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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holdbuysell's picture

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

You've been signed up here for only 22 weeks...what gives?

buzzsaw99's picture

I don't know where they get that 4.5% real return on equities. What a crock! Is the author guaranteeing a 4.5% roi for the next five years straight? Cash in the matress looks a lot better than giving it to a bunch of maggots so they can keep buying bigger fucking yachts every year.

GMadScientist's picture

B-b-b-b-b-but I've got "company match"...I'd be silly not to put 6% of every paycheck into the casino. ;)

GMadScientist's picture

One downer either doesn't get sarcasm or works for a mutual fund.

Spigot's picture

I would put the red line two Xs up, just above Emerging Market Debt. Real Estate is dead, period (until inventory and bancrupcies are washed out of the system). Emerging Markets are severely exposed to fraud and currency depreciation and typically blow up in your face.

And one has to factor in taxation on profits as a decided negative influence...on net yeild.

GMadScientist's picture

I'd put that red line just above private equity and see, all these investments pay out in US dollars.

More succinctly: fuck paper.

Oldwood's picture

How about investing in assets rather than gambling on equities? Real assets don't lose value. Equities are pieces of paper. Promises. And we know what they are worth...don't we.

Confundido's picture

No, we don't know what they are worth. We are simply able to touch them, so we can remind ourselves we still own them...

StychoKiller's picture

Hmm, got a trunk full of stawk certificates do ya?  DTCC pwns yo @zz!

Spigot's picture

Here's the rub: if you run a pizza shop you average 30% ROI/annum (at least before ZeroCare). If you think "investing" is choosing to trade yer FRNs for one pc of paper or another, then you are gonna get skrewd. If you own and run a business you are much closer to the actual profitability part of the equation. Equities and bonds assume you paid the costs of management of the company and costs of finance to issue the bond, as a detraction from the yeild you get. IOW they got paid before you took the risk, ummm hmmmm. Remove these layers and with smarts you could actually MAKE a profit. You will have to work for it, though.

In order to tap into the money stream you have to exchange value for the money. Customer too lazy to divide a #10 can of beans ($4 at SAMS these days) into 10 12ounce bags and freeze? Sell em 1# or 12 ounce cans for $2. THAT is how you make money. Not buying friggin pcs of paper.

StychoKiller's picture

Hmm, gotta check out the closest Asian/Hindu market for millet and farro...

JustObserving's picture

That's what happens when your debts get too high.  Then you cannot service them.  So you have to print money and buy your own debt driving down interest rates to almost zero.

That kills yields for everyone.

And then strangles the economy.

csmith's picture

"...perhaps we can if that capital destruction mostly occurs on the central banks’ own balance sheets?). "

Ding! Ding! Ding! What do we have for him, Johnny?

We all know that any capital loss which happens on a central bank balance sheet DOESN'T REALLY EXIST !!!

andrewp111's picture

Once a central bank starts paying out more in interest than it takes in, we are on the road to hyperinflation. Every hyperinflation in modern times has had this precursor sympton.

blindman's picture

somehow there should be a rotation about
the x axis included in this graphic over time?
and the question of "return", how does return
relate to value? r= basis value as an income
producing object x employment. as employment
goes to zero so does return but intrinsic value
is the same. this is why there is a rotation
called for as venture capital becomes a greater
loss than cash in the mattress. it is because
risk is not scalar but a vector plotted with
insufficient dimension. something like that ..

blindman's picture

i think i figured it out.
if you rotate the entire graph 90 degrees and
visualize the third dimension also rotating vs
time with greater and greater frequency you
have the image, the flushing toilet is a perfect
analogy. the basis is a waste product or at best
a resource with no identifiable value as the frequency
of the entire dynamic in the domain increases.

olto's picture


Can't you see that the new is not the same as the old?

blindman's picture

now that you mention it, no i can't.

