The inflation problem is only in the minds of central bankers

Yesterday we looked at the trend towards negative interest-rates and today we can link this into the issue of inflation. So let me open with this morning’s release from Swiss Statistics.

The consumer price index (CPI) remained stable in December 2019 compared with the previous month, remaining at 101.7 points (December 2015 = 100). Inflation was +0.2% compared with the same month of the previous year. The average annual inflation reached +0.4% in 2019.These are the results of the Federal Statistical Office (FSO).

The basic situation is not only that there is little or no inflation but that there has been very little since 2015. Actually if we switch to the Euro area measure called CPI in the UK we see that it picks up even less.

In December 2019, the Swiss Harmonised Index of Consumer Prices (HICP) stood at 101.17 points
(base 2015=100). This corresponds to a rate of change of +0.2% compared with the previous month
and of –0.1% compared with the same month of the previous year.

Negative Interest-Rates

There is a nice bit of timing here in that the situation changed back in 2015 on the 15th to be precise and I am sure many of you still recall it.

The Swiss National Bank (SNB) is discontinuing the minimum exchange rate of CHF 1.20 per euro. At the same time, it is lowering the interest rate on sight deposit account balances that exceed a given exemption threshold by 0.5 percentage points, to −0.75%.

If we look at this in inflation terms then the implied mantra suggested by Ben Bernanke yesterday would be that Switzerland would have seen some whereas it has not. In fact the (nearly) 5 years since then have been remarkable for their lack of inflation.

There is a secondary issue here related to the exchange rate which is that the negative interest-rate was supposed to weaken it. That is a main route as to how it is supposed to raise inflation but we find that we are nearly back where we began. What I mean by that is the exchange-rate referred to above is 1.084 compared to the Euro. So the Swiss tried to import inflation but have not succeeded and awkwardly for fans of negative interest-rates part of the issue is that the ECB ( European Central Bank) joined the party reminding me of a point I made just under 2 years ago on the 9th of January 2018.

For all the fire and fury ( sorry) there remains a simple underlying point which is that if one currency declines falls or devalues then others have to rise. That is especially awkward for central banks as they attempt to explain how trying to manipulate a zero-sum game brings overall benefits.

The Low Inflation Issue

Let me now switch to another Swiss based organisation the Bank for International Settlements  or BIS. This is often known as the central bankers central bank and I think we learn a lot from just the first sentence.

Inflation in advanced economies (AEs) continues to be subdued, remaining below central banks’ target
in spite of aggressive and persistent monetary policy accommodation over a prolonged period.

As we find so often this begs more than a few questions. For a start why is nobody wondering why all this effort is not wprking as intended? The related issue is then why they are persisting with something that is not working? The Eagles had a view on this.

They stab it with their steely knives
But they just can’t kill the beast

We then get quite a swerve.

To escape the low inflation trap, we argue that, as suggested by Jean-Claude Trichet, governments
and social partners put in place “consensus packages” that include a fiscal policy that supports demand
and a series of ad hoc nominal wage increases over several years.

Actually there are two large swerves here. The first is the switch away from the monetary policies which have been applied on an ever larger scale each time with the promise that this time they will work. Next is a pretty breathtaking switch to advocacy of fiscal policy by the very same Jean-Claude Trichet who was involved in the application of exactly the reverse in places like Greece during his tenure at the ECB.

Their plan is to simply add to the control freakery.

As political economy conditions evolve, this role should be progressively substituted by rebalancing the macro
policy mix with a more expansionary fiscal policy. More importantly, social partners and governments
control an extremely powerful lever, ie the setting of wages at least in the public sector and potentially
in the private sector, to re-anchor inflation expectations near 2%.

The theory was that technocratic central bankers would aim for inflation targets set by elected politicians. Now they want to tell the politicians what to so all just to hit an inflation target that was chosen merely because it seemed right at the time. Next they want wages to rise at this arbitrary rate too! The ordinary worker will get a wage rise of 2% in this environment so that prices can rise by 2% as well. It is the economics equivalent of the Orwellian statements of the novel 1984

Indeed they even think that they can tell employers what to do.

