Interest Rates in Wonderland

"Well, I never heard it before, but it sounds uncommon nonsense"

                                 - The Mock Turtle, Alice in Wonderland

"Well now that we've seen each other," said the Unicorn, "if you'll believe in me, I'll believe in you."

                                 - The Unicorn, Through the Looking-Glass


As negative interest rates strengthen their grip on global policy and markets, Macro Man cannot help but a feel a sense of unease, a visceral disquiet that there is something very wrong with the world.  He suspects that he is not alone in this regard.

Although some of these misgivings no doubt arise because negative interest rates just "feel" wrong, ultimately there are more tangible reasons for concern because of what negative interest rates represent and what the implications are.   Looked at simplistically, negative rates entail a government-sanctioned authority imposing a charge upon private sector agents, with the proceeds helping to either directly (via QE bond purchases) or indirectly (via lower bond yields deriving from private sector buying) provide a subsidy to the central government.

There are two reasons to object to this sort of policy prescription in the current circumstance.   The first is that charging the private sector to provide funds to the public sector is tantamount to a tax, in this case on banks (and, potentially, depositors).  Such a policy would appear to be perverse, given the implicit goals of increasing monetary velocity, credit creation, economic growth, and inflation. 

The obvious rejoinder to this charge is that something that is "essentially" a tax is not in fact officially a tax, and unlike official taxes avoiding and evading this particular tax is allowed, nay encouraged.   Indeed, avoiding the tax through deploying cash in "more productive" pursuits such as lending, riskier investments, and consumption is the entire raison d'etre of the policy.  While this may be true, there is also a secondary consideration: what sort of impact are negative rates likely to have on inflation expectations?

While Macro Man is not aware of any empirical or theoretical study on the subject, it seems to him that a negative nominal return on cash would likely lower, rather than raise, such expectations, insofar as it represents a loss in nominal future spending power across the economy.   If one assumes a constant real spending power (a heroic assumption, perhaps, but no less heroic than many economists' assumptions), then inflation expectations have to come down to match the reduced nominal spending power of cash.

The second objection to negative rates is more troubling from a philosophical perspective.  Central banks are comprised of unelected officials who, with certain exceptions, are completely independent from the governments who appoint them.  Yet these monetary officials are crafting a policy that looks suspiciously like taxation- a fiscal measure that comes exclusively under the remit of elected governments.   If citizens do not like the taxation policies of their governments, they can vote them out.   If they do not like the the effective taxation policies of their central banks, they can...do what?  Particularly in the case of the Eurozone, it is unclear exactly how the populace could dispense with Draghi's services should popular unrest come to that.  (To be clear: Macro Man is not suggesting that it should or will.)

The Swedish Riksbank published a note last year on negative rates that includes a useful schematic, reproduced below.   The upshot is that there is a limit to how negative rates can go, insofar as a) banks would not lower their lending rates in concert with deposit rate cuts, and b) even if banks begin to charge negative rates on deposits, at a certain level depositors would be incentivized to withdraw their money and hold cash, despite the transactional friction of doing so.

                                  Source: http://www.riksbank.se/Documents/Rapporter/Ekonomiska_kommentarer/2015/rap_ek_kom_nr11_150929_eng.pdf

In extremis, political and monetary authorities could drag the the economy fully down the rabbit hole while pushing back against cash withdrawals to ensure that their policies regained/maintained traction.  An obvious way to rekindle a preference for electronic as opposed to physical money would be to implement a so-called "Gesell tax", which entails a tax on cash via a requirement that physical notes be stamped periodically to remain legal tender.   Although this is no more radical than the steps taken in the 1930's- including the ban on private ownership of gold- in the modern political climate it would appear to be a policy ideally conceived to foment revolution.   Indeed, a Stamp Tax on printed materials was one of the key grievances of the American colonists in the decade preceding the Declaration of Independence.

