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.