On The Hypocrisy Of Central Banks Removing Tail-Risk

Tyler Durden's picture

Via Martin Sibileau of "View from the Trenches",

One cannot but wonder at the idiocy blindness of those who sustain that both the European and the US central banks removed “tail risks” in the last days, with their new measures. To start, the whole idea that a tail risk exists is simply a fallacy of Keynesian economics. It assumes there is a universe of possible outcomes and, as if humans acted driven by animal spirits, randomly, each one of them has a likelihood of occurring. In all honesty... what else can occur if a central bank prints money to generate a bubble? Why would the bursting of the bubble be called a tail-risk, rather than the logical outcome? Why, if that was tried in 2001 in the US, resulting in the crisis of 2008... why would it be any different now, when there is an explicit announcement to print billions per month? Why?


...as if that was not clarifying enough, as an example of the chaos that the Fed and ECB's actions have engendered on the world via uncertainty over risk-free rates - and the stunning realization that the global risk-free rate curve is now split between Europe (ST) and US (LT)...

With the European Central Bank backstopping short-term EU sovereign debt (as long as the issuer submits to a fiscal adjustment program), we should see two trends taking place:


The first one, mentioned in our last letter, is that the market should arbitrage between the rates of core Europe and its periphery, converging into a single Euro zone target yield. The Italian auction mentioned above, together with continuous weakness in Germany’s sovereign debt, the movement of capital out of the US dollar to the Euro zone (lifting the Euro to $1.31) and the rally in EU banks, would seem to indicate that this convergence is slowly materializing. The critical piece here, the one that will really nail this coffin, is the return of deposits transferred to the core of the Euro zone, back to the periphery that originated them. This is what’s behind the ongoing negotiations towards a banking union. Ironically, if the banking union was successful, making deposits return to banks of the periphery, it would make it easier for the Germans to leave the Euro zone, because the current imbalances of the Target 2 system would disappear, radically lowering the cost of the exit!


The second trend, the one we missed last week, consists in that –perhaps- we will no longer be able to talk about “the” risk-free rate of interest, when we refer to the US sovereign yield. If the first trend proves true, there would be no reason to believe that the short-term US sovereign yield should keep as low as it is vs. the equivalent EU sovereign yield. For all practical purposes, in the segment of up-to-3 years, the European Central Bank would set the value of the world’s risk-free rate! The big assumption here is of course, that the first trend, above, holds true. Only then, the arbitrage between the US sovereign yield and the EU sovereign yield could be triggered.


What would the levels be, for the up-to-3 year yields? As we know, the European Central Bank will not pre-commit to a yield target. Of course, they don’t want to be challenged, because there is only so much they can sterilize before they start suffering a net interest loss, as we explained last week. But from a dynamic perspective, what counts is not the level, but the driver: In the long run, as the sterilization fails (also explained in our last letter and first proposed back on May 13th, 2010), the short-term “risk-free” rate of interest would be driven by the consolidated fiscal deficit of the Euro zone.

Having said this, the remaining question is what determines the value of the long-term risk-free rate of interest. The Fed, in our view, although not announced last Thursday, will eventually continue to purchase long-term US sovereign debt. Effectively in the beginning, the Fed would set the value of the risk-free yield curve, past the three-year point. When things get out of control and inflation expectations for the US dollar take the lead (in a few years), the fiscal deficit of the US should determine the dynamics of the long-end of the curve….Does that make sense? No! (At least not, if you are not Keynesian) Because if “things get out of control”, we must say good bye to long-term interest rates altogether. That market will evaporate, and the US will only be able to sell short-term debt.

At that point, if the Euro zone still exists as we know it, the battle for the ownership of the risk free rate will have been won by the European Central Bank, by definition. Why? Because by definition, if the Euro zone still exists, it is because they succeeded in stabilizing their fiscal problems. Otherwise, the shortening of the term horizon for the US sovereign yield should continue contracting, until hyperinflation completely wipes it out.

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roadsnbridges's picture

CBs cured AIDS?  WTF?

Oh, that tail-risk.

Pladizow's picture

That power curve just moved further away from the axis and now has a tail a black man can appreciate - Oh My God Becky!

ZIRP, NIRP, QE, TWIST, LTRO = Life Support!

Vampyroteuthis infernalis's picture

You hit it Pladizow. The elites have found a way to stay on top without submitting to the short term problems. Money heroin will wear off someday.

asteroids's picture

The FED and ECB have obviously co-ordinated on an infinite printing policy. But, what if they are wrong?. The "crisis" is now 4 years old! Folks, we have fought world wars in shorter time! What if every other central banker on the planet follows same?

roadsnbridges's picture

No 'what if' about it.  How long will you survive on eating yourself?

Landotfree's picture

“things get out of control”

There is no control when a system is based on the equation.

"The FED and ECB have obviously co-ordinated on an infinite printing policy."

Sorry no such thing exists nor could exist.

The Fed's mission is simple, expand the global credit market to it's max potential, then when it collapses watch just like everyone else.   A little late to be complaining don't you think?  Of course you can lodge your complain with the complaint department which will shred it upon filing.


"JELTZ (INTO THE P.A.) There's no point in acting all surprised about it. The plans and demolition orders have been on display at your local planning office in Alpha Centauri for fifty of your Earth years, so you've had plenty of time to lodge formal complaints." _Hitchhiker's Guide to the Galaxy


RobinHood73's picture

"FED PUT " Is our Pavolvian "DINNER BELL". Notice how the market is only starting to weaken now that QE Infinity has bee nannouced? That is not coincidence. That is because Primary Dealers are dumping to the public , who have been trained and brainwashed to believe in the safety and commitment of the central bank. ITS A GIANT POKER GAME AND THE PUBLIC ARE THE SUCKERS AT THE TABLE

roadsnbridges's picture

You bought then, right?

