16th July 2012
It has been along the lines of the aphorism that those who have some will get more and those who have little will not. We now live in bond yield terms in what is something of a bi-polar world and it would appear that Rudyard Kipling's phrase "never the twain shall meet" is an apt description. And in addition I am sorry to report that economists have often rushed to put their flag on one of the poles and claim that it means their theories are correct conveniently forgetting the existence of the other pole.
What do you mean by a bi-polar world?
Examples of one pole are given regularly on this blog as I recount borrowing costs in the peripheral nations of the Euro. This morning the Spanish and Italian ten-year bond yields are both over 6% at 6.73% and 6.08% respectively. They find themselves facing bond yields which are best make debt financing expensive and also ones which if they are sustained will make them insolvent.
We do not have to leave Europe to see examples of the opposite pole. Germany is an example of this but so is the UK and the most extreme case is Switzerland. This morning the German ten-year bond yield is at 1.25% and the equivalent UK Gilt yields 1.53%. I had to be careful with the decimal place for the UK because in my career it has been ten times the current amount! You may need to be sitting comfortably for the next bit as in Switzerland we see a ten-year yield of 0.53%.
One corollary of this is that countries at one pole can borrow extraordinarily cheaply. In the past week or so three countries have issued ten-year debt at record interest rate lows or if you prefer price highs. The UK at 1.72%, Germany at 1.31% and if we extend our geography to anothe case the United States at 1.46%.
The Economic Consequences of this
We see circumstances where monetary policy appears impotent
If we examine my country the UK we saw official interest-rates cut to 0.5% over 3 years ago. And if we examine the Liebor scandal there seems to have been further pressures on semi-official interest-rates too. Added to that we have seen bond yields plummet and the Bank of England try to pump cash into the economy as well via the £328 billion of Quantitative Easing it has indulged in. It will try again with another £1 billion this afternoon. And of course there is the new bank subsidy scheme called "Funding for Lending".
On the other side of the coin we see this from the National Institute for Economic and Social Research which I reported on last week.
Nevertheless, these figures suggest that the UK economy remains broadly flat; a trend that has persisted for around 24 months.
So we see evidence for a modern version of what John Maynard Keynes called a "liquidity trap" where (further expansionary) monetary policy becomes ineffective. When this was conceived I am not sure that economists differentiated between short-term interest rates such as the UK base rate and bond yields much if at all. However I think that both are now at levels where we are in a liquidity trap. I have argued much of this before but the further plunge in bond yields in 2012 seems to have reinforced this. The past falls in the credit crunch era should have helped more than they have so this years are unlikely to help the economy much if at all. I also worry that via demonstrating the seriousness of the situation there is an undercurrent or backwash effect on confidence and expectations.
In essence it all comes down to the question why are we not doing better than we are? And we can widen this to the United States as evidence of a slowing down there builds.
Negative bond yields are spreading
Another trend which I pointed too on Friday is the spread of negative yields. We have had negative real yields in many places for some time- where likely inflation exceeds the interest-rate received- and official policy has been in general to drive real yields below zero. But we are seeing more and more ordinary or nominal yields drift below zero.
Switzerland is the most extreme case currently where even her five-year bond yield is negative this morning at -0.025%. Marginal maybe, but five years along the curve…. Could her ten-year yield go negative too? That would be quite something. It would not be much fun being a saver in Switzerland would it? It would be fascinating to see the level of savings and borrowing that was stimulated. As we stand the most negative number is the Swiss two-year yield at -0.425%.
This issue has surfaced in Germany too as her two-year yield has fallen to -0.05% and her three-year yield has drifted below zero too. Investors are apparently willing to get back less than they invested to get the security of the stamp of the Federal Republic of Germany on their investment. We will have to see if they are right that the two to three year zone presents a particular danger.
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