Rob Parenteau: Draghi’s Doom Loop(s) – More Than Just the Euthanasia of the Rentiers

By Rob Parenteau, CFA, sole proprietor of MacroStrategy Edge and a research associate of The Levy Economics Institute

The recently adopted quantitative easing (QE) approach by the ECB, in concert with the negative deposit policy rate (NDPR) introduced last summer, has set off a number of nested disequilibrium dynamics that may unwittingly introduce a material increase in systemic risk for the eurozone, and perhaps beyond.

Lord Keynes anticipated what he termed a “euthanasia of the rentiers”, as he expected active monetary policy would be successful in reducing long-term interest rates, and the share of the population living off of bond coupons would eventually just wither away. By way of contrast, if the following assessment is correct, Draghi may have signed a mutually assisted suicide pact with finanzkapital in the eurozone.

The logistics of implementing QE (including questions about whether there are enough bonds for the ECB to purchase, as well as the related market “liquidity” concerns), or whether or not QE represents what Lord Turner refers to as “open monetary financing”, are not the real problem, or at least not the most compelling ones. Rather, the implementation of QE with a large and increasing share of the bond market displaying negative yields to maturity (NYTM) presents a number of serious challenges to financial stability in the eurozone.

To cut to the chase, the ECB’s QE and NDRP measures may be setting investors up for a discontinuous price event, much like what was experienced in the equity market meltdown back in October 1987. Even if a disruptive yield spike is avoided, or even contained and reversed by ECB heroics, pursuing QE under NYTM market conditions may lead to a significant dampening down of bank and insurance company profitability. In the extreme, the solvency of key eurozone financial institutions could once again come under question. This could further complicate the ECB’s chances of achieving their 2% inflation goal, as it may dampen the bank lending channel as a key transmission mechanism for unconventional monetary policy.

The entire set up, in other words, begins to take on many of the characteristics of Andrew Haldane’s Doom Loops. In this case, however, the ECB may unintentionally be setting off nested Doom Loops that will feed on each other, and thereby magnify systemic risks quicker than investors and policy makers might otherwise imagine possible. Below is a concise sketch of the main elements of the Doom Loop dynamics the ECB may have set in motion.

1. NYTM bonds still pay positive coupons, but the price of the bond has been bid so far above the par or face value that over the full life of the bond, the holder of the bond will face a certain loss when the bond matures. NYTM bonds are therefore never likely to be willingly held to maturity by private investors, as they guarantee a loss. No client of institutional investors is likely to ever have a nominal loss as their target return on their assets – especially on assets meant to be managed to cover future nominal liabilities that tend to grow over time, like corporate pension fund liabilities.

2. NYTM bonds are therefore held solely for prospective capital gains, via sale of the bond before the maturity of the bond. This requires the holder of NYTM bonds to believe they will be facing a virtually certain Greater Fool (GF) in the fixed income market. This GF must possess ample if not nearly infinite buying power, as well as the motivation to constantly bid up prices of NYTM bonds, or else the existing holder of the NTYM bond faces the risk of not finding a buyer at a higher price, which means they will face a certain nominal loss from having to hold the NYTM bond to maturity.

3. Central banks (CB) with fiat or sovereign currencies (that is, money not exchangeable on demand into a fixed number of other currencies or commodities) fit the description of this GF perfectly, as their balance sheet expansion is virtually unrestricted. In the case of the ECB, their purchasing of bonds in GF mode is limited only by the inflation ceiling constraint of 2%. With price deflation spreading across the eurozone, the ECB is clearly highly motivated to play the necessary GF role, and very unconstrained in doing so.

4. Buyers of NTYM bonds have to believe CBs will execute QE sufficiently to produce falling yields and rising bond prices. The GF must be committed to delivering risk-adjusted returns that are compelling enough to private investors to take the risk of holding NYTM bonds. Unless the GF can credibly and continually create the expectation of higher prices and hence capital gains to holders of NYTM bonds, private investors will want to dump their entire holdings of NYTM bonds if the GF appears to be backing away from the designated role.

5. Since the CB is the GF, and since existing holders and new buyers of NTYM bonds require the GF to continually be prepared to bid NYTM bond prices higher, any indication the CB will terminate, or taper, or even pause on its originally indicated path of QE purchases introduces a significant risk. The stock demand for NYTM bonds, not just the flow demand of private investors, then shifts against NYTM bonds en masse. There is a likely revulsion of investors, a la Charles Kindleberger, with NYTM holdings, since the market set up with NYTM bonds is not unlike the game of Musical Chairs.

6. The minute the CB is even vaguely suspected of pausing in its purchase program (the equivalent of reaching for the needle on the record in the Musical Chair analogy), there will be a simultaneous desire to dump NYTM bonds, which could also have repercussions for the creditors and owners of financial institutions trying to dump NTYM bonds. To the extent that the “smart money” (aka wise guys in hedge fund land) recognize there is a distinct first mover advantage in the game of Musical Chairs, the mere hint the CB is preparing to pause may be sufficient to set off a stampede of private investors out of NYTM bonds.

7. When portfolio preferences adjust against holding NTYM bonds in this sharp and simultaneous fashion, bond pricing may go discontinuous (huge gaps in prices, or even no bid), as the stock supply offered up in the market will tend to overwhelm the natural flow demand for NYTM bonds.

When pricing goes discontinuous, quantitative driven models (as well as “algos”) tend to blow up, since they presume continuous pricing at all times. Measures of volatility will also tend to surge, which means risk budgets will get gobbled up quickly. As risk budgets get eaten up, forced sales of risky assets tend to spread across institutional investors. In the extreme, investor sell large blocks of financial assets that are still liquid, even if they are unrelated to the original asset class under distress, as a hedge against the holdings they wish to sell, but are facing no bid market conditions.