Finally, in a full employment context,
employers have an incentive to implement wage increases to keep their best performing employees
and, given that nominal labour costs of all employers would increase in parallel, they would able to raise
prices in line with the increase of their wage bills with limited risk of losing clients

Ah “full employment” the concept which is in practical terms meaningless as we discussed only yesterday.

Also as someone who studied the “social contracts” or what revealingly were called “wage and price spirals” in the UK the BIS presents in its paper a rose tinted version of the past. Some might say misleading. In the meantime as the economy has changed I would say that they would be even less likely to work.

Putting this another way the Euro area inflation numbers from earlier showed something the ordinary person will dislike but central bankers will cheer.

Looking at the main components of euro area inflation, food, alcohol & tobacco is expected to have the highest
annual rate in December (2.0%, compared with 1.9% in November),

I would send the central bankers out to explain to food shoppers how this is in fact the nirvana of “price stability” as for new readers that is what they call inflation of 2% per annum. We would likely get another ” I cannot eat an I-Pad” moment.

Comment

Let me now bring in some issues which change things substantially and let me open with something that has got FT Alphaville spinning itself into quicksand.

As far as most people are concerned, there is more than enough inflation. Cœuré noted in his speech that most households think the average rate in the eurozone between 2004 and last year has been 9 per cent (in fact it was 1.6 per cent). That’s partly down to higher housing costs (which are not wholly included in central banks’ measurement of inflation).

That last sentence is really rather desperate as it nods to the official FT view of inflation which is in quite a mess on the issue of housing inflation. Actually the things which tend to go up ( house prices) are excluded from the Euro area measure of inflation. There was a plan to include them but that turned out to be an attempt simply to waste time ( about 3 years as it happened). Why? Well they would rather tell you that this is a wealth effect.

House prices, as measured by the House Price Index, rose by 4.2% in both the euro area and the EU in the
second quarter of 2019 compared with the same quarter of the previous year.

Looking at the situation we see that a sort of Holy Grail has developed – the 2% per annum inflation target – with little or no backing. After all its use was then followed by the credit crunch which non central bankers will consider to be a rather devastating critique. One road out of this is to raise the inflation target even higher to 3%, 4% or more, or so we are told.

There are two main issues with this of which the first is that if you cannot hit the 2% target then 3% or 4% seems pointless. But to my mind the bigger one is that in an era of lower numbers why be King Canute when instead one can learn and adapt. I would either lower the inflation target and/or put house prices in it so that they better reflect the ordinary experience. The reason they do not go down this road is explained by a four letter word, debt. Or as the Eagles put it.

Mirrors on the ceiling
The pink champagne on ice
And she said: “We are all just prisoners here
Of our own device”

Why is the US Repo crisis ongoing?

The US Repo crisis is something that seems to turn up every day, or if you prefer as often as we are told there is a solution to trade war between the US and China. On Friday the New York Federal Reserve or Fed provided another US $72.8 billion of overnight liquidity in return for Treasury Bonds ( US $56.1 billion) and Mortgage-Backed Securities ( US $16.7 billion). So something is still going on in spite of the fact that we have two monthly plus Repos ( 42 days) for US $25 billion each in play and 3 fortnightly ones totalling around US $59 billion. So quite a bit of liquidity continues to be deployed and this is before we get to the Treasury Bill purchases.

In accordance with this directive, the Desk plans to purchase Treasury bills at an initial pace of approximately $60 billion per month, starting with the period from mid-October to mid-November.

As an example Friday saw some US $7.525 billion of these bought. So the sums are getting larger.

How did this start?

The Bank for International Settlements or BIS which is the central bankers central bank puts it like this.

On 17 September, the secured overnight funding rate (SOFR) – the new, repo market-based, US dollar overnight reference rate – more than doubled, and the intraday range jumped to about 700 basis points. Intraday volatility in the federal funds rate was also unusually high. The reasons for this dislocation have been extensively debated; explanations include a due date for US corporate taxes and a large settlement of US Treasury securities. Yet none of these temporary factors can fully explain the exceptional jump in repo rates.

Indeed, as for a start the issue has proved to be anything but temporary.

Where the BIS view gets more interesting is via the role of the banks or rather a small group of them.