As of yet, negative interest rates are still in their infancy, so the empirical evidence as to their impact upon the real economy is fairly scant.  To be sure, we can observe price action in government bond markets, but in the case of the Eurozone and Sweden there is also the issue of central bank purchases to consider, and it is difficult to distinguish between the two as to impact on bond markets.

However, one of the criticisms of NIRP is that it will adversely impact banks' margins, and that is something we can measure.  The chart below is an adaptation of one from the Riksbank paper linked above.  It shows the Riksbank deposit rate, the rate on demand deposits (in this case, those held by households, although non-financial corporation deposit rates are virtually identical), the composite loan rate on the stock of existing bank loans to households and NFCs, and the spread between the loan and deposit rates.  As you can see, margins have plunged to the lowest level in the history of the dataset, although they are really just continuing a trend set in motion when Riksbank deposit rates went to zero.

The phenomenon is more clearly observable in the Eurozone.   Using a similar dataset (though in this case, the loan rate is a composite cost of borrowing for NFCs), we can clearly observe a clear decline in both loan rates and margins since the imposition of NIRP in June 2014.  Note that these charts do not account for the negative margin between the rate on banks' consumer deposit liabilities and central bank deposit facility assets.

To be fair, this has coincided with a long-awaited increase in MFI lending to the private sector, which was one of the points of the whole exercise, so it is difficult to call it a failure at this juncture.  By the same token, if margin compression throws banks back into the mire, as it appears to have done recently, the renaissance in the flow of credit may prove ephemeral.   It is also important to recognize that the regulatory burden imposed by loans also probably limits the utility of monetary policy to kindle banks' desire to lend.

As for the impact upon the real economy, it is difficult to draw any firm conclusions given the dearth of available samples and our inability to conduct proper scientific experiments.  (In other words, there is no way to empirically test counterfactual scenarios as there is in a controlled laboratory environment.)  Nevertheless, Macro Man sifted through the scraps of what little data we have to try and identify any trends in the real economy.

He looked at Denmark and Sweden (time constraints and an accidentally-deleted spreadsheet precluded the inclusion of the Eurozone in this piece, unfortunately) and attempted to judge the change in certain domestically-sensitive economic variables: nominal wages, house prices, and the relative performance of bank stocks to the broader equity index.   He acknowledges that this is an imperfect methodology, particularly as the wage and house price data are only released quarterly; nevertheless, we may be able to distill some insights as to where NIRP is having an impact.  The study looked at the cumulative change in the above mentioned variables, expressed in annualized standard deviations.

Looking at Denmark, where we have the longest history of life down the rabbit hole, we can see that NIRP did little to boost wages over its first couple of years,  though the impact on house prices was more immediate and substantial.   Banks outperformed over most of the sample period, though a word of caution: only two banks (Danske and Jyske) were in the sample basket, so it may be difficult to distill too many home truths from such a narrow sample.


In Sweden, we observe not-dissimilar trends over a narrower sample period.   House prices have been a notable beneficiary of NIRP, rising an impressive 3 SDs over just three quarters after its imposition.  Of course, given that housing was already en fuego, the desirability of this outcome is debatable at best.  Wages and banks have both done OK since the depo cut into negative territory, though the margin is slender and the sample size tiny.


So really, the results are unsurprisingly inconclusive; at this juncture we just don't have enough data to make sweeping judgements.  That being said, there are a couple of trends that have emerged that are strong enough for us to distill conclusions.   It seems very clear indeed that NIRP has a depressing impact on bank lending margins; at this juncture it is too early to say that it is posing a threat to financial stability, but recent returns do not look good.   At the very least, it suggests that European banks under NIRP should struggle to perform well, like any other business feeling the pressure of substantial margin compression. 

The impact upon housing seems fairly clear; what better place to park large sums of cash that are under threat of implicit confiscation by the monetary authorities?  Again, how well that plays out remains to be seen.  After all, the Fed tried goosing house prices as a way of climbing out of the post-TMT doldrums a dozen-plus years ago, and didn't that end well?

