Yet Another Unintended Central Planning Consequence: Running To Stand Still

Tyler Durden's picture

Via Louis-Vincent Gave of GK Research (A Gavekal Company),

Lemmings And The Quandary of Negative Real Rates

For most portfolio managers, investable assets can be thought of as sitting somewhere on the risk-return curve shown below. Of course, depending on valuations at a particular point in time, positioning in the economic cycle, or overall geopolitical risks, some of the relative positions may change. But over long periods, investable assets have tended to display the risk-reward characteristics highlighted by the efficient frontier below.

Now in recent decades, investors could assume that across the length of an economic cycle, almost all investments would provide a positive real return. Diversification across the curve made ample sense, and this is precisely what happened: looking at the stock of global assets, one sees that out of an estimated $209trn in global financial assets (excluding real estate), $52trn sits in equity with $45trn in government debt, $65trn in loans (possibly a good chunk of which finances real estate), and $46trn in corporate debt. In other words, roughly one quarter of the world’s financial assets are in equity (on the top-right hand of the risk-return curve) with three quarters in debt (at the bottom left of the curve). This asset mix brings us to the policies followed today by most Western central banks of guaranteeing negative real rates for as long as the eye can see. This policy of negative real rates has an obvious goal: push out investors from the bottom left of the curve to the top right, thereby boosting animal spirits, creating jobs, and returning Western economies to a more solid growth environment. But could these policies suffer from the law of unintended consequences?

If we look at the risk-return curve today it is obvious that 75% of global financial assets are now locking in real losses, unless of course, inflation collapses and deflation takes hold in the major economies. Consider a 2 year treasury bond yielding 0.25% as an example. With inflation running at around 1.7%, anyone buying such an instrument is locking in a -1.5% real capital loss for the next two years. The same argument can be made for Germany where yields are even lower than in the US, even if inflation is running at the same pace (and likely to accelerate further), or indeed Japan, France or the UK... In short, in today’s world, it is almost impossible to gather any kind of real returns on fixed income instruments without either taking significant duration risk and/or quality risk, i.e.: moving up to the right of the curve.


Now let us assume for a second that the world will be spared a massive deflationary wave and that, consequently, the assets at the bottom left of the curve will lose 1.5% real per year every year for the next five years. This means that, for global assets to stay roughly in the same place, equities will need to provide a real return of 4.5% per annum every year for five years. This is broadly in line with the long term return of equity markets and, given that global equities are not blatantly overvalued, such returns may well be achieved. However, it is important to note that such returns will only serve to compensate for the capital destruction taking place in the fixed income market. Real returns on equities of 4.5% will not leave us any richer compared to our starting level. This means that investors will have effectively spent five years on a treadmill running to stand still. When you consider that no asset growth was registered in the previous five years, we are facing a whole decade devoid of capital accumulation. Given the world’s ageing population, isn’t this bound to be problematic?

Indeed, at a time when most pension funds are already far under water, does a policy that locks in real losses for plan managers really make sense? In short, can the world today afford the real capital destruction central banks are engineering through negative real rates (perhaps we can if that capital destruction mostly occurs on the central banks’ own balance sheets?). This quandary brings us back to the law of unintended consequences: just like the pensioner who, sitting on a fixed amount of capital, will simply buy more and more bonds as interest rates are pushed down (for he needs a fixed level of income—witness Japan over the past twenty years), won’t the world’s pension funds, sitting on real losses because of their existing large fixed income holdings, prove ever more resistant to moving to the far right of the curve? Could the negative real interest rate policies, by destroying capital, guarantee the world a period of sub-par investment growth, sub-par productivity growth, and sub-par economic growth instead? This is what occurred in Japan for a decade, once the bank of Japan moved to a zero rate policy. Basically, ZIRP meant the banks could not make much money, nor were they interested in taking much risk or making loans. And without bank credit, the economy just puttered along, while equities continuously de-rated.

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thisandthat's picture

Can't wait for the world of tomorrow...

The Heart's picture

"Can't wait for the world of tomorrow..."

Granny used to say, "Be careful about what you ask for."

Hate to say this, but anyone living east of Hanford or in the vicinity of this mess is in deep doo-doo.



markmotive's picture

Another consequence...we're all fat.

Seriously...decades of easy money and endless debt has allowed us to live far beyond our natural means. We buy more, we travel more, we eat more.

Same thing has happened to citizens of empires that came and fell long before us.