US repo markets currently rely heavily on four banks as marginal lenders. As the composition of their liquid assets became more skewed towards US Treasuries, their ability to supply funding at short notice in repo markets was diminished.

As the supply of reserves fell in the QT or Quantitative Tightening era they stepped up to the plate on a grand scale.

As repo rates started to increase above the IOER from mid-2018 owing to the large issuance of Treasuries, a remarkable shift took place: the US banking system as a whole, hitherto a net provider of collateral, became a net provider of funds to repo markets. The four largest US banks specifically turned into key players: their net lending position (reverse repo assets minus repo liabilities) increased quickly, reaching about $300 billion at end-June 2019 . At the same time, the next largest 25 banks reduced their demand for repo funding, turning the net repo position of the banking sector positive (centre panel, dashed line).

So things became more vulnerable as we note this.

At the same time, the four largest banks held only about 25% of reserves (ie funding that they could supply at short notice in repo markets).

Then demand for Repo funding was affected by the US Treasury.

After the debt ceiling was suspended in early August 2019, the US Treasury quickly set out to rebuild its dwindling cash balances, draining more than $120 billion of reserves in the 30 days between 14 August and 17 September alone, and half of this amount in the last week of that period. By comparison, while the Federal Reserve runoff removed about five times this amount, it did so over almost two years

As you can see the drain from QT was added to in spite of the fact that the market had become more vulnerable due to the lack of players. There was a clear lack of joined up thinking at play and perhaps a lack of any thinking at all. A factor here was something the BIS identifies for the banks.

For instance, the internal processes and knowledge that banks need to ensure prompt and smooth market operations may start to decay. This could take the form of staff inexperience and fewer market-makers, slowing internal processes

After a decade the experienced hands had in general moved on.

But it was not enough to collapse the house of cards. There were other nudges as well on the horizon.

Market commentary suggests that, in preceding quarters, leveraged players (eg hedge funds) were increasing their demand for Treasury repos to fund arbitrage trades between cash bonds and derivatives. Since 2017, MMFs have been lending to a broader range of repo counterparties, including hedge funds, potentially obtaining higher returns.

So hedge funds were playing in the market but as it happened were not an issue for a while as the US Money Market Funds (MMF) turned up. But then they didn’t.

 During September, however, quantities dropped and rates rose, suggesting a reluctance, also on the part of MMFs, to lend into these markets. Market intelligence suggests MMFs were concerned by potential large redemptions given strong prior inflows. Counterparty exposure limits may have contributed to the drop in quantities, as these repos now account for almost 20% of the total provided by MMFs.

So there is a hint that maybe a hedge fund or two became such large players that they hit counterparty limits. Also redemptions from MMFs would hardly be a surprise as we note the interest-rate cuts we have seen in 2019.

Why should we care?

There is this.

 Repo markets redistribute liquidity between financial institutions: not only banks (as is the case with the federal funds market), but also insurance companies, asset managers, money market funds and other institutional investors. In so doing, they help other financial markets to function smoothly.

So they oil the wheels of financial markets and when they don’t? Well that is one of the causes of the credit crunch.

The freezing-up of repo markets in late 2008 was one of the most damaging aspects of the Great Financial Crisis (GFC).

In case you did not know what they are.

A repo transaction is a short-term (usually overnight) collateralised loan, in which the borrower (of cash) sells a security (typically government bonds as collateral) to the lender, with a commitment to buy it back later at the same price plus interest.

Also it is one of those things which get little publicity ( mostly ironically because they usually work smoothly) but there is a lot of action.

 Thus, any sustained disruption in this market, with daily turnover in the US market of about $1 trillion, could quickly ripple through the financial system.

Comment

Some of the factors in the Repo crisis were unpredictable. But it is also true that the US Fed was at best rather flat-footed. There had been a long-running discussion over the use of Interest On Excess Reserves or IOER to banks on such a scale which was not resolved. Then there was the way that so few banks (4) were able to become such large players creating an obvious risk. Then the role of the MMFs as by their very nature they flow into and out of markets and are likely to flow out when interest-rates are declining.