Whatever the merits of NIRP, at the very least we can say that there is a clear negative externality in the compression of bank margins at a time when global credit creation via the lending channel remains sluggish.  Moreover, there is nothing that NIRP can do about global oversupply across a range of markets, other than to further distort the cost of capital so as to potentially incentivize more mis-investments (which could ironically exacerbate the oversupply issue.)

It seems fitting to close with another quotation from Lewis Carroll, this time via the Queen of Hearts:

"My dear, here we must run as fast as we can, just to stay in place.   If you wish to go anywhere you must run twice as fast as that."

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Anonymous
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February 2, 2016 at 7:12 AM ×

Many are speculating on who falls over first, china... japan, europe, I suspect it will all move rather quickly once one major "falls over"

I just cant understand the dow and S&P500 up here and not falling = sit on cash

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CV
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February 2, 2016 at 7:30 AM ×

Bravo! A great note MM. The point about inflation expectations is intriguing ... must think more about it.

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Nico G
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February 2, 2016 at 8:10 AM ×

finally liquidated all EUR positions this morning, am not paying IB 0.48% interest for EUR deposits (in force on the 5th) or anyone else - ever

hello CHF, hello more CAD, hello MXN NOK a bit of GBP 10% later (!!) and even ZAR for a little suicidal fun. still can't believe we are to deal with this circus - remember when Japan and Italy were the two textbook champions of household savings? Are they still buying govies below par today.

to me, folks who try to understand NIRP and even be ok with it is like trying to understand the latest trend in contemporary art, when they sell 'nothing' for millions. Artistic - that is the central banking world of today. Folks, savings are like Tony Montana or Boris the Blade you can kill them all you want but they won't go down easy it's gonna get messy

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LB
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February 2, 2016 at 8:19 AM ×

In the UK, housing will, indeed, be the issue. Retirees can cash in pension pots; with the lack of risk-free return , more of this cash will buy property , some of it on leverage. The government in policy coordination with Carney in his FPC role have raised taxation on buy-to-lettors in order to reduce speculative profit margins. Since demand outstrips supply , landlords will simply put rent up. This is happening with ultra-low rates , albeit the BOE no longer refer to them as such, negative rates would increase the velocity of this cycle and will be ruinous to society.

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Rossco
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February 2, 2016 at 8:35 AM ×

The Communists confiscated private savings all in one hit in order to pay themselves handsomely for as long as the charade of collectivism could last.

Todays unelected do it my stealth, slowly and almost unnoticed, for as long as the charade of Capitalism can last.

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Nico G
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February 2, 2016 at 8:36 AM ×

Jan 21 – Kuroda emphatically tells Japanese parliament he is not considering NIRP.

Jan 22 – Kuroda flies to Davos.

Jan 29 – Kuroda enthusiastically embraces NIRP and promises more of it if needed

from Mauldin who has a clear knack for compelling chronology

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Anonymous
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February 2, 2016 at 8:45 AM ×

If one reads history, it is clear to see that a thriving middle-class in society provides prosperity & democracy. Russia never had a middle-class and fell to a dictatorship veiled as communism. Currently central banks are destroying the middle-classes in DMs. I would be shocked if there is not a MASSIVE violent response further down the road, and I think it is likely that politicians blame central bankers when society fails. Central bankers across the world are literally going to be publicly executed.

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Rossco
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February 2, 2016 at 8:47 AM ×

Kuroda has taken a rather lopsided gamble in my view. It strikes me that in return for a few big figures in USD/JPY he has cost both speculators and likely some real money participants quite a bit.

His credibility is now shot and one would think his ability to jawbone will now be seriously diminished. If he now has to resort to "shock and awe" tactics to achieve his goals then his role becomes mucg more difficult and perhaps ultimately tenuous

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Anonymous
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February 2, 2016 at 8:55 AM ×

Nico,

Where did you get that -0,48% on EUR deposits? Only see that IB still has a floor on interest paid on deposits of 0%...