DJ Happy Ending's picture

I've made a mountain of money in junk bonds and high yield REITs in the last five years so whatever.

akak's picture

Bully for you.

Let's see you repeat the performance in paper over the next five as well.

DJ Happy Ending's picture

Ok, let's. Game on. Everyone said the same thing to me back in 2009 when I was doubling down.

The canary in the coalmine will be nations that import most of their food. When the SHTF in a few of those places, I will begin to think twice. Until then, ride it bitchez.

akak's picture

Pennies, meet steamroller.

DJ Happy Ending's picture

You're just bitter. Nations that export food will be hit last. You watch.

I buy gold coins for my babies because I know it will end eventually but why not ride it until then?

akak's picture

I don't think I am bitter, or jealous, or envious, I merely suggest that the risk of investing based on the assumption of an indefinite continuation of the current financial and monetary status-quo is most likely rapidly rising.

DJ Happy Ending's picture

I never said anything about indefinite. Re-read where I said I'm buying gold coins and watching for SHTF in nations that are net imports of food. Nice try.

StychoKiller's picture

(SMACK!!)  And down goes Ponzi, down goes Ponzi! :>D

bunnyswanson's picture

You could eat a mountain of shit but if there are no vitamins, minerals and essential elements our bodies must have, your will still be hungry. 

If your shit is full of high fructose corn syrup, you'll be diagnosed with fatty liver disease, impacting the metabolization process, and eventually ending in liver failure.  I know a man with NASH who has been a veggan (with a sweet tooth) for 20 years.

Do you salt your shit?  Wash your shit down with a soda ladden with salt?  Kidney failure is on the calender.  Don't drink the water though because the fluoride in it will deposit itself on the pituitary gland, I believe, which will have a profound impact on a sense of well being.  Caffeine consumption goes up to get through the day, another assault on the kidneys and CNS.

So you have overweight, undernourished citizenry whose ability to function is impaired.  Educating them with information that is formulated to keep them from asking questions so the fat cats can do as they please.  Knees and hips go out, energy required to move across the room is what one would use to get through the day.  But it's intentional because this was necessary .... before the seige. 

Movies.  That is what they used to Pacify the masses.  Netflix movies every night, sometimes 2 movies in a row on a weekend, something our grandparents did a few times a year because it was a luxury to sit in place for 2 hours and watch a movie, there was too much to do.  The malls were open 24/7 during The Great Credit Extensions.  Entire sections of undeveloped areas of the towns around central california turned into malls, outdoor, Stores and Stores and more fucking stores.  Every time you walked into the door someone would give you a credit card application; no one was ever refused.  10% off the purchase.  The gimmicks they used worked. 

 A One-World-Sewage-System - And if you think I would sit here and do nothing while globally, a group of men who are friends with George W. Bush got into position to rule the entire globe, basically ensuring that at some point in history, 200 years or 1000 years from now, a homicidal maniac is sitting in the throne, bestowing on the peasants what Billy got in Turkish Prison, you've lost your fucking mind.

bunnyswanson's picture

It is important to add to this concept of "if you build it they will come" or "If you give them credit and high-end stores with to-die-for items priced reasonably" then will come.

But now..the new malls/stores are where everyone shops.  Leaving the original shopping arena of the towns without business, those were the entry level new businesses who had no customers.  New mall has about 15 customers walking around, Macy's has about 3 customers.  Everyone looks bored and resentful.  Credit was extended to not only home buyers but new business owners, and when the blue collar workers lost their jobs, they lost their customer base. 

China is doing well at the cost of America.  So is India.  The elected officials are alright with that.  Even in light of the tax revenue going to other nations....they have handed tax revenue to other nations all for the dick pounding they get from their campaign donors.

It is nonsensical and simply outrageous that US citizens can even look each other in the eye when considering what is clearly leading up to foreclosure.   This isn't a movie.  NZ, australia, EU, Canada, it's all right fucking there.  We cannot talk about it because the MSM meme is the only meme allowed to be acknowledged.  It's a mindphuck that will send humanity into a tailspin that will never end.  never....never.  it will never be reversed if we do not stop it now.

You are either with us or against us.  He said that and it applies to everything now.  But this is insanity.  This is a flawed attempt to guarantee financial security to the wealthiest people on earth.  Men have pride.  Competition is fun, it's a "bet" and winning is the goal.  They make mistakes.  If they were perfect, they'd have approached in a manner that would informed us and ask our opinions.  Voting perhaps would be nice.