The BIS analysis adds to what we know but changes in stocks give us broad trends rather than telling what flowed where or rather did not flow on September 17th or since. As David Bowie put it.

Ch-ch-ch-ch-changes
Turn and face the strange
Ch-ch-changes
Don’t want to be a richer man
Ch-ch-ch-ch-changes
Turn and face the strange
Ch-ch-changes
There’s gonna have to be a different man
Time may change me
But I can’t trace time

Number Crunching

The BIS has been looking into some other areas.

An analysis of the #TriennialSurvey finds that global notional for #OTCderivatives rose to $640 trn in 2019, dominated by #InterestRateDerivatives

Average daily turnover of OTC interest rate derivatives more than doubled over 2016-19 to $6.5 trillion, taking OTC markets’ share to almost half total trading

30 years, 53 countries, 1,300 reporting dealers, and $6.6 trillion daily FX trades,

Weekly Podcast

 

QE and its role in the Dollar shortage, zombie banks and productivity woes

Overnight there have been some intriguing releases from the BIS or Bank for International Settlements, which if you were not aware is the central bankers central bank. The BIS has, although it would not put it like that been reviewing some of the problems and indeed side-effects of the QE ( Quantitative Easing) era, So what does it tell us? Well one major point links to yesterday’s post on India and indeed to the travails of Argentina and Turkey.

The second defining feature is the rise of foreign currency US dollar credit . US dollar-denominated debt securities issued by non-US residents have been the key driver of this trend, surpassing bank loans for the first time in the second half of 2017 . The overall amount of dollar credit to the non-bank sector outside the United States has climbed from 9.5% of global GDP at end-2007 to 14% in the first quarter of 2018. Since end-2016, however, the growth in dollar credit has been flat.

So the US Dollar has been used as a new form of carry trade as people and businesses choose to borrow in it on a grand scale. Also as global GDP has been growing the 14% is of a larger amount. But to me the big connection here is the way that this pretty much coincides with plenty of US Dollars being available because the US Federal Reserve was busy supplying them in return for its QE bond purchases. Correlation does not prove causation but the surge fits pretty well and then it ends not long after QE did. Or more precisely seems to have faded after the first interest-rate increase from the Fed.

The question to my mind going forwards is will we see a reversal in the QT or Quantitative Tightening era? The supply of US Dollars is now being reduced by it and we wait to see what the consequences are. But it is hard to avoid noting the places that seem to be as David Bowie and Queen would put it.

It’s the terror of knowing what this world is about
Watching some good friends screaming, ‘Let me out’
Pray tomorrow gets me higher
Pressure on people, people on streets

Things seem set to tighten a little further tomorrow should the Fed tighten again as looks likely.

Zombie Companies and Banks

This development has been brought to you be the financial world equivalent of Hammer House of Horror. All the monetary easing has allowed companies to survive that would otherwise have folded, or to put it another way the road to what is called “creative destruction” or one of the benefits of capitalism was blocked. A major form of this was the way that banks were bailed out and some of them continue to struggle a decade later but also took us down other roads. For example the debt model of the Glazers at Manchester United looked set to collapse but was then able to refinance more cheaply in the new upside down world. Ironically it was then able to thrive at least financially as in football terms things are not what they were.

The BIS has its worries in this area too.

In this special feature, we explore the rise of zombie companies and its causes and consequences. We take an international perspective that covers 14 countries and a much longer period than previous studies.

It is willing to consider that the era of lower interest-rates and bond yields which covers my whole career and some has had consequences.

A related but less explored factor is the drop in interest rates since the 1980s. The ratcheting-down in the level of interest rates after each cycle has potentially reduced the financial pressure on zombies to restructure or exit. Our results indeed suggest that lower rates tend to push up zombie shares, even after accounting for the impact of other factors.

So cutting interest-rates for an economic gain looks to have negative consequences as time passes. How might that work in practice? The emphasis below is mine

Mechanically, lower rates should reduce our measure of zombie firms as they improve ICRs by reducing interest expenses, all else equal. However, low rates can also reduce the pressure on creditors to clean up their balance sheets and encourage them to “evergreen” loans to zombies . They do so by reducing the opportunity cost of cleaning up (the return on alternative assets), cutting the funding cost of bad loans, and increasing the expected recovery rate on those loans. More generally, lower rates may create incentives for risk-taking through the risk- taking channel of monetary policy. Since zombie companies are risky debtors and investments, more risk appetite should reduce financial pressure on them.