StychoKiller's picture

LOL!  The moniker explains it all!

blindman's picture

they always do, there are no random events or names.

blindman's picture

another reason there needs to be a rotation about the x
axis , the return is in a unit that is being diminished
by the creation and operation of the return generating process.
that might be called "diminishing returns" in a diminishing
unit of measure.
another analogy might be the electric
snake used by plumbers to clear out the septic waste line
that connects to the sewer system and becomes fouled with
clogs of rootlets and feces contaminated materials. if there
is rotational energy the blades can cut and move through the
matter to clear the line but if you lose the power to rotate
the snake the line remains clogged.
yea, i know, it is all about the bathroom, feces and plumbing.

Confundido's picture

Private equity shall be the winner. Or why do you think in Iraq, Somalia, Argentina, Bolivia, Egypt etc., everyone owns a small business with no bank accounts, not taxable, etc?

GMadScientist's picture

Notice any missing asset classes in that chart?


StychoKiller's picture

And...I type again:

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

Downtoolong's picture

Running as fast as you can to stay in place. Isn't that what happened to Alice in Wonderland? But, that's a different fairy tale than the one we're living now.


blindman's picture

speaking of unintended consequences ...
Palestinians Sneak Sperm Out of Israeli Prisons
Fertility doctor cooks up smuggling scheme
By Neal Colgrass, Newser Staff

Posted Feb 24, 2013
(Newser) – The wives of Palestinians held in Israeli prisons are getting pregnant in an odd way—by smuggling out the prisoners' sperm, NBC News reports. But the families won't say how they get the sperm past a glass separation, body search, and an airport-style scanner. "If I told you the way we smuggled it, definitely the army will prevent it from happening and there are prisoners we don’t want to deprive of this same chance," says mother-to-be Lidya Al-Rimawi, who only divulges that they used "a small nylon bag."
so it is true the prison industrial complex is about population
control, literally.

GMadScientist's picture

Hmmm...condoms up the butt...well at least the little guys will have an early inkling of what kind of future awaits them.


Cheesy Bastard's picture

so it is true the prison industrial complex is about population
control, literally.

Seems to me in this case it's more about copulation control.

Alcoholic Native American's picture

I have no capital that can be used to seek more, spare me these sob stories of capitalist lacking promising ventures, if only that could fix the economy, as far as i can tell that is how we got here in the first place.


The propaganda is getting deep.

GMadScientist's picture

Exactly. If they don't like the economy wrecked, why'd they wreck it in the first place?

Pure Evil's picture

So they could steal the depreciated assets for pennies on the dollar.

Seer's picture

The "economy" was always on a collision course with "finite planet."

GMadScientist's picture

Agreed; Mother Nature is suitably unimpressed with their stack of derivatives (she made all that paper first, ya know), but these clowns didn't need to stomp on the accelerator and rip out the steering wheel.

Rusty Shorts's picture

Time is Money, but Money is running out of Time.

espirit's picture

On a continuing curve plotted against time, the roller-coaster ride is about to pick up speed.

BTW - I think the bottom tracks are missing.

Yen Cross's picture

 It's 03:00 in London. Yep, It's about time for these philosophical conversations.

Yen Cross's picture

 Once was enough. You have a crumb on your right lapel.

olto's picture

Bad day/night, Yen??

Have another up of tea----kick back----give your discriminating mind a rest-----check your pulse rate----take a deep breath

Now, doesn't that feel better??

No charge---I retired in 1993

Yen Cross's picture

   I'm doing voodoo with a "dead person".

olto's picture


You are doing "doo doo with a vead person"?

I don't get it-----Oh----sarc, right.

You are a really funny dude, Yen----wanna dance???

The rules say that we can't say-----shhhhh!

hannah's picture

funny how the 'cash in the mattress' level seems to be the safest. at least you keep most of your cap(less qe).

pbppbp's picture

I don't see gold or silver on that chart.

StychoKiller's picture

Sigh, once more:

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

cobra1650's picture

No gold or silver on the

cfosnock's picture

Its called "The Red Queens Race"...


"A slow sort of country!" said the Queen. "Now, here, you see, it takes all the running you can do, to keep in the same place. If you want to get somewhere else, you must run at least twice as fast as that!"

which way western man's picture

"jews" building their "jew" only land of milk and honey whilst flooding the rest.......this is what a REAL genocide looks like