Staged events, skits and their global Media  Cunt News Network...telling us what really happend. 

All one would need is a media outlet.  That's all.  If you could get this to the living rooms, let everyone know globalization is a scheme which will leave the middle class to go the way of teh Mayans and if you can't work, you can't live, and if you get sick, you have a duty to die.

Fuck that.  Go the opposite direct that these mad hatters.  They are sheltered from the reality and the worst of this planet is due to them and their colleagues, not the people.  It's another misinformation campaign to sway public opinion. 

Believe me, they'll thank us when it is over.  There's a better way and who will implement it will be the people, not the banks, et al.

Groundhog Day's picture

Debt free savers have been waiting for deflation for a long time.  Are we just suckers who should piss our savings away, go into debt and wait for a bailout or will our prudence pay off? I for one am getting tired of waiting

Diogenes's picture

Government is the enemy of every decent honest hard working citizen. As long as you continue to work and save they will suck you dry and call you dusty.

bunnyswanson's picture

A merciless govt perhaps.  An unstable govt.  A corrupt govt.

In a democracy you vote for the man who will give you a stable country because this will allow you to raise your family and enjoy your hobbies and prosper as you wish without worrying about whether medical/utilities/education/water/law and fucking order.

A govt is necessary.  If you think we can all manage without a leader than well, take a look at the Katrina aftermath. (Gun confiscation)

It's poor leadership that brought us here.  Nothing more, nothing less.  One world govt is a fantasy by men who know they'd rather die than go down the ladder of success.

Chuck Walla's picture

In a democracy you vote for the man who will give you a stable country because this will allow you to raise your family and enjoy your hobbies and prosper as you wish without worrying about whether medical/utilities/education/water/law and fucking order.

And in Bunny's wold, Bush is the villain, just one in a long line of Progressives. And Obama, Sugar Daddy of Welfare for votes, destroyer of people everywhere is the answer to stability?


Join with me then...


bmwm395's picture

ok sweet showe me how i can meke more i ll do it itss all a joke

srry im drunk burrp


StychoKiller's picture

I can has a flying car?  Anyone for Jet-packs?

max2205's picture

Small caps will get fucked 1st.   But we'll get 4% a month till then

q99x2's picture

The Shits going to hit the F'n fan before 5 years or I'm going to puke.

Never One Roach's picture
Protesters, police clash in Spain



By Laura Smith-Spark, Per Nyberg and Laura Perez Maestro, CNN updated 7:52 PM EST, Sat February 23, 2013

Madrid (CNN) -- Tens of thousands of protesters amassed in Madrid and other Spanish cities on Saturday to voice their anger over harsh austerity and the way the country's being run in the wake of its financial crisis.

In Madrid, demonstrations turned violent and two police officers were injured, Spanish national police said on Twitter. Forty people were arrested.

dolph9's picture

The Spaniards don't get it.

Despite the success of their soccer team, they are Germany's bitch.  Unless they grow some balls and decide not to be Germany's bitch, they will suffer just like the Greeks.

StychoKiller's picture

Austerity?  In Spain?  The Spanish Govt is spending even moar Zeuros, yet it's austerity?

Maybe for the little people...

El Gordo's picture

I consider cash in the matress to even be a risk asset in today's financial environment.  No guarantee it will be worth anything in the near future.

holdbuysell's picture

That curve left out a few crucial assets.

StychoKiller's picture

Ever read "Flatland"?  Aurum is a 3-dimensional construct on those 2-dimensional graphs.


shinobi-7's picture

How ironic after so much criticism to see that under the same circumstances, Western countries follow the same “Japanese” policies! The “old man” would tell us to expect similar results!

Uber Vandal's picture

Are you sure that Real Estate shouldn't be below the zero line when property taxes and business closures are factored in?

And if you get technical, with fat finger-Corzine-Madoff trades, a real return of zero may start to look good.

holdbuysell's picture

I'll add flash crashes, a structurally unsound stock exchange, market-rigging and market-destabilizing algos, and blatant non-policing of corruption/theft by the SEC.

The concept of only investing in Wall Street what you can afford to lose is eerily similar to what's said about gambling in Vegas. So sad.


hidingfromhelis's picture

There ya go, taking all the fun out of what's left above the line.  

Unfortunately, in this sham of a market, the real line is a whole lot higher due to the reasons you noted.  That forces people into the rigged markets to take greater risks to avoid a negative return.  Nice catch-22, isn't it?