The reason for the emphasis is that in essence that is the rationale for QE. That is something of a change on the past but as inflation as measured by consumer inflation mostly did not turn up the central banks got out their erasers and deleted that bit. It has been replaced by this sort of thing which links to the Zombie companies and banks theme.

In addition, QE can stimulate the economy by boosting a wide range of financial asset prices. ( Bank of England )

Note the use of the word can so that even the Take Two version can be erased! But the crucial point is that yet again the Zombies are on the march via central banking support. I guess most of you have already guessed the next bit.

Visual inspection suggests that the share of zombie firms is indeed negatively correlated with both bank health and interest rates.

Why are Zombies such a problem?

The have negative effects on economic life.

a higher share of zombie firms could depress productivity growth,

Could? Later we get more of a would as we see an old friend called “crowding out” return to the picture.

Zombies are less productive and may crowd out growth of more productive firms by locking resources (so-called “congestion effects”). Specifically, they depress the prices of those firms’ products, and raise their wages and their funding costs, by competing for resources.

But there is a deeper consequence.

We find that when the zombie share increases, productivity growth declines significantly, but only for the narrowly defined zombies………. The estimates indicate that when the zombie share in an economy increases by 1%, productivity growth declines by around 0.3 percentage points.

Comment

There is a fair bit to consider here. The first is the role of the BIS in this which in some ways is welcome but in others less so.  The former is an admittal of some of the side-effects of easy monetary policy but the latter is the way we are getting it a decade late. Or in the case of Japan a couple of decades or so late! To my mind intelligence also involves an element of timeliness. Although to be fair to do quantitative research you do need an evidence base. The catch as ever for the evidence in economics is the way that some many things are varying not only with each other but also with themselves over time. Or if you prefer heteroskedasticity and multicollinearity.

As to the issues they tend to be on the back burner because they are inconvenient for the establishment. The career path of economists at central banks is unlikely to be improved by research into the collateral damage of its policies especially ones which it may not be able to reverse. At the moment both ZIRP and QE are in that category even in the US. So should the period of QT lead to the issue below rising in volume get ready for the claims that it could not have been expected and is nobody’s fault.

I need a dollar dollar, a dollar is what I need
Hey hey
Well I need a dollar dollar, a dollar is what I need
Hey hey

On that subject I note that a bank borrowed 563 million Euros from the ECB overnight which is odd with so much Euro liquidity around. Next we come to the issue of the productivity puzzle which seems likely to have a few of its pieces with zombie companies on it. The same zombie companies and especially banks that have been so enthusiastically propped up. Time for some Cranberries.

Zombie, zombie, zombie, ei, ei
What’s in your head?
In your head
Zombie, zombie, zombie

What is happening with Bitcoin?

The world of Bitcoin is ever-changing at least in price terms. As I type this then one Bitcoin would cost some US $6720 as opposed to the peak of US $19187 in October of last year. So quite a drop but we also need to note that if we go back to this time last year it was just below US $2000 albeit the rocket engines to take it higher were firing up. So in terms of it being a replacement for money the price moves over the past year make it almost impossible to think of it as a store of value although if we look further back it remains party-time for longer-term investors.

The background

This is that Bitcoin continues to come under verbal and written attack. From Financial News this morning.

Three of the world’s most respected economists have led a joint attack on bitcoin, claiming the digital currency will be “regulated into oblivion” as governments globally move to clamp down on money laundering.

So the heat is on in terms of threats.

Joseph Stiglitz, Nouriel Roubini and Kenneth Rogoff have renewed their assault on the  cryptocurrency believing it will be subject to further sharp and damaging falls as authorities crack down on criminals using Bitcoin to launder money and to avoid paying taxes.

These are familiar lines especially from Kenneth Rogoff who infamously does not like cash either. As to the title I think there are more than a few grounds to challenge this hype.