8. In this fashion, feedback loops with adverse consequences can be set into motion, with attempts to sell NYTM bonds leading to more attempts to sell the same; leading to more discontinuous pricing, and so on, as we witnessed in 1987 with the portfolio insurance mechanism in the US equity market. It is not unlikely, as in 1987, that forced or panic selling could spread to more liquid assets in the bond market, or even to more liquid assets in the equity and other markets

9. In theory, this vicious cycle/Doom Loop process would supposedly end when yields are once again high enough to represent a good risk/return proposition to private investors. Yet there are likely to be large capital losses in the portfolios of holders of NTYM who could not find buyers once the music stops and the GF/CB steps back. Their risk budgets will also be very restrictive at that point. So-called value buyers may be few and far between under these circumstances. After all, it is harder for private investors to reach for yield when they are facing a risk budget that has been exceeded, and sitting on large unrealized capital losses).

10. There are several reasons why the GF, in this case the ECB may elect to pause or taper early. The financial media is beginning to recognize some of the reasons for the game of Musical Chairs to end earlier than September 2016, which marks the currently planned termination of the PSPP. These include:

a) Supply constraints may complicate the ECB buying program in future months – after all, the ECB has been massively front run by investors flocking to government subsidized and virtually government guaranteed capital gains, and the supply of high quality bonds may not be large enough given ECB portfolio risk constraints;

b) Eurozone macroeconomic data may continue to surprise on upside, and inflation may revive sooner once oil and other commodity prices find a bottom (note that Draghi has already declared victory in turning eurozone economy around, just by announcing QE);

c) Bank net interest margins and insurance company profitability may be sufficiently eroded by negative deposit rates (which are acting as a tax on excess reserves held by banks at the ECB), by flattened yield curves (which are reducing their various carry trades), and by an ever increasing share of the bond market exhibiting NYTM (which means they effectively are off limits to purchase by the banks and insurance companies), that major financial institutions begin to push back, such that political opposition could build within ECB (probably through German financial institutions getting the Bundesbank to lead the charge) to curtail or even reverse QE early.

To conclude, what we appear to have in play here is a game of Musical Chairs, but it may prove to be a game with remarkably high stakes. Once the music stops – or even the hint of the music stopping filters out across institutional investors – everyone will race for a chair (i.e. try to sell NTYM bonds). The absence of a GF at that point in time means there will be no buyer, at least not until yields spike sufficiently to warrant taking on the perceived risk, which will probably be quite high under those circumstances, as longer maturity bonds at low nominal yields have high durations – that is, bond prices react a lot to small changes in nominal yields.

The Draghi Doom Loops traced above are probably features of the ECB’s current QE and NDRP policy that either have not been recognized by investors, or have not been thought through by ECB, or both. Indeed, one could argue institutional investors are quite happy to have government guaranteed returns (that is, government subsidies in the form of capital gains for wealthy bondholders as the ECB bids up bond prices in its PSPP operations) from the GF/ ECB all the way out to September 2016 termination of QE. But to mash up metaphors, these institutional investors may be picking up pennies in front of a steamroller, and caught (unwittingly, and in part by the demands of the quarterly relative performance objectives that largely dictate their behavior) in a game of Musical Chairs that is likely to end sooner than they think – and end very badly, at that.

We will elaborate further on these and other Draghi Doom Loops in future essays, as there are further complicating dynamics that have been set in motion, but still do not appear to be widely recognized yet. Keynes’ forecast of the fate of rentiers may prove to have been far too kind: It would be a great irony if Draghi’s QE and NDRP initiatives have forged a mutual assisted suicide pact with finanzkapital in the eurozone.

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  1. P Walker

    I’m not an expert on these things, but I get a feeling this NYTM gambits are just going to ensure another future financial crisis, which one has to wonder, is the actual desire of these policymakers.

  2. James Levy

    I think, and I may be wrong, but I think that the author is succumbing to the fallacy that what we are dealing with is in some way analogous to the market models worshiped by neoclassical economics. What we are dealing with in reality is a group of players–key nation-states and their financial giants, the ECB, the richest and best-connected financiers and rentiers–who are running a game, not administering a market. The whole thing is fixed, and the rules are changed as and when the major players want them changed. They may screw up, but they have enormous power to intervene and change outcomes to suit their interests. Of course, they could set off a chain of events that pass beyond their control, but to think that “the market” is going to “punish” them is not realistic.

    1. Lambert Strether

      Hmm. I wish you’d give more detail on how he succumbs. I’m not seeing his reading as much different from yours (and the mechanism reminds me a lot of accounting control fraud, on a higher plane of existence, as it were).

      I wonder if the State as “Bigger Fool” is related to Yves’s idea that finance time is faster than political time. I mean, if you’re always inside the other guy’s OODA loop, it’s very easy to make him look like a fool.

      1. James Levy

        My feeling came from the idea stated that this is a “bond market” and that “the music may stop” because of actions in that market. My guess is that the PTB can both keep the music going and arrange so that there is a “chair” available if it stops for all the important players to find a seat. In other words, it’s like the post-crash “market” in CDOs and Swaps–completely fraudulent if you are a TBTF entity because it is backstopped to infinity by the key players who can simply create Euros or dollars on their computers and make whole those they wish to be whole. But again, this is not my area of expertise and I could be wrong or misunderstanding the argument presented above.

        1. Robert Parenteau

          James: Our minds are moving in similar directions on this question. If you go far enough down the chess board, if we do get a rate spike, it is not too hard to imagine the ECB will be forced to come in and place a ceiling on yields by offering to buy any and all bonds (except Greek ones, of course) yielding over say 1 or 2%. I suspect the wise guys picking up pennies in front of the steamroller are thinking this as well. In which case you may get a surge in excess reserves, raising the effective tax on banks. And you probably destroy bank and insurance company profitability faster on this scenario.

  3. Georgie Welchade

    Without mentioning the devil by name, Rob Parenteau is necessarily implying that some direct or indirect version (revamped maybe ?) of the Gold Standard is coming to your neighborhood soon… be it SDRs (which I seriously doubt) or Yuan-based maybe ?… or just old plain vanilla Gold Standard, my grandpa’s and your grandma’s Gold Standard, the one the world should have never left in favor of blood sucking fiat money politicians worldwide loved until today. Good luck…

    1. diptherio

      Indeed, the amount of circulating exchange medium should be arbitrarily limited by the amount of shiny metal we can dig out of the ground. Eminently rational!