This was just another down Monday, to let the 101K's feel they got in cheap.

TheSilverJournal's picture

Once a bubble is created, the question is not if it bursts, the only question is figuring when will it burst.

Rainman's picture

rumor number is December 21 2012

tbone654's picture

trade date or settlement date?

Tao Jonesing's picture

What about exogenous shocks such as the oil crisis of the 1970s?  Can't an exogenous shock unrelated to monetary policy trigger "tail risk"?  Or did Keynesians invent exogenous shocks, too?

Hurricane? Tsunami? Earthquake?  Other acts of God?  All Keynesian inventions . . .

lolmao500's picture

The Tail Risk is Ben doing the SANE THING and stop all his insanity before it drives us to WW3.

roadsnbridges's picture

Is it really a possibility to get hyperinflation in the developed world anymore?

What needed product is so restricted to nation of origin so as to cause problems?

Other than Goobermint, I see none.  The 2nd Amendment can cure that one.

q99x2's picture

The central banks have moved to the physical war against the people of the earth. I'm not sure if that kind of language still applies. English right?

Drachma's picture

Bernanke to Epimenides: "All Central Bankers are liars."

LMAOLORI's picture



The Fed is pursuing an end run around congress but it's the politicians fault in the end because they could do away with the fed if they wanted to.

Sneaking Past Congress

Hedgetard55's picture

Ben got to work, as instructed by Chuckie S.

kaiserhoff's picture

Great Piece.  It's easy to get jaded.  It's easy to think this shit, with all the guns in the world behind it can go on forever.

Thanks Tylers.  Don't know quite why or how you do it, but you nail the jello to the wall.

It is impossible to squeeze the balloon, and duct tape all the possible tears in the rubber.  I, among many others, need to be reminded of that.  Gotsidank, and may the poison tree frog smile upon thee;)

mayhem's picture

I think Nov 7th will be a shit sandwich or balls to the wall. Gonna be a squeeze. Hanging chads and all that fun stuff!

babylon15's picture

Why hasn't hyperinflation happened in Japan?

Amagnonx's picture

This is a really good question, and I would love it if someone could devote some time to understanding the economic mechanics that has transpired in Japan.  I think would be a really good model to understand - to determine what has been done, and how it has impacted on the value of their currency and how that might play out with the US dollar.


Personally, I don't understand it in detail - perhaps one of our more informed contributors could serve us an analysis.

Amagnonx's picture

Well, this other current ZH post has some info on the subject;  http://www.zerohedge.com/contributed/2012-09-17/japan%E2%80%99s-slow-mot...

"Borrowing at near zero cost has been its hallmark for years. Due to Japan’s institutional setup and cohesive insular psychology, the government has been able to sell 95% of its debt within Japan. Individuals directly or indirectly hold over 50%. Government-owned or controlled institutions hold over 40%."

I guess while there is a market for the debt, then confidence is retained - once the debt market gets tapped out, then rates rise and you switch to pure monetiztion, and confidence may erode rapidly - maybe someone else can comment on this.




Just Ice's picture

Hyperinflation occurs due to loss of confidence in the currency.  (Different from simply high inflation or currency devaluation...though both of these can ultimately lead to loss of confidence.)  Holders of the currency try to dump it in favor of holding goods or other currencies and sellers of goods and services become reluctant to accept it except in larger quantities, initially, then not at all.

As Japan's stock and real estate bubbles deflated (commencing around 1990) and interest rates were lowered the yen declined in value, culminating after the Asian currency crisis in late 90's, from roughly 130 down to 68. (And I am talking about the Yen's value, not USD/Yen which is often simply quoted as "Yen".  I'm also posting from recollection so if the exact figures or timing is a wee bit off, no nitpicking.)

So the yen was, in fact, devalued by about 50% by the markets due to increased money printing and debt taken on for various "stimulus" projects, (which of course were non-stimulative, just increased their debt, much as US has been doing in current times), together with declining rates of interest.

There was not, however, a loss of confidence in the currency. At that time, as up to even recently, no one was particularly worried about Japan "defaulting" on JGB's since the holders were mostly Japanese, a people with abundant savings, hence Japan's increasing debt was/has been considered as "owed to themselves". Additionally, at that time, the yen was the only one of the majors, used in international trade, to bear a ridiculously low rate of interest.

The increasingly globalized financial industry realized circumstances had in essence suddenly created "free money" to be had upon borrow. Thus, not only no loss of confidence, but a demand for the currency came into being to support a subsequently burgeoning carry trade...taking cheap money, that with a negligible interest to be repaid, and using it to flip into (or invest in) higher return vehicles/countries/instruments. 

sudzee's picture

Your premise is not quite correct. The Yen appreciated against the USD fron 130 to 68. Low interest rates created a demand for Yen for the carry trade.

Just Ice's picture

You are mistaken as you are either quoting USD/Yen rather than Yen or you are talking about the Yen's appreciation post-Asian currency crisis into its recent Fall 2011 high.   The Yen is currently above 127*.  

Low interest rates creating demand for Yen for carry trade is indeed what was stated in my post as well.


* http://ampfutures.com/quotesandcharts.html

HurricaneSeason's picture

More like Ba-ooom. Two syllables.  Germany wont play.