StychoKiller's picture

In other werdz, the given curve is discontinuous (in the mathematical sense!)

Stay away from derivatives of that function! :>D

Hedgetard55's picture

A Wall Street ho came in my shop this afternoon and we somehow got on the subject of Bernanke and his bailout of banks and his 85 large per month printing, and this black female ho gave me the standard line about how if he hadn't bailed out the TBTFs that the ATMs would have run dry and yadda yadda... I wanted to... well, never mind, the ho' left the shop after I predicted for her the financial collapse of the USA within 3 years. Fucking bitch.

Pure Evil's picture

Of course she's happy Berstank bailed out the TBTFs.

If he hadn't there'd be no money to buy crack and pay the Ho's for giving a skully.


Mr. Hudson's picture

This "the sky is falling" stuff is getting old.

Hedgetard55's picture

The sky has already fallen, you stupid motherfucker, and you don't even know it yet. 

Mr. Hudson's picture

So, what are you going to do about it, besides whining and crying? If the sky has already fallen, and all you can do is complain, then who is the "stupid" one, dummy?

GMadScientist's picture

So is the:

- Unemployment

- Zero or negative returns on safe investments

- Lack of Wall St criminal prosecutions

- Monetization of public debt

- Deficit spending

- War

- Continuous whining from ignorant shitwits such as yourself

QQQBall's picture

Not being snarky...  "Monetization of public debt".  We creaste money out of thin air to "loan" to ourselves, This will continue until it cannot.  

holdbuysell's picture

The subprime sky fell, but of course nobody in the status quo saw it coming. They were, shocked, SHOCKED when it hit. Even Bernanke said subprime was contained to the very end.

Looking back on it, they made Baghdad Bob look completely credible.

Now, all those problems and more are building once again (student loans, car loans, debt levels, and on). This is the most obvious train wreck in progress that anyone not vested to riding it into the concrete wall can see objectively.

orez65's picture

I'm really trying to understand people like you.

Why can't you understand that the "the sky is falling"?

Do you understand what money is?

Do you understand what aggregate demand is? And that it is Keynesian fiction?

Do you know who John Maynard Keynes is and his economic theory?

Do you know what monetization of US Treasury debt is?

Do you understand what the Federal Reserve is and what it does?

Because if you did, then you would know that "the sky is falling"

StychoKiller's picture

An argument can be made that the sky has already fallen, but no one has started counting the casualties yet...

Bicycle Repairman's picture

The casualities will not be counted.  Why?  They're losers.  Right?

orez65's picture

I'm really trying to understand people like you.

Why can't you understand that the "the sky is falling"?

Do you understand what money is?

Do you understand what aggregate demand is? And that it is Keynesian fiction?

Do you know who John Maynard Keynes is and his economic theory?

Do you know what monetization of US Treasury debt is?

Do you understand what the Federal Reserve is and what it does?

Because if you did, then you would know that "the sky is falling"

Diogenes's picture

I agree with you completely. I have been reading this site since 2009 and you are totally right. Unfortunately in that time I have kept out of the stock market because I was sure it was ready to collapse any minute, and missed a four year bull market.

So now I'm thinking there is a flaw in this reasoning someplace but can't figure out where. The economy is still up shit creek, all the stats are bogus, the markets are totally manipulated and I missed out on a 40% run up.

Missiondweller's picture

Because we have "normalcy bias" and think we still have a free market.

You/ I would have both been right if it were not for endless QE. Still, I don't believe this craziness can go on forever. I highly expect you'll be able to buy the Dow arounf 6500 again at some point in the future.

The Dow/Gold ratio drops to 1 every 30 years or so.  I say gold and the Dow will meet around 6500.

StandardDeviant's picture

Annoying, isn't it?  It suggests to me that the right strategy under these conditions is short-term trading -- maybe trend-following with a fairly tight trailing stop; or one- to two-month options strategies which are short gamma?  If/when TSHTF, you'll lose on your current trade, but with limited risk, and with a string of short-term gains in your pocket.  A lot of work, though.

Alternatively, there's the approach promoted by Nassim Taleb in his latest book, "Antifragility" (highly recommended, BTW!):  most of your assets in something low-risk and boring, and a few highly risky bets which are exposed to positive "black swans": biotech, maybe?

Any comments from the pros (if any are left) on this site -- institutional traders, prop traders, CTAs, etc.?  Or has everyone thrown in the towel and joined an algo fund?