      The problem isn’t fiat money–it’s fiat money combined with a political dialogue stuck in a gold-standard world…well, that’s one of the problems, anyway…

    2. Georgie Welchade

      Are you aware what the price of an ounce of PHYSICAL gold would be if your truly rational line of thought (with which I fully agree) is followed ?

      * Worlwide derivatives exposure = $ 1.5 Quadrillion
      * Worldwide GDP = $ 80 trillion (and deflating rapidly)
      * Worlwide debt = $ 200 trillion (and rising rapidly)
      * Worlwide UN-funded liabilities = $ 400 trillion (and rising like a rocketship to Pluto)

  4. David Mills

    Another possible extension of this is that the private banking monetary system will have to end. Per Georgie Welchade’s comment re: the gold standard, and the necessity of par clearing across currency areas, the central bank would have to step in and fractional reserve banking would be history. Brave New World.

  5. Ben Johannson

    Could be the eurozone is running a comorbid policy of creating such poor economic outcomes investors are willing to take a soaking on their bonds. Stranger things have happened

  6. craazyboy

    Unfortunately, when Keynes coined the phrase “euthanasia of the rentiers”, he didn’t make any distinction between a “rentier” being inbred royalty or merely being grandpa and grandma needing to live off of low risk interest earned from a lifetime of meager savings. So now we have Central Banker Soylent Green – without the nice government provided facility and free movie to watch at The End. But inbred royalty is still doing OK.

    Economics has never adequately dealt with the fact that humans might live to be 80 years of age – and there aren’t enough economist jobs so we can all be employed as economists doddering around and drooling out economic policy to anyone that will listen.

  7. JTMcPhee

    Wonderful cogent analysis and explication of How Everything Is F__ked. I have the pessimist’s certainty that it is even worse than presently appreciated.

    And for the unfortunate billions (I typed “bilkions” but spellcheck choked on the attempted pun) who have to try to eat and stay out of the changing climate but have been yoked to this poignantly, grossly elaborate, heavily gilded Royal Carriage, this all means exactly what, again? Draghi, that Very Serious Fellow, has his lines of retreat and resort destinations all marked out, and you can bet the rest of the High Flyin’ Private Jet Fokkers have too. “IBG, YBG, suckers!

    So we are (are we?) at the end of all things, for billions of bilkions, the sap-muppet ordinary people who are the unfortunate pivots and mounts of the grand LEversw of Power? All our wealth has been reduced to Magic Funny Money in disappearable electropence, or has “legally” been plundered, so what we mopes have might be the weapons we own that at best might serve to keep the lower-order brigands from stealing our stuff and snuffing us and our families as the World System detonates, along with maybe some innate peasant wisdom in aid of re-creating comity at more, ah, human, scales? Of course, the Few are fitted out for a nice slow parachute descent, into previously prepared Resort Redoubts of continued privilege, of course, for the Haves, provided by that other magical misnomer, “the government,” which is what and who, again, that generates the actual real wealth that the stinking froth of leveraged Funny Munny floats atop?

    Is/are there suggested remedies, and anyone to activate them? Other than a great cleansing Bonfire to burn it all down, and take another run at it, naturally on the backs of people who happen to survive, and who mostly will have not the slightest notion of what huge “Something” broke loose from its delicate fraudulent moorings and fell and crushed them? And thus be too likely to have it all play out again, this time without the wealth that can be taken from the ground?

  8. Robert Parenteau

    I did consider titling this piece: Draghi, the new pilot at Germanwings, but I felt that was in rather poor taste, even if it did seem to capture the essence of the situation much better than recycling one of Keynes’ bon mot phrases…and now that I think about it, probably one of the few actual phrases the New Keynesians ever really adopted from Keynes (though without daring to quote him directly on all that, since it would probably incense that wing of the capitalist class that funds their neoliberal story telling and policy narrative), as it appears that all Paul Krugman and his colleagues in that camp (maybe excluding Larry Summers, on his good days) can write about in recent years is the need for lowering real interest rates further and further until we reach the bliss point where they elicit full employment investment…which seems MIA, as companies are too busy maximizing shareholder value by extracting and redistributing profits (to management and large shareholders determined to minimize their time to the gated community and golf course on Kauai) rather than reinvesting them in the tangible capital stock…while negative and falling nominal interest rates are putting banks and insurance companies out of business…and how’s that one likely to work out for you, Mario? Ironically, the ECB could even become the catalyst for the disappearance of the euro from forex screens in the not too distant future, but I don’t even need to go there.

      1. susan the other

        Yes Lambert. It’s runway foam everywhere. If corporations are borrowing money to buy back their shares because other people want to sell them all, and corporations know full well they will have to cut their expenses with an ax soon, isn’t it the same process? And if it is, and there is no functioning economy anywhere, bonds with nirp might actually be the best investment.

    1. Georgie Welchade

      Dear and most respected Rob Parenteau,

      Your moment of truth has arrived.
      Everyone else’s moment of truth has arrived also… so welcome to the club !
      The buck stops right HERE right NOW, okay ?

      So please stop beating around the bush and spell out your opinion on the Gold Standard end game or any variations thereof.

      Congratulations on your excellent article above.

      Next time just damn the torpedoes as ” Draghi, the new pilot at Germanwings” would have been an excellent title.

        1. Georgie Welchade

          OKay dear paperbug, just go happily back to your paper wealth until it burns burns burns.
          I humbly suggest you re-read Rob Parenteau’s excellent article above.
          Go figure…

      1. Santi

        Doh! I forgot Spain is under relatively high deflation, more than 1% yearly, so the real interest is still positive. Not that negative nominal rates make sense to me, still…

  9. cassiodorus

    Will someone please explain to me why I shouldn’t expect the euthanasia of the masses instead? Rich folks with lots of bonds can always expect that governments will bail them out, while the masses can expect that their bank account balances will receive continual haircuts to pay off someone else’s debts. Everything about neoliberal economics stinks of class warfare. What’s different about the bond market?