Thanks

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February 2, 2016 at 8:58 AM ×

Good job, please forward to Draghi, Kuroda and co...
we're talking about bank margins... please think about Asset management world...

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Nico G
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February 2, 2016 at 9:19 AM ×

anon855

from January 29th:

"Over 2015 and continuing into 2016, many central banks set negative interest rates for funds deposited with them. While initially, these were often viewed as short-term measures, they now appear to be policies with open-ended duration.

Interactive Brokers has absorbed the costs of these policies, and will continue to do so for smaller currency balances. However, with the announcement today that the Japanese central bank is also establishing negative rates, we are forced to recognize that such policies may be in place for a substantial period. As such, we must commence reflecting these market rates in our interest policies.

Starting 5 February 2016, IB will move to a credit interest policy for currencies with negative benchmarks (for example, EONIA, LIBOR, TIBOR, etc) where accounts with balances over approximately 100 thousand USD will be subject to a negative credit rate of Benchmark Rate minus 0.25%. Details by currency, as follows:

EUR: over 100'000 EUR, BM - 0.25% (as of this announcement, roughly -0.48%) "

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Anonymous
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February 2, 2016 at 10:03 AM ×

http://www.zerohedge.com/news/2016-02-01/john-cleese-political-correctness-will-lead-orwellian-nightmare

Very, very true.

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CV
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February 2, 2016 at 11:06 AM ×

Can is just run this past everyone here, which is in a similar vein to some of the "paradoxical" effects of -ve rates MM describes above. I have been arguing the portfolio balancing effect with a friend of mine for a while. Said friend is a PM in an EZ insurance company, and as such is limited, but he does have some wriggle room. Now, his point is that -ve rates (which hurts him because he needs to be very creative in managing cash/bond positions) doesn't really incite him to take more risk with his tactical allocating.

Quite the contrary; his point his that the LACK of return on his benchmark securities actually forces him to take LESS risk with his tactical/strategic allocation because it removes a "return cushion" from the main portfolio.

Yes/no/doesn't matter?

The thing is ... we DO see signs of carry trade flows in EUR and JPY due to -ve rates, and this is all well understood, but maybe large portfolios don't react the way they "should"

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Anonymous
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February 2, 2016 at 11:08 AM ×

SNB's Jordan Declines To Comment On Whether SNB Has Intervened In Mkts Or Not

= They intervened.

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Booger
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February 2, 2016 at 11:18 AM ×

Yen: yen was facing the most strength since 2012 and the biggest long position in years going into the BOJ meeting. I guess Kuroda was being opportunistic in not letting all that QE work go to waste. I am not sure why we are surprised when CB's lie. Politicians we expect to be liars but CB are somehow put on a pedestal.

NIRP: the main problem with interest rate suppression is that it causes people to misprice risk. It is just human nature to do something because everyone else is doing it and because that was the done thing. We may look back on this period and wonder WTF, people were willing to pay for negative yield 5 and 10 year government bonds or bonds of any variety at a negative yield! That is about as crazy as buying pets.com stock in 1998-2000 or buying financials 2006-7. I guess if everyong was eating shit sandwiches, a large proportion of people would be doing that too to keep up. That is not to say that now is the time to short GB's but it is pretty insane to be long government bonds with negative yields.

One would suppose NIRP would tend to create housing bubbles and the macro consequences of housing bubbles tend to be greater than other bubbles so the potential negatives in the long term are significant.

CNY: Bass is talking his own book. But short USD.CNH is a tighter idea than short JGB's. The Chinese probably had a better chance of controlling the stockmarket than the exchange rate battle. That they keep persisting indicates they think the consequences of a deval on foreign loans would be too much. But the blood is in the water. The cycle time seems to reduce and the short sellers come back. It does not look much different from other currency crisis in the past, in that the CB will defend and mess around with rates and carry costs to try to destroy the speculators. The spike in CHIBOR last month was spectacular.

