"Central Banks Have To Keep Fooling All Of The People All Of The Time"

Tyler Durden's picture

Submitted by Alasdair Macleod via GoldMoney.com,

Today's obvious mispricing of sovereign bonds is a bonanza for spending politicians and allows over-leveraged banks to build up their capital. This mispricing has gone so far that negative interest rates have become common: in Denmark, where the central bank persists in holding the krona peg to a weakening euro, it is reported that even some mortgage rates have gone negative, and high quality corporate bonds such as a recent Nestlé euro bond issue are also flirting with negative yields.

The most identifiable reason for this distortion of free markets is bank regulation. Under the Basel 3 rules, a bank with sovereign debt on its balance sheet is regarded by bank regulators as owning a risk-free asset.

Unsurprisingly, banks are encouraged by this to invest in sovereign debt in preference to anything else. This leads to the self-fulfilling second reason: falling yields. Central bank intervention in the bond markets through quantitative easing and commercial bank buying leads to higher bond prices, which in turn give the banks enormous profits. It is a process that the banks wish would go on for ever, but logic says it doesn't.

Don't think that there is an economic justification for negative bond yields: there isn't. Even if price inflation goes negative, interest rates in a free market will always remain positive. The reason for this cast-iron rule is interest rates are an expression of time-preference. Time preference is the solid reason that possession of money today is more valuable than a promise to give it to you at some time in the future. The future value of money must always be at a discount to cash-in-the-hand, or put the other way, to balance the value of cash today with cash tomorrow always requires a supplementary payment of interest. That is always true so long as interest rates are set by genuine market factors and not set by a market-monopolising central bank, and then distorted by banking regulations.

So we have arrived close to the logical end-point in falling yields, and in some cases we have gone beyond it. We must also conclude that negative yields are a signal that bond prices are so over-blown that they are vulnerable to a substantial correction. Furthermore, when the tide turns against bond markets the downside could be considerable. The long-term real yield on high quality government bonds has historically tended to average about three per cent, which implies that sovereign bonds would crash if central banks lost control of the market.

Bond bulls are on weak ground from another angle. If history tells us that real yields of three per cent are the norm, has government creditworthiness changed for the better, justifying a lower yield? Well, no: the accumulation of debt across all welfare economies is less sustainable than at any time in the past, and demographics, the number of retirees relative to those in work and paying taxes, are rapidly making the situation far worse.

Macroeconomists will probably claim that so long as central banks can continue to manage the quantity of money sloshing about in financial markets they can keep bond prices up. But this is valid only so long as markets believe this to be true. Put another way central banks have to continue fooling all of the people all of the time, which as we all know is impossible.

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knukles's picture

At least Biden's heading to Iowa to stump and Kerry's not ruling out another run, so not all's bad in the forecast.

Self-enslavement's picture
Self-enslavement (not verified) knukles Feb 8, 2015 5:43 PM

Stop referring to them as Central Bankers. They aren't Bankers. They're counterfeiters.

ZerOhead's picture

They like to think of themselves more as magicians.

Abracadabra and Presto! Another trillion dollars of freshly created debt gets pulled out of the hat. Now kindly pay in gold on your way out please Mr. Muppet...

ZerOhead's picture

This just in...

Greece offers to forego all debt haircuts in exchange for a $325 billion euro refinancing at -5% interest.

Redneck Hippy's picture

Greek issues perpetual bonds at negative interest rates.  If Germany and the ECB aren't interested, I'm sure the Swiss central bank would see as a godsend, permanently drive down the franc. $325 billion is probably less than they've already lost in the FX markets. Win/win.

supercelld's picture
supercelld (not verified) knukles Feb 9, 2015 5:49 AM

I'm making over $7k a month working part time. I kept hearing other people tell me how much money they can make online so I decided to look into it. Well, it was all true and has totally changed my life. This is what I do... www.globe-report.com

saulysw's picture

I think the world is waking up...slowly...

Yen Cross's picture

 Hey, did anyone catch that gap down in aud/jpy on the Asia(N.Z.) open?  :-)

  The central bank farce~fest(jawbone) is going to be a lot of fun this week.

Winston Churchill's picture

A message from Vlad.

So much for secrecy.

ZerOhead's picture

Wants to talk to Obama in person without having the NSA/CIA/MOSSAD find out she's not on the same page as the neoclowns and try to kill her first...

eddiebe's picture

Well no, they don't have to fool all the people all of the time, they just have to buy the right people all of the time and kill the ones they can't buy. The rest may know what is going on, but can't or won't do anything about it. 

Actually it is going on and has been for hundreds of years now. Hoping or saying that it can't keep going on is really counter productive.

JPMorgan's picture

You can only conclude what they are doing behind the curtain is NOT in the general publics interest if they have to try fool the masses all of the time.

How much purchasing power has the dollar lost since 1913 again? 

B2u's picture

We need to ask Brian Williams about all this.  He must be involved with the solution...

wanwer's picture

Ok.  So tell me how to make money on this.  Puts on TLT?  How far out?  Details.

Redneck Hippy's picture

Puts on TLT is a bad idea.  How can U.S. bonds drop while Europe's at NIRP and the ECB and BOJ are buying up all the available bonds?  Demand/supply says U.S. bonds go higher.

Hannibal's picture

(from another Hedgie commentator)

"All paper money is a tax on existing money, the act of printing money itself negates the need for any other taxes. All other taxes are class warfare. Paper money is either used to enrich the wealthy or it is used to enrich those impoverished.

Good Socialism or Evil Socialism.

Transfer of wealth to the elite or transfer of wealth to those in need. Class warfare on the common man or class warfare n the 1%. However, the enslaved class has only itself to blame for letting their children grow up to be cops and soldiers that protect and serve the 1%. Self enslavement if you will."

yogibear's picture

It's the Western banksters vs Putin.


tok1's picture

I think they want higher rates (FED/BOJ) as zero / negative will bankrupt banks/pension funds and they know it.


They cant scream it out loud so the data will pop up and surprise.. Watch Japan Dec GDP...

stingboo's picture

Your bank deposit = unsecured loan to criminals..   oh, wait...I forgot.. that's where FDIC steps in: Fucking-Dummy-Is-Clueless