    1. Georgie Welchade

      Dear Cassiodorus,

      Your input is welcome (of course) but please try hard to think out real questions young man !
      The answer to your false dichotomy is that you can’t fill vacuum with more vacuum.
      You just can’t bail out (or bail in, for that matter) nothing with nothing.

      Lots of your ‘worthless bonds’ can’t be bailed out by more worthless bonds nor by worthless wallet-size green xeroxcopies with pictures of dead historical personalities.

      1. cassiodorus

        I really doubt that governments will feel obliged to pay off 100% of the debts of big corporations which gambled away astronomical amounts of money on bonds or whatever. Rather, governments will continue to offer said big corporations an ongoing package of financial optics so as to make it look as if they are solvent, while the rest of us receive “austerity planning.” This is my understanding of what happened in the ’08-’09 crisis, or at least this is what I got out of reading Nomi Prins. Citigroup isn’t really solvent as far as I know, but they still have a branch two blocks from my home. Key passage from this post:

        Even if a disruptive yield spike is avoided, or even contained and reversed by ECB heroics, pursuing QE under NYTM market conditions may lead to a significant dampening down of bank and insurance company profitability. In the extreme, the solvency of key eurozone financial institutions could once again come under question.

        As long as they can shut up the “coming under question,” they’re fine.

        Oh, and I’d appreciate a less condescending response, as I’m sure is true of many others who post here.

        1. Georgie Welchade

          Formalities and etiquette aside, the article’s message is simple :

          We’ve hit the iceberg head on already while the Captain and his Senior Crew pull every trick in their book trying to keep everybody calm. Meanwhile, unmitigated water keeps flooding our financial ship right here right now.
          The instant a few passengers panic, mob behavior would leave us all (literally) dead in the water with no financial system in place, just worthless papers of every sort (bonds, cash, you name them) that just burn baby burn with no store of wealth anywhere in sight.

          State subsidization with yet more worthless nothing (vaccum) just drowns the system into even deeper vacuum with yet more vicious negative feedback loops triggered off.
          So…huge reset guys, with a prior bout of hyperinflation while the Masters of the Universe try to pull yet one more system-saving trick.

          Sorry if I’ve stepped on anybody’s toes,
          Please excuse by rough love.

          1. JTMcPhee

            Real wealth? Is that arable land, potable water, breathable air, meaningful work to do, someone to love and be loved by?

            Of course, the Funny Munny is buying or has bought up the first three, since those formerly possessed of the Commons have been weak and foolish enough to give their birthright to a sly little sh_t for a bowl of porridge…

              1. JTMcPhee

                Was that irony, or just me ignorance of conventions of thought showing? Seems to me all of those can be expended and/ or wasted, stolen and transferred, and the Chinese with their funny Munny and other rich folks are buying up title to a whole lot of arable land, and acre-miles of cool, clear water, and there’s an active market in air emissions “rights to pollute,” though TPPTIP may trump and kill the need for that.

                Can’t eat, drink or breathe stock certificates, bond coupons, 100-room mansions or Maserati exhaust manifolds. I guess it’s incumbent on me to go learn the correct definition of wealth.

                1. JTMcPhee

                  And seriously, is there a “scientific definition,” in economic science, of “wealth?” Seems like an old unresolved issue, like “what is money?”

                  3.Economics: Total of all assets of an economic unit that generate current income or have the potential to generate future income. It includes natural resources and human capital but generally excludes money and securities because the represent only claims to wealth. Two common types of economic wealth are (1) Monetary wealth: anything that can be bought and sold, for which there is market and hence a price. The market price, however, reflects only the commodity price and not necessarily its value. For example, water is essential for human existence but is usually very cheap. (2) Non-monetary wealth: things which depend on scarce resources, and for which there is demand, but are not bought and sold in a market and hence have no price. Examples are education, health, and defense.

                  Deep waters, I guess. Interesting how ordinary people will give their stuff and their labor, like in what goes into building megayachts and multiple estates and swank cars and bling, in exchange for debt, or money, or whatever, and just because certain people are seen and presumed to be “wealthy” because they own pieces of paper or the electronic equivalent. And that other ordinary people will take the representative items of value presented by presumed wealthy people to their worker types, in exchange for foodstuffs and payment of the cable and water and electric bills of said worker types.

                  Old SNL lines, as I recall them:

                  Bill Murray: “I don’t get it.”
                  Gilda Radner: “And you never will.”

          2. cnchal

            The instant a few passengers panic, mob behavior would leave us all (literally) dead in the water with no financial system in place, just worthless papers of every sort (bonds, cash, you name them) that just burn baby burn with no store of wealth anywhere in sight.

            Ironic that these are the conditions QE and ZIRP were meant to avoid. Wasn’t that the precise reason for Hank Paulson’s $700 billion bank bailout demand? Tanks in the streets and all that.

            If those conditions ever come to pass, what would a store of wealth be? I’m thinking weapons, sandbags and provisions, and for sure, gold can be useful bartering medium, but one would need a gun to back it up. Cash might work too.

            Things have gotten a little fuzzy, when it comes to wealth creation and storage. Data can be “made” as it’s sold at a marginal cost approaching zero. The money from sales can then be used to buy real physical goods, where the marginal cost is always greater than zero. It seems like the infinite cyber world could be distorting the finite real world.

            Just yesterday, Lawrence Summers, dropping pearls of wisdom into Justin Trudeau’s ears was said to have said he is also not fond of major tax cuts at a time when technological acceleration is concentrating more and more wealth in the hands of those few able to understand and benefit from a transforming economy

            Not only do we have technological acceleration, the rate of wealth concentration is accelerating.

            Gold is a rational thing to have when considering the madness of crowds and how you want to be situated when that crowd goes mad. What doesn’t seem rational about holding gold, is that to spend it you need to convert it to a currency, or get out the cutters and cut a chunk off and trade it.

