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Tuesday, March 3, 2015

Storing Paco

Via Marginal Revolution.

Tyler is referring to the current interest rate environment in Europe, where banks pay middle-aged women to borrow money to fund their sexual hook-up site, and tell students they don't need their crummy little checking accounts.
To breathe life into Europe’s economy and stoke inflation, policy makers recently resorted to a drastic measure tried by some other central banks. The European Central Bank, which dictates policy in the 19-member eurozone, announced a plan that involves printing money to buy hundreds of billions of euros of government bonds.

Just the anticipation of the program prompted bond prices to soar and the euro to drop in value. Other countries that do not use the euro were then forced to take defensive countermeasures to keep a lid on the value of their currencies, encourage lending and bolster growth.

Switzerland, for instance, jettisoned its currency’s peg to the euro, shocking markets, and cut interest rates further below zero. Denmark’s central bank has reduced rates four times in a month, to minus 0.75 percent. Sweden followed suit earlier this month.

The most profound changes are taking place in Europe’s bond market, which has been turned into something of a charity, at least for certain borrowers. The latest example came on Wednesday, when Germany issued a five-year bond worth nearly $4 billion, with a negative interest rate. Investors were essentially agreeing to be paid back slightly less money than they lent.

Bonds issued by Switzerland, the Netherlands, France, Belgium, Finland and even fiscally challenged Italy also have negative yields. Right now, roughly $1.75 trillion in bonds issued by countries in the eurozone are trading with negative yields, which is equivalent to more than a quarter of the total government bonds, according to an analysis by ABN Amro.

One reason investors are willing to tolerate such yields is the relative safety of the bonds, in a weak economy. Traders are also betting that the prices of the bonds will keep going up.

Up, up and UP! We've never heard that before, have we?

Tyler's metaphor, his pet dog Paco, refers to the fact that savers now have to pay the banks to store their money (Paco) instead of having their money run around and play (generate positive returns). Negative interest on deposits basically transforms cash into gold, implying huge, zombie-army levels of risk, like a survivalist who incurs storage and opportunity costs in order to hoard canned beans and ammo. But the risk doesn't seem to be out there, with healthy profits and positive consumer confidence. So this implies, to Tyler, that there is some barrier to new investment. (He loses me at this point--economic stagnation? wealthy entrepeneurs cashing in their chips?)

Tyler continues: "I liked Paco (more importantly Paco liked me), but I do not enjoy living in a Paco economy. I think of the calm before the storm and wonder how to reconcile the observed calm and the potential for the storm. I do not like the most obvious attempts at reconciliation."

In other words, something really obvious should be happening to explain negative interest rates (which, as a practical matter, are economically impossible) but darned if anybody can find it.

The impolitic (Austrian, crackpot) view is that the ECB is distorting the supply-demand curve for loanable funds by charging member banks for "excess" reserves and handing out free money for bonds that should be deeply discounted. Tyler loves being obscure (i.e., Straussian), and he's extremely smart, so he could very well be saying what I think he is saying: this is nuts and it will end badly.

Old friend of this blog Archer Of The Forest has a more succinct explanation.

6 comments:

Bumbling American said...

I can't think of a better name for an economist to give a dog

Kakistocracy said...

Here's another word economists should become accustomed to using: disintermediation.

Visibilium said...

Fractional reserve shenanigens have caused banking customers to expect deposit services to be provided either free or at negative nominal cost. Getting real about providing financial intermediation would involve an old-fashioned 100% reserve requirement.

Let the peeps get angry and begin renting out mattress space for their neighbors' millions.

The Anti-Gnostic said...

Presumably the banks can cover their costs from the spread between interest paid on depositors' savings and interest earned on investments with depositors' money. But there's no spread at this point because the banks are gorging on bonds, to the extent they're pushing yields negative.

So either there's so much risk out there the banks don't know what else to do with the money, which doesn't make sense. Or there's deflation making cash so much more valuable, which my household expenses tell me isn't true either.

Something is up, and nobody really knows what it is.

Visibilium said...

Your presumption would be correct if banks could control the pace of withdrawals. Checks are payable on demand or else they ain't good checks, yet savings accounts would not technically be payable on demand if depositors decided to withdraw their marbles. The government plays games with conditions of payment and reserve requirements to afford banks the opportunity to run real-sorta businesses.

But...back to your point. Since I'm a sorta expert, I'll offer my bare-assed guess that currency fluctuations are occurring. These fluctuations affect both risk and purchasing power. Therefore, both of your guesses--risk and price level changes--are correct. Currency is what holds both effects together.

Excuse my rehabilitative profanity, but I've simply spelled out the easy shit. What lots of finance guys are contemplating are (1) Ms. Fed's next move and (2) the extent to which quantitative easing has become more attractive to more governments, especially the Euro zone.

The Anti-Gnostic said...

IOW, as Porter explains, banks will buy the German government's 19-year old Impala for $40K today because the ECB is going to buy it for $41K later.

This probably ends with a war somewhere.