The three respected economists have renewed their assault on the cryptocurrency

Bank for International Settlements

Towards the end of June the General Manager of the BIS Augustin Carstens weighed in heavily on this issue. One particular section was breathtaking in its cheek and apparent avoidance of reality. The emphasis is mine.

Cryptocurrencies promise to replace trust in long-standing institutions, such as commercial and central banks, with trust in a new, fully decentralised system.

The trust issue is one that those in Denmark will be mulling right now. From the Financial Times last week.

The Kremlin critic investigating an alleged $230m Russian fraud is set to file a criminal complaint against Danske Bank in its home country of Denmark, accusing it of being a central player in a vast money laundering scheme.

As you can see we are shooting two birds with one stone as we note the “trust” in Danske and the fact that yet again it is a bank accused of money laundering on a grand scale or the exact opposite of the claims of Kenneth Rogoff.

Danske is under mounting pressure over the alleged money laundering. Mr Browder and local media claimed this week that the amount of transactions that flowed through the Estonian branch of Denmark’s biggest lender may have been as much as DKr53bn ($8.3bn), more than double previous estimates.

As the total market capitalisation of Bitcoin is US $141 billion it seems to lack the ability to match the banks in this area even if every Bitcoin is used for money laundering. After all Danske is only one bank and even if we just remain in the relatively small geographic area of the Baltics there seems to be a lot of money laundering going on. Here is the Baltic Times on the IMF visit to Latvia which ended at the weekend.

strong measures are necessary to restore the system’s reputation following the halt to ABLV Bank’s operations, the IMF points out. Effective implementation of anti money laundering and combating the financing of terrorism (AML/CFT) recommendations has to focus on reducing the proportion of questionable foreign deposits and the risks they pose to Latvia’s financial system.

For those wondering about ABLV I analysed its fall on the 19th of February. As to the ramifications this emerged at the end of last month according to Reuters.

Ilmars Rimsevics, a member of the European Central Bank’s policy-making governing council, was charged with soliciting and accepting a bribe, the Latvian Prosecutor General’s office said on Thursday.

This has posed two legal moral and ethical issues. Firstly there is the issue of financial crime in the Baltic based banks which presumably is why the head of ECB banking supervision Ms Nuoy has just visited Lithuania as according to domino theories it is the only one currently standing. Also it has raised the issue of how and if the law applies to central bank governors in the Euro area.

Oh and Mr.Carstens has thoughts in this area as well.

The goal should be to ensure that cryptocurrencies cannot undermine the role of central banks as trusted stewards of monetary and financial stability.

Technical Details

Hyun Song Shin has been the go to man for this sort of thing at the BIS for a while now although he does start by posing an issue for the BIS itself.

Much has already been said about how impractical cryptocurrencies are as a means of payment,
as well as the scope for fraud and other illicit activities they open up. The line from Agustín Carstens’
speech that they are a combination of a bubble, a Ponzi scheme and an environmental disaster has been
much discussed.

I thought that central banks liked bubbles! Is he really trying to tell us that they do not? The issue of the “precious” returns yet again as in spite of all the fraud issues people like this always highlight problems which are usually much smaller elsewhere.

Returning to his main points they are as follows.

One is the lack of scalability, which is about providing flexibility and capacity to function as a payment system regardless of the number of transactions.

The second problem is the lack of finality of payments. A payment being recorded in the ledger
does not guarantee that it is final and irrevocable. For cryptocurrencies, what counts as the truth is a matter
of agreement among the bookkeepers.

This bit also caught my eye.

At one point last December, the voluntary user fee
reached $57 dollars per transaction. So, if you insisted on buying a coffee for $2 with bitcoin, you would
have had to pay $57 to process the payment.

As someone who lives in central London I would like to know where you can get a coffee for US $2? More seriously Bitcoin needs to up its transactions game although if this was a bank no doubt the message would be that it is a result of its success.

Energy

This is a hotly debated topic as this from Crypto briefing highlights.

Published by the research team at CoinShares, a London-based cryptocurrency investment firm, the report argues that significant Bitcoin mining operations are principally powered by cheap renewable energy, and use roughly half the amount of energy that has been previously suggested.