            1. craazyboy

              “technological acceleration is concentrating more and more wealth in the hands of those few able to understand and benefit from a transforming economy”

              Missed that Summers comment. Whatta gem. He is a master of deflection.

              In the 80s and 90s, tech acceleration was MSFT, Intel, Cisco, Qualcom, Sun, Nokia, Oracle…even IBM…and all the supporting electronics, hardware and software vendors.

              This millennia it’s Apple, Google, Facebook, Apple, Google, Apple, Twitter, LinkedIn, Apple and Google.

              So that’s how they’ve been concentrating wealth lately?

            2. Georgie Welchade

              No cutters Cnchal, no cutters.
              And yes (relax) it’s rational, 100% rational, as gold would only be store of value (wealth) that, of course, for practical purposes is converted to a currency that would act as unit of account and payment medium (or means).

              Every so often and only if needed, depending upon different factors (trade balance, deficits, etc.) the currency at hand would be devalued against gold, the only valid, proven store of value for the past 6000 years which has all of the advantages and virtues of any other possible ‘stores of value’ put together and none of their defects… PLUS an additional, unique feature: the marginal value of each additional unit of gold stored is infinite.

              1. cnchal

                Rational. Everybody has their own version of it and their own justification for it. It is what makes a market. People have different ideas of what constitutes value and wealth, and for my version of rational, value and wealth have different meanings.

                Every so often and only if needed, depending upon different factors (trade balance, deficits, etc.) the currency at hand would be devalued against gold . . .

                Why devalued? Why not the opposite? The currency “value” of an ounce of gold fluctuates based on the individual belief on whether the current price is too high or too low. If the rational perception among individuals is that gold is cheap, it gets bought, and if it is expensive, sold. In a financial panic the perceived value could go extremely high as gold would be portrayed as a safe haven, but at that point in time, it would be rational to convert gold to currency.

                . . .the only valid, proven store of value for the past 6000 years which has all of the advantages and virtues of any other possible ‘stores of value’ put together and none of their defects…

                Diamonds are a store of value wealth. It seems irrational to claim gold is the only valid, proven store of “value”.

                the marginal value of each additional unit of gold stored is infinite.

                Now, that’s just crazy talk. Lets, for example, say an individual has managed to accumulate 1000 ounces of gold as a store of wealth, and the current price is $1200 per ounce. The value of an additional ounce is $1200, quite far away from infinite.

                1. Georgie Welchade

                  Marginal value is not value itself.
                  What marginal value means is that the more gold you own, the better it is.
                  The more anything else you may own (whatever) it’s not better.
                  Actually it could be worse. Think it through.

                  Yes, true enough, gold could be either devalued or revalued, although normally it would be periodically de-valued rather than re-valued in relation to the legal tender (currency)

                  Diamonds have dozens of disadvantages that gold does not have. Please google them out on your own.
                  Hint: central banks accumulate gold, not diamonds.

            3. different clue

              If the Bonfire of the Moneys ushers in the econopocalypse, and I find myself living in a world where I have a spare glass of water and someone else has a krugerrand, perhaps I will sell my spare glass of water for that krugerrand.

              Or perhaps I will decide that someone who thought Krugerrands would see him through times of no economy and bought or learned nothing bio-humanly useful is a liability, whose survival is much to be discouraged. Perhaps I will tell him to take his Krugerrand and go somewhere else. No glass of water for someone with nothing but a krugerrand.

        2. craazyboy

          Well, whenever someone comes along from out of the blue and uses bold type in their comments – they are signaling that some important wisdom is forthcoming and you are about to learn something.

          But anyway, the post is about Draghi of course, however, some of us fretted about the dreaded yield spike coming sometime in our 6 year history with QE. Not yet. A yield spike means a massive bailing on guv bonds – which we have not seen in treasuries. Then again, in Europe the only US Treasury quality guv bond is the German Bund. There are less of those, so Draghi may find himself buying a whole lot of lesser quality guv bonds in order to perform whatever magic it is that QE does. Which does worry Germany – because if a CB ever does need to tighten policy, they probably won’t get what they paid for the crappy bonds when they sell them to tighten up the money supply. The “loss” is then monetizing the debt – which will likely act to devalue the Euro in FX, and likely cause more domestic inflation than they hoped for. The other little problem is we know easy money goes straight into asset inflation, leverage, weird derivatives(and stodgy insurance companies still need to play the game) – so the risk of another financial crisis goes up an unknown amount.

          1. Georgie Welchade


            The article is not about Draghi but rather about the coming collapse of the fiat-money world-financial system.
            Super Mario is just another Goldman Sachs hit man fully aware in his case of the futility of the motions he is being forced to go through.
            The problem has been well known for years.
            As a matter of fact, that was one of the reasons behind the creation of the Euro.
            Unfortunately the Euro also failed miserably, the Yen has been dead in the water for years, etc., etc.
            So, what needs to be adressed right NOW is what will substitute the currently doomed financial system But no one dares to touch the subject, not even with a ten foot pole.
            Not even Rob Parenteau, however excellent his post has been for everyone to understand the current failed status of world finances.

            1. cnchal

              But no one dares to touch the subject, not even with a ten foot pole.

              I’m curious. What needs to happen to get the banksters to give up money printing and have a gold standard that can’t be gamed?

              Does gold get revalued at some hypothetically imposed value to represent the volume of all the money in existence? If so, who makes that decision?

              What is to be done about gold that was sold or lent multiple times? What is so especially trustworthy of the gold warehouses? Haven’t they sold gold to someone, without actually having the gold, like fractional gold?

              Take that ten foot pole, and pry the subject open. Let the words flow.

              . . . what will substitute the currently doomed financial system . . .?

        3. Georgie Welchade

          Bold or no bold, I rest my case.