The combo of capital control liberalization, economic growth slowing and capital flight = the Chinese are fighting too many battlefronts and will probably not win the exchange rate battle. At some stage there will be some real risk aversion and being pegged to a super strong USD will be diabolical, capital flight may become massive in that environment. Short Yuan could be a multiyear thing and to me it could be what short USD.JPY was 2 or 3 years ago in terms of fundamentals. How to best play that is an interesting question and I am not sure what the best option is there.

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Adrem
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February 2, 2016 at 11:27 AM ×

Excellent effort MM.

Interest rates are used to discount the future worth of a flow of income. The higher the discount rate the lower the present value of the future cash flows. Cannot use NIRP which is a short-term rate but long rates are extremely low by past standards, and NIRP is pulling them down. So we have a situation where the present value of an income flow 10/20 years down the road is pretty much the same as today. That seems to spell stagnation with a capital "S".

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Macro Man
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February 2, 2016 at 11:33 AM ×

CV: I find that eminently believable. A "guaranteed" positive low risk return is an excellent foundation on which to layer riskier bets, as there is a cushion (in terms of maintain positive performance) if it goes awry.

A similar argument was made years ago in Japan against ZIRP: namely, that by depriving the populace of interest income, the BOJ discouraged, rather than encouraged, spending, as the population was forced to sock away an ever increasing amount of cash to generate the desired level of interest income.

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Macro Man
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February 2, 2016 at 11:35 AM ×

Booger, China's exposure to foreign currency denominated loans is actually quite modest. In this it is a stark contrast to most classic EMFX blowups.

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Polemic
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February 2, 2016 at 11:40 AM ×

Negative rates are only any use once people lend to normal users at negative rates. at eh moment most users see rates spread around par. You borrow at +ve and place at -ve. Which is a tax on both sides of money flow and will just slow things down as MM says.

Th absurdities of negative rates sees the public used to cash and the only ones who suffer are the banks who on one hand are being encouraged to lend but as they do so their reserve requirements rise and they get punished on those with -ve rates s they ar the ones forced to hold this negative yield 'good credit' rubbish. hence -ve rates so far out the german curve. Hardly an incentive to lend and will add cost to the lending process which leads to HIGHER rates being charged to the consumer of debt.

THE cost aren't a nicely linear through zero, depending as yo go through zero, but more parabolic with the base at zero.

Perhaps it's worth recycling this again

http://macro-man.blogspot.co.uk/2012/07/i-flation-and-negative-money.html

because we are already seeing greater and greater pushes to move cashless and it's no wonder when the authorities are arbed through cash vs official rates.

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Polemic
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February 2, 2016 at 12:04 PM ×

BTW is watching Uridashi and Samurai issuance/repayment as fashionable as it was?

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Corey
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February 2, 2016 at 12:16 PM ×

Makes one less sanguine on US banks if one feels like I do that it's only a matter of time before they join the RoW in Wonderland.

You've provided an excellent explanation on -ve rates and potential implications. What really sends me down the rabbit hole though is how much the effects are at odds with the stated goals. They want banks to create credit and to accomplish this they..make it harder for them to make money! Forgive me, but this can't be a simple oversight or policy error. Its plain black and white, staring them right in the face. They say they are out of options and at least this is something, but again, it produces a detrimental effect - which brings me back to why?

Maybe it's tin foil Tuesday, but part of me is struggling not to think that they do realize the implications of their policy and are doing it on purpose.

Thanks for the post it has been v helpful.

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Anonymous
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February 2, 2016 at 12:38 PM ×

I thank you for initiating a discussion on negative rates. Immediately obvious is that this policy has some inherent conflicts and it makes one wonder if the Central banks recognise these at all. I have little faith in their ability to think through all of the consequences of their policies backed up by some screaming howlers from them in the past.

