing the LIBOR crime: Ilse Aigner, Minister of Agriculture and Consumer Protection, said in an interview with the {Handelsblatt} business daily today, that “if interest rates are being manipulated by banks to increase their profits from trading, that is a profound scandal.” “Interbank rates influence financial products of a value totalling numerous trillions of dollars, including savings accounts, money market funds, and loans,” Aigner said. “It cannot be that in the end, the consumers have to foot the bill again, for interest-manipulation by some unscrupulous… Read more »
So there is apparently 1.6 billion barrels of oil off the coast of Cork. So if a barrel of oil is roughly $100 ( give or take ) that is roughly $160 billion sitting off our coast. Anyone know how much of this the state can expect? Or has this all been sold already for a few quid and extention on a house for a t.d?
http://www.rte.ie/news/2012/0725/providence-oil-find-could-have-1-billion-barrels-business.html
I cannot help feeling we are missing a trick. We are screwing around with Economics as though it can be engineered. I see mathematics being applied with other fancy analytical paraphernalia. The sick joke of it all is that Economics has no underlying immutable laws as truly engineered systems would. Economics is also study of psychology and I feel no one discusses this. We look at returns on investment and present value analysis etc. but we never ask – what is the psychology driving all this stuff. What are the psychologies behind what is happening today? The level of paralysis… Read more »
Here is an account of a previous European monetary union that ran into a few difficulties.
http://www.moneyweek.com/news-and-charts/economics/europe/1919-end-austro-hungarian-currency-union-59716?utm_source=newsletter&utm_medium=email&utm_campaign=Money%2BMorning
This evening an economist in Milan who advises various banks and writes for the “il giornale” ( I know it belongs to Berlusconi) stated on the radio that Italy should revert to the Lira. He claims that the changeover would be similar in it’s effects to the scenario when Italy was forced out of the SME in 1992 and incurred a 20% devaluation. He claims that there was a ZERO effect on inflation.
It is also noteworthy that such a “flyer” was put on drive time peak radio. Maybe a signal of things to come.
Astonishing language from someone who is supposed to be intelligent …
“some sort of anti-patriotic conspiracy to impoverish the average, hard-working American”
Oh no. The Fed and their friends would never impoverish us!
Not an article to set the heather alight. 4/10
Low value. Cold, impersonal, academic, cynical. Disarray among posters descends into farce reflecting the chaotic and self interested psyche of a nation pulverised into panic, ingorance and perpetual stupidity. Little sympathy
Could have been penned by anyone with as much personality and empathy as a week old darkening pound of sausages lying at the back of the fridge
Not good
Congress passes Ron Pauls bill to edit the Fed
now to work on the senate. This is Historic
http://www.nysun.com/editorials/ron-pauls-triumph/87913/
Waiting patiently for you to come home and fuck me! https://bit.ly/3UIKI2R