          * Worldwide derivatives exposure = $ 1.5 Quadrillion
          * Worldwide GDP = $ 80 trillion (and deflating rapidly)
          * Worldwide debt = $ 200 trillion (and rising rapidly)

          * Worldwide UN-funded liabilities = $ 400 trillion (and rising like a rocketship to Pluto)

          1. skippy

            Firstly its damn near impossible to quantify the derivatives thingy, GDP is equally wonky wrt quantifying, lastly you forgot to establish the other side of the balance sheet…. assets which offset.

            The bimetallism w/ big numbers pathology is a bias seeking exercise, rapturists comes to mind.

            Lastly the hilarious thing is those that bastardized fiat did so with a bimetallism bent, wanted the luxury of not mining the stuff [low input – overhead] w/ similar interest characteristics [tho managed for personal pleasure] and to forward a narrow ideological agenda.

            Skippy…. BTW bimetallism suffers the same human tool user problem that fiat does E.g. its not the bloody form of exchange that’s at issue, its the impetus behind its use.

            PS. one of the first pervasive uses of gold in society was religious iconography… the gift that keeps on giving it seems….

            1. Georgie Welchade

              “Assets” that ‘off-set’ you ask for ?
              Or did you mean ass-ettes ?

              At any rate the answer is always pure and simple DEBT, and the result the debt-deflation-liquidity trap.
              The Federal Reserve is as “Federal” as Federal Express and it has 0 (zero) reserves.
              Do I need to go any further ?
              And no, it isn’t the ‘use impetus’ but rather the lack of store of value.
              Any ‘money’ needs to have it.

              1. skippy

                I don’t see any data in your comment, only pejorative rhetoric, which in turn just makes it an uniformed ideological diatribe. Go get a Z1 a look up the off setting assets, till then your just another money crank with out a paddle.

                Skippy… BTW whats this store of value thingy your banging on about, seems even in bimetallism’s best days it was the result of government edict and not some supernatural power.

                1. Georgie Welchade

                  What more DATA would you want to know Skippy besides the fact that your lovable Federal Reserve is as private as PRIVATE gets and has 0 (zero) reserves ?
                  That’s enough DATA to shut out anyone’s innocent thoughts about Trillion dollar printing for Crissake. And if that’s ‘pejorative rhetoric + uninformed diatribe’ (wow, I love your fancy linguistical footwork, you should script political speeches man !) that’s the Fed’s own fault, not yours or mine.
                  Skippy, don’t skip the subject no more and just tell us exactly WHAT are the Fed’s ‘offsetting assets’ besides deep throat, unpayable, uber toxic DEBT huh ?
                  And the store of value ‘thingy’ is what will bite your tail sooner than you think Skippy

                  1. skippy

                    US Government assets [physical and financial] ninny, look at the Z1.

                    The Fed is a creation of law, as such its under the auspices of congress and if you don’t agree with its policy’s, take it up with Milton Friedman – Greenspan – Rubin and the rest of the Chicago posse. They have been informing economic and monetary policy for some time now.

                    Whilst your at it, take it up with the sorts that funded their little enterprise and established the “pay to play” political system, which enabled so much control fraud.

                    Skippy…. or you can just incessantly respond with Pavlovian knee jerks… jerking something at least…

    2. TMoney

      As one of the masses, euthanasia is an unappealing option unless I get to bail-in some of the beautiful people with me. It is the fear of torches and pitchforks from the rabble (I’m near, but not at the front). However, while there is another season of American Idol and a box of cheese-its, the rabble will remain firmly planted in their La-Z-Boy’s

  10. Lambert Strether

    For anyone who came in late, here’s Haldane on the Doom Loop in the LRB (2012):

    In this crisis, as in past ones, catastrophe insurance was supplied not by private creditors but by taxpayers. Only they had pockets deep enough to refloat banks with such huge assets. This story has been repeated for the better part of a century and a half; in evolutionary terms, we have had survival not of the fittest but the fattest. I call this phenomenon the ‘doom loop’.

    Consider the effects of the too-big-to-fail problem on risk-taking incentives. If banks know they will be bailed out, those holding their debt will be less likely to price the risk of failure for themselves. Debtor discipline will therefore be weakest among those institutions where society would wish it to be strongest. This encourages them to grow larger still: the leverage cycle isn’t merely repeated, but amplified. The doom loop grows larger. The biggest banks effectively benefit from a disguised, and growing, state subsidy.

    Adding, here’s more from Simon Johnson in 2009 in a review of Haldane’s Banking on the State, where the concept originated. It sure doesn’t take long to forget this stuff, does it?

  11. Chauncey Gardiner

    Too clever by half?… don’t think so. Suspect policy implications have been considered out to at least the third derivative. Else, why did He of The Squid et al gain support from key constituencies?

    Cui bono?… Debtors, carry trade speculators, German exporters, owners of German equities, others?

    And who is being thrown under the bus?… so what else is new?… The dog barks, the caravan moves on.

    So part of the cargo is to be plundered?… well, it’s just an “unforeseeable and unforeseen” cost that can be subsequently addressed and even provide seedlings for a fresh round of QE… Wash, Rinse, Repeat.

    … And all accomplished just by using/abusing “Money”, the ghost in the machine.

  12. kevinearick

    Dispatching Labor

    Feudalism, employing poverty to inflate RE control and price, is the primary source of dissonance, noise, gravity, whatever you want to look at, which depends upon Family Law, the arbitrary assignment of debt with no due process, as a catch-all, for those who escape filtering by the law, the FILO bankruptcy queue. Credit access merely pays compliance, without which poverty, in the empire, is nearly certain.

    The market, geared to pensions, feudalists pitting Boomers against Millenials, is inflating because money, in all its forms, is becoming increasingly worthless as a measuring device. Moving the monetary function to China, amidst the noise of an efficient killing machine, isn’t changing anything, but the baseline. Closed proprietary systems are a failure, because the set point is arbitrary relative to nature, resulting in a positive feedback loop with climate variability, PT, which dc cannot tolerate for long.