According to the report, published today, the Bitcoin mining industry consumes approximately 35 TWh every year; 50% less than the 70TWh currently claimed by the Bitcoin Energy Consumption Index, which also argues that BTC mining has a carbon footprint that exceeds 32m tonnes annually. ( TWh =Terawatt Hours)

Best of luck with the idea that renewable energy is cheap! There are of course some examples but in general it is raising energy costs.

Comment

There is much to consider as we mull  whether these are just birthing pains or crippling ones? On the side of the former is the way that the establishment continues to spend so much time trying to rubbish Bitcoin. If it is so bad why bother as it will collapse of its own accord if they are right? We get nearer the truth as we note that the accusation of promoting financial crime is beyond laughable from people who promote the “precious” with their next breath. As to technology I am also reminded that the UK banks are often accused of having systems still based in the 1970s. That may or may not be true but it is true that the Bank of England did not lower Bank Rate beyond 0.5% because it was afraid of the impact on the banks. Even now according to Governor Carney it thinks they cannot take them below 0% a consequence which I think is much for the best albeit it does highlight quite a weakness in IT.

Looking ahead this is so reminiscent of the development of the railways if we look at the broader picture. They are of course still with us although there are more than a few commuters who wish that they were not if their social media output is any guide.

Money, get away
Get a good job with more pay and you’re O.K.
Money, it’s a gas
Grab that cash with both hands and make a stash
New car, caviar, four star daydream,
Think I’ll buy me a football team ( Pink Floyd )

 

 

 

Negative Interest-rates are on the march again

This week is set to see much more news on the world of negative interest-rates and yields and we are already being warned that they are on the March with Reuters reporting this.

As you can see we have a new world record as Jeff Lynne would put it. Also it is a sobering reminder of the numbers we deal with today as yet again we find ourselves looking at trillions when supposedly there is not only no inflation but Larry Summers wants us to have much more of it. More of him later but for now let us continue with the policy of NIRP (Negative Interest-Rate Policy) which followed hot on the heels of the supposed cure-all of ZIRP where interest-rates were 0% or near to it.

The European Central Bank

The Euro and the European Central Bank are like the “supermassive black hole” that the band Muse sang about with its deposit and current account rate of -0.3% sucking neighbouring countries such as Denmark, Sweden and Switzerland into being satellites to it. If we move to government bond yields we see that the 2 year in Germany is at -0.55% and the 5-year at -0.36% as I type this so both are below the buying limit of the ECB itself. Thus markets are forecasting further easing on Thursday afternoon.

The most extraordinary features of this landscape are the way that 2-year bonds in France yield -0.44% and especially that the ones of Italy yield -0.06%. These in no way reflect economic reality in those two countries and are one of the clearest examples of market manipulation around.

The president of the ECB Mario Draghi has promised us more on Thursday via his Open Mouth Operations. We can expect another deposit rate cut to -0.4% or 0.5% as we again wonder how after around 5% on interest-rate reductions another 0.1% or so can possibly be key?! Also take care as other interest-rates may well move as other central banks ( Denmark and Japan for example) have moved to protect “the precious” and we may see an effort to exclude the banks from any pain. There are likely to be more bond purchases or QE with an extra 10 or 20 billion Euros a month added. We could see another “To Infinity! And Beyond!” effort by extending the scheme but last time the response to this was on the lines of Shania Twain.

Okay, so you’re a rocket scientist
That don’t impress me much

So if it comes it is likely to be as part of a combination. Also there may be other moves to help the banks which just by chance will help the Italian banks which one Mario Draghi used to supervise. Perhaps we will be warmed up to the purchase of high quality assets ( financial lexicon for these times red alert) at a future date like he did with Asset Backed Securities.

Bank for International Settlements (BIS)

This has intervened in the debate via its Quarterly Review and has in fact explained why the Bank of England shied away from 0% let alone NIRP back in the day.

Each central bank conducted an in-depth review of its IT systems as well as of its documentation and account rules.

