EU Economy: Dude, where’s my money?

Why the attempt at suppressing the reward of dispossessing oneself (i.e., “Interest”) failed… and where has that money gone.

It sometimes happens. You are tired, distracted, scared, nauseous…. and that’s when it hits you, a different way of looking at things, some vantage point on reality you hadn’t found before. A bit like being the point man of a patrol in enemy territory.

In my case, the “Enemy territory” have been the financial markets. Mainly because of this:

ECB total balance sheet (source: Bloomberg LP)

Now all that Central bank liquidity, like a Tsunami hitting a shore, has wreaked havoc on price discovery which is (was, actually) the basis of the accumulation of wealth since time immemorial. Just to do a quick “back of the terracotta tablet” recap on why I think what’s happening is way off the reservation, here is how I would explain “interest” to a very young niece at a wedding reception, where there is neither time nor Laptops to go bonkers with Math.

Imagine, if you will, that you are in possession of a rather large sum of money, a sum which is large enough to surpass your foreseeable needs for years. As long as that sum is in your safe, you can freely dispose of it in any way you see fit: buy new clothes, a new car, buy your dream cottage in the countryside and live off the land, etc. Cash on hand is the ultimate optionality: it can transform itself (and you) into any things that it’s conceivably traded or exchanged… even a new passport, if you like Cyprus (poking someone? Of course).

So, it is quite reasonable to surmise that after these last six rows lines on a page, any reasonable person would think that he would part with freedom of disposing of that sum only under one or more of these conditions:

  1. he is forced, legally or not, to part with it;
  2. he is voluntarily doing something with it;
  3. under 2. above, he RECEIVES some sort of compensation, commensurate with his sacrifice.

Just to clarify further: if you think I am wrong, and “markets” *cough* are PROVING me wrong, you must accept that you stand by the opinion that a rational person should have a positive utility fromPAYING something in order to lose availability of his savings over time.

 Bluntly said, he must rationally accept the following contract:

Start date: Today, November 14th 2020

End date:                             August 15th, 2030

Amount paid:                                     105.800€

coupons:                                                 zero

principal:                                             100.000€

LOSS                                                  5.800€

In even simpler terms, a low risk tolerance saver with a bit over 100k Euros is predicted to prefer such a losing bet to (COVID permitting) a reasonably expensive weekend in Paris with a loved one… Just don’t tell my wife. She doesn’t speak English anyway, so if you don’t talk I most certainly won’t.

Now, do you think that contract above is possible or not? Would you accept it? Would you trust someone that would, to be in charge of your savings?

First one is easy: yes, hence the strange end date:

Current ten year German Government Bond (source: Bloomberg LP)

For the second, by all means, I am slightly more libertarian than Professor Bernardo de la Paz (look it up).

As to the third, apparently savers say an emphatic YES! 

The amount of bonds with negative yields has been Zero for 3.000 years of interest rates, but now it skyrocketed.

Total amount of Negative Yielding bonds in USD Trn. (source: Bloomberg LP)

Yet, this seemingly doesn’t faze Central Bankers. They are very much into “Climate Risk”, slightly less into “We’d better set money markets straight before someone comes to chop out heads!”. Why? 

Of course, the headlong rush by central banks to push down yields favors debtors, but especially the biggest ones: Governments. That’s where my daily nightmares helped… in imagining a dystopian parallel reality.

In this mirror world, rates never breach Bagehot’s1idea that rates should never be set by the central bank lower than 2%; rather, the Government simply sets a withholding tax on rates, which currently would be set on that ten year Bund at about 130% of the coupon. That issue currently yields minus 0.58%, from which :

-2.58% / 2,00% = 129% tax rate.

Generic 10 year Bund yield, source: Bloomberg LP.

Of course, the nature of money being what it is, such a tax would have generated an incredible diversity of loopholes, exempt entities, favored investments, etc. etc., with the added complication that you wouldn’t have been able to enforce a similar system on Equity / Private equity / Real Estate investments. So, our world is more “Elegant”: EVERY asset class is “taxed”, exactly like a making tide lifts all boats, from the sleekest yacht to the most ungainly barge. Of course, it also wets parts of the environment unsuited for such a humid environment, nonetheless…. We can put a conservative estimate in.

From the Graph above we can see that one estimate of negative yielding bonds is now at 16642 Billion USD. Let’s surmise that in the other universe, those securities would yield 2%, and let’s charitably say that the average negative yield on those securities is zero. That would put the amount of this “Central Bank Tax” at 330 Bn USD, or approximately 280 bn EUR per year.

Now you see my wry smile when I saw the figures of the Recovery Fund… To my small mind, Central Bankers have enacted EVERY YEAR a fiscal transfer from savers to debtors bigger that the whole of the Recovery Fund, with no awareness of the people involved or any political scrutiny. Politicians are of course quite happy with that: those kind of windfalls have NEVER happened in the history of mankind. Of course, this also impacts on what kind of politicians you have, and what they are inclined to do (i.e., anything).

I don’t want to delve in the “It would have been better or worse” discussions, especially since it’s totally immaterial: the glass vase is broken in tiny pieces, and I am unwilling and unable to put it back together. But I am slightly miffed that monetary and financial authorities are fixated on odds and ends outside their specific purview, like “Climate”, “Social justice” et al., without feeling in the least compelled to open an honest discussion on what going back to positive interest rates would entail. 

Because, Ladies and Gentlemen, make no mistake: negative interest rates, if you accept my three points above, do not exist in Nature. They are THEIR construct, and in the boondocks from where I come from, “you break it, you own it.

-Giovanni Ponzetto