    Empire gravity is like a truck. Depending upon the cargo, you want to head the truck uphill, downhill or to a level surface. You don’t need to know where the elevator is to dispatch it. In fact, you don’t want to know where it is. What you care about is balance, because energy is neither created nor destroyed. It is simply transferred. The opportunity cost is that which the herd cannot see, which is most everything, because it spends an increasing amount of time mapping a shrinking corner of the box it chooses to inhabit.

    When in doubt, turn uphill. You can always coast back down, with greater perspective. You don’t need physical switches on a rail, if you employ gravity, against itself. Empire is just a brake, in the form of a political buffer. The more effort it employs to hunt you down, the bigger the cloud, the more it brakes itself, which is no emergency to labor, dispatching itself, leaving money behind to chase itself.

    The non-profits are really taking the wood to my pregnant wife for having the temerity to work, saving their A every time they fail, empire SOP, and they can’t figure out how she always rises above it, so they gather more wood. Growing little ones under a microscope has its advantages. The accounting wizard changes nothing, but the actuarial duration mismatch, inflating away the pensions, hiring 55+ at Wal-Mart.

    The empire loses the spiritual war, and then the intellectual war and then the physical war, winning all the battles. Crony capitalism, crony socialism or crony communism; private, public or non-profit; it’s all the same to labor. Empire globalization is its own worst enemy. But keep building those hospitals in the city, consuming garbage, expecting a different outcome, a crowd in a sandbox, fighting over disposable toys. Desalination ships? Next.

    The empire computes itself, assuming that the universe does the same. If you say something often enough, that doesn’t make it true. If you need to be liked, to belong to a herd, marriage isn’t for you; buy property with other people’s debt instead, and mimic marriage, with contract law. Warren Buffet isn’t vertically integrated, to pump paper profits, with pension paper as fuel, by accident.

    The actuarial accountants need your children, to multiply earnings, which are not earned, in the calculation of NPV, to maintain financial smoke and mirrors, until they can’t. In the empire, no good deed goes unpunished, which is why labor is a stranger, and G is always an accounting ponzi, in search of a scapegoat. You may want to open up commercial loans to intelligent labor, or not and keep chasing digital money in a digital cloud. There is no private economy in America, which the empire can see, from China or anywhere else.

  13. John Yard

    Can someone clarify who in the Eurozone is actually purchasing bonds with negative yields ? it would seem to be a career-ending move . This is not the ‘picking up nickels in front of the steamroller’ – there is no nickel to pick up. Or is risk aversion so deep that taking a sure loss is better than , say, buying a utility with a low, but positive dividend. That seems a pessimism inappropriate for even the EU. I am at a loss to understand this, even after closely reading the article and comments. Help !

    1. craazyboy

      The simple answer is the ECB is doing it. But there are probably more complex reasons too. Maybe large cash accounts aren’t insured, so you buy 3 months bills if you’re worried your bank may fail at any moment. The big bond traders have all sorts of strategies that bet on minute changes in the yield curve – so they may be buying a mix of maturities combined with shorts and leverage? Who knows what twisted things make sense to them.

    2. Calgacus

      The nickel is based on the expectation that the ECB will be the Greater Fool buying your bond before it matures, justifying you purchasing more than the principal + coupon value. E.g. Suppose a bond pays $5 (coupon) in one year and $100 (principal) in two years. Ordinarily paying more than $105 now, say $106, for it would always be crazy. But not if you are sure that a central bank will pay you $107 for it in a month. The Eurocrats seem to want to turn back the clock, just like goldbugs. They are nostalgic for the financial instability and strange practices of the gold standard. The US Treasury occasionally did things a bit like these Euro games, in the 19th century. Nice work if you can get the nickels before the steamroller, which may not come.

  14. financial matters

    I think the ECB would be better off creating a simple money market fund. Let anyone invest and get a guaranteed 2-3% positive interest rate. Essentially allowing anyone that wants to save a guaranteed ‘Eurobond’ rate. That’s the positive side of being able to create money to foster stability. Anyone wanting more yield for more risk can get into other products.

  15. Oguk

    I am kind of understanding this! Am I the only one who is bothered by the constant mistyping of NYTM as NTYM? Ok, I am a n00b. But hey, my mother was an editor, she would not have tolerated this!

    I lost it at “c) Bank net interest margins and insurance company profitability may be sufficiently eroded by negative deposit rates…” Can someone explain?

    1. cnchal

      Can someone explain?

      Insurance company profitability depends on them making good on their promises to pay, made some time ago. When interest rates turn negative, and you have to pay the bank to take your money, it will be impossible for the insurance companies to make any money. Perhaps it’s even a planned rub out of the insurance industry by the banks. Won’t Warren be surprised? Sixteen years and counting since Glass Steagall was finally shattered.

      From wikipedia

      1999 The Gramm–Leach–Bliley Act (GLB Act), also known as the Financial Services Modernization Act of 1999, repealed part of the Glass–Steagall Act (GS Act) of 1933. The GS Act had prohibited any one financial institution from acting as any combination of an investment/security firm, a commercial bank and an insurance brokerage; therefore, the GLB Act removed the barriers which the GS Act had established upon the financial institutions in the 1930s for acting as any combination of an investment/ security firm, a commercial bank and an insurance brokerage: Thus, with the passage of the GLB Act, any one financial institution—after combining any of the following:

      1. an investment/ security firm, 2. a commercial bank and 3. an insurance brokerage—could act as the combination of those financial entities. That is to say, these three separate, financial entities no longer had to be separate with the passage of the GLB Act. The legislation was signed into law by President Bill Clinton.

      I find the typos endearing. It’s the human touch.