Actually the Bank of England was more worried about the IT systems in the UK’s banks and that a year 2000 moment might apply if interest-rates went to 0%. As we live in a bankocracy it stopped at 0.5% where we in the UK remain. Sadly the BBC’s Andrew Marr was far to busy giving free publicity to the new book of former Bank of England Governor Mervyn King yesterday morning to ask such a relevant question. Indeed the toadying reached new heights with the use of the word “legendary” by the obsequious Marr.

As to the BIS on negative interest-rates they have caught up with something which has been a theme on here for 5 years or so.

The experience so far suggests that modestly negative policy rates transmit through to money markets and other interest rates for the most part in the same way that positive rates do. A key exception is retail deposit rates, which have remained insulated so far, and some mortgage rates, which have perversely increased.

We are reminded again of the principles of Goodhart’s Law and the Lucas Critique. But we find ourselves reviewing a situation where central banks can influence money markets but the impact on the real economy is not only muted it may be inverse and perverse. An example of this has been provided by Frederick Ducrozet of Bank Pictet.

Cost of negative rates = €2bn

Against a total loan portfolio of 17 trillion Euros this is a rounding item perhaps but nonetheless it is a transfer from bond investors to governments of 2 billion Euros a year which is usually described under the category of taxation. This is a deflationary move which of course is supposed to stop deflationary trends as my financial lexicon for these times finds plenty of work.

Being based in Switzerland perhaps the BIS economists have a genuine reason to rue this development.

In particular, Swiss banks have raised the lending rate on mortgages, even as government and corporate bond yields fell in line with the money market rates

The biter bit? Anyway this is yet another deflationary influence on a policy which is supposed to provide a stimulus. If we take a broad brush view then negative deposit rates to apply to wholesale deposits but extremely rarely to retail ones. Will this continue as Mario Draghi sings along to Madonna?

Deeper and deeper and deeper and deeper
Sweeter and sweeter and sweeter and sweeter

The BIS has its concerns.

Looking ahead, there is great uncertainty about the behaviour of individuals and institutions if rates were to decline further into negative territory or remain negative for a prolonged period>

Larry Summers

Larry seems to have worked himself into a panic, are the Harvard pensioners after him again? Or has his role in the repeal of Glass-Steagal come back into the news? From the Washington Post.

Market measures of inflation expectations have been collapsing and, on the Fed’s preferred inflation measure, are now in the range of 1 to 1.25 percent over the next decade.

Seeing as the target is 2% per annum that means a small undershoot in mathematical terms. However this may be the problem as Larry does not seem to be so hot at what he would call math.

In the 1970s, it took years for policymakers to recognize how far behind the curve they were on inflation and to make strong policy adjustments.

Actually the official measure of US consumer inflation peaked at 14.8% in early 1980 so a 12.8% overshoot is the same as a 0.75% to 1% per annum one Larry? Actually perhaps someone might nudge his elbow and point out that commodity prices are now rising (Brent Crude Oil has risen above US $39 as I type this).

Larry Summers wants everyone to pay more for things at which point he will do his best to claim that the inflation created makes people better off when in fact it makes them worse off.

Comment

There will be much to consider this week on the subject of negative interest-rates. Mario Draghi has repeated his pre- December Open Mouth Operations but you see according to the Bank of England Underground blog December was a disappointment.

That means the effect of QE2 on asset prices was still notable, for example, we estimate the extension led to a 5% depreciation of the euro against the dollar and a 6% increase in equity prices. Nevertheless, the extension’s impact was still substantially less than the initial programme both because the extension was smaller and had less impact per €100bn of purchases.

The situation is complex as we had more QE and an interest-rate cut combined but less bank for your buck (Euro) is the message here. Oh and you may note that QE and NIRP are being judged in terms of the exchange rate and equity markets. One in the eye for those who claim that there is any such intention!

Meanwhile Bank of Japan Governor Kuroda has been speaking clear this morning.

The answer is very clear. Individuals and firms as a whole will definitely benefit from this policy……..Deflation will not return to Japan. Price stability with 2 percent inflation will definitely be achieved.

Of course he introduced negative interest-rates only 8 days after denying any such intentions. Still here is food for thought for Japanese depositors and savers.

In other words, the interest earned on depositing 1
million yen for a year declines by 190 yen — from 200 yen to 10 yen.