    2. Robert Parenteau

      Oguk: Thanks for catching my dyslexic spelling typo. I have a day job and three kids so the time I have to hunt and peck these missives out is somewhat scarce…as in between 2-4am in the morning, or as in the case of this one, on an 11 hour flight to Paris, after a week of sleep deprivation, so thank you for bearing with me, and more importantly, thank you for flagging something my tired eyes failed to see. I could sorely use an editor, but this is a much more efficient and connected world we live in, so we get to do it all these days, violating Adam Smith’s division of labor…which may explain why labor productivity growth has nearly crept to a halt across every mature nation like Japan, US, UK, eurozone, etc…or maybe that would be the effect of all the free iPorn, I dunno. And on the c) issue, the reply by reader cnchal below is right on the money, but I hope to elaborate on this one aspect further in later pieces, if I don’t drop of insomnia or lose my eyesight first, as it is a very import part of the nested Doom Loops set in motion by former Goldman Sachs managing director Draghi. Best, Robert

      1. Oguk

        @cnchal and @robert: Thank you both for your responses! The typos actually forced me to think about what I was reading more. (But I was tired when I was reading.) We are all only human. Cheers.

  16. craazyman

    i don’t think this one makes any sense. Consider a zero-coupon bought at 105 maturing in 1 year at 100. If 1-year yields are -6% people would hold it till maturity. Negative YTM bonds will roll down the curve like any other bonds and get priced in relation to prevailing market yields. Where’s Haygood to explain all this? If he says this will blow up the financial system, I’ll believe it. However, the negative YTM and longer durations certainly makes any jump in yields all the more volcanic when it happens. Maybe it’ll be like Yellowstone finally blowing sky high. Just like that Russian general said, he said they”d nuke Yellowstone and set off the volcano if things get bad in terms of US and Russian politics. That would be bad. No argument there. It’s hard to imagine how bad things would have to get before they’d push the Yellowstone Button there in Moscow. But it’s not impossible. Evidently there are people who think about these things and put plans in place, just in case. Wow. What if they missed Yellowstone and hit Pike’s Peak? I’m not sure f that would still be traumatic or just hilarious. I guess you”d have to know what they were aiming for, to put it in context. it seems to me that”s the same thing with interest rates. Negative 10% is Yellowstone, but negative 4% is Pike’s Peak. There’d be a mushroom cloud but it would blow over,

    1. craazyboy

      When the spike comes the mushroom cloud appears over anywhere that has finances like 1994 Orange County (derivatives) or 1994 Mexico (cut off from rolling over debt) or 1987 LatAm (same reason).

      Which in our infinite wisdom in financial management today means the entire planet. Warren Buffet’s “Financial WMDs”. The derivatives market can’t clear and net out to zero notational value if one big player in the market goes bankrupt.

      But it’s all good so far – so enjoy your wealth and good fortune. Have a $5 bottle of CA wine, or even a watermelon and share in the Nation’s wealth. I’d still hold off on buying the Edward Green shoes just in case your checking account survives the fallout and it might be nice to have a little money to pay a few weeks of rent.

      But if it does happen, Washington can always nuke Pike’s Peak and blame Putin for missing Yellowstone with their crappy missiles. We’ll all get a good laugh out of it and Washington can then nuke the Soviets and wipe out Europe’s natural gas supply. Then things will finally get back to normal.

      1. craazyman

        i don’t have any wealth and whatever good fortune I had I lost going short after reading all the Doomers and Gloomers who post their financial science fiction here. I am too easily influenced by intellectual drama. But I did have a nice $8 bottle of Argentinian wine the other night! Don’t cry for me peanut gallery! / The truth is I’ll get my 10-bagger / And that’s a promise / With Edward Green shoes / I’ll have my swagger

        It’s impossible for the whole world to go bankrupt. Think about who they’d owe money too. The Reptilians? The Grays? The Ferengii? (Not to equate reality with television, of course). It’s impossible for the whole world to go bankrupt. it owes money only to itself and nobody else. it can get into an argument with itself though, and the shale can hit the fan. That’s true.

        1. craazyboy

          That’s how it works. They get all confused over who has any money and wealth, then sue each other in court for each others financial statements. This takes years to resolve(unless the Fed prints up trillions to make everyone whole – like they did for Goldman – but only $12B there – or was it Treasury, I forgot) and meanwhile velocity of money goes to zero and no one knows who’s rich anymore. ‘Cept the 99% knows fer sure it ain’t them. hahahaha

          Now you got the tune “Don’t Cry For Me Argentina” going ’round my head. Gonna look for it on youtube.

          Also, hoard watermelons. I have a good feeling about watermelons.

  17. bold'un

    Negative interest rates on bank balances can be thought of as a wealth tax, which is not so dangerous or extraordinary; it’s a tax since not many private individuals can actually benefit from borrowing at negative rates. A sudden end to the negative interest rates – say moving from -1% to +1% – is not so different in its effect on bond prices than moving from 4% to 6% yields in the good old inflationary days; sure there are losers, but the exposure is calculable and not open-ended.
    Throughout history there have been growth, inflation, demographic, climatic and other cycles, and maybe negative rates are signalling a possible down phase in certain series such as earnings, dividends and real estate prices. If that happens, the pension or insurance that buys short/negative bonds may lose less money than those who bet their future on equities and real assets…
    Common sense would tell us that {greater longevity + lower fertility + more expensive energy} means that someone (youth!?) will need to work harder for less pay/leisure than the experience of the last 70 years would lead them to expect. We could translate this into a syllogism:
    1) If pensioners get the real yields they hope for, then they will have no trouble funding their retirement
    2) Funding and servicing longer retirements looks like being a severe real resource allocation problem
    3) Pensioners will not get the real yield they hope for (real in terms of the cost of living they will face).

    1. susan the other

      Wouldn’t it be relatively inexpensive to nationalize US pension fund obligations while the world gradually decelerates from all that frothy free marketeering, say over the next decade? For sure there is more at stake than meeting the 8% return necessary to keep seniors fed and warm. But nationalizing pensions would stop some of the financial bleeding, or hosing.

  18. RBHoughton

    Agreed its musical chairs and I think its getting widespread. The oil majors are involved with the Shell/BG deal. There is still a few small insurers and banks around. Commodity brokers appear to have rationalised their trade – any chair removal there will be expensive.

    All-in-all, it looks as though its all ending up rather predictably – not with a bang but a whimper. I suspect paper from the debt-based system will not be attractive for real exchange much longer.

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