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marcusbalbus
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February 2, 2016 at 12:41 PM ×

MM: you are intuitively recognizing the "Fisher Effect". Read the blog by Stephen Williamson (New Monetarist Economics).

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washedup
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February 2, 2016 at 12:42 PM ×

MM/CV the idea of negative rates acting as a cushion and resulting in risk aversion only applies if investors still benchmark to positive returns!
Two decades out, imagine a massive outperformer (call him Worryin Nuggett) who has milions of followers - CAGR? 4% as the S&P 500 has only returned 1%, all from dividends. Invested in storage space for paper bills at the right time perhaps..

Look, Kuroda's actions were squarely aimed at weakening the yen - its unfathomable to me that central banks with trillions at their disposal could wade a pinky into CME WTI futures and solve this 'inflation expectations' problem, instead they are choosing to wrestle a whale covered in KY jelly - bit like Hitler's march to Russia if u ask me.

As far as risk sentiment goes, only dollar weakening that is seen as quasi-stable will achieve it - I think its a matter of time (and some more dumpster diving by spoos) that they figure it out and create some kind of coordinated intervention to achieve it - if they are willing to try negative rates this is easier in comparison (easier even than the aforementioned oil trade), much better bang for the buck, and the most fun part, it would blow up those cheeky speculators, y'know.

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Macro Man
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February 2, 2016 at 12:46 PM ×

@ marcusbalbus, yes of course, thanks for pointing that out.

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Bruce in Tennessee
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February 2, 2016 at 12:50 PM ×

http://global-rates.com/interest-rates/central-banks/central-bank-america/fed-interest-rate.aspx

American interest rate (Fed) 0.50 % 12-16-2015
Australian interest rate (RBA) 2.00 % 05-05-2015
British interest rate (BoE) 0.50 % 03-05-2009
Canadian interest rate (BOC) 0.50 % 07-15-2015
European interest rate (ECB) 0.05 %

...This is part of the argument I've pondered over too, MM. It seems to me ZIRP and NIRP are "magical" numbers, that is, that once this process started the trend to the globe to zero and the trend seems to be toward NIRP. As noted above the Aussies have kept a 2% this entire time, and don't seem to be suffering any more that anyone else not named China. Although central banks always lower interest rates in times of weakness, it seems to me that there is a lower bound, say 2%, that once it is breached merely adds to the slow-flation. If the Fed did raise rates to say, 1.5% what would the consequences be? When you take the time element into account, 8 frickin' years, are economists saying that things will be a lot different at 1% than ZIRP? Perhaps you could have that opinion at t=0, 2008, but now you have the evidence of time, and you can't go on supposition only...

2 cnets....

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Bruce in Tennessee
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February 2, 2016 at 12:58 PM ×

This of course, really gets down to devaluation of currencies and exports....at least a main driver, if not THE main driver...

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February 2, 2016 at 1:29 PM ×

Negative returns are in most situations the natural state for stores of value. Before financial systems existed, almost all investments had negative returns if you didn’t put work and energy into them. To store value, you had to accumulate stuff, buildings or land. Most options either had high maintenance costs, were subject to risk of damage from natural causes and theft, were very volatile or required hard labor to get production out of.

Even in societies with financial systems, getting risk free, hassle free, positive real returns has been difficult for most of history. This just reflects the natural laws of thermodynamics that tell us that everything tends to decay without a constant supply of work and energy. In general, most things require maintenance to keep their worth.

In actual nature, where money isn't an option, squirrels' cache of nuts are eroded by spoilage or theft from other animals.

The 20th century was probably the most notable exception. Because of unprecedented demographic and technological growth, positive risk free real returns were easy to find. The recency effect probably explains some of the confusion people have about this. It is possible that under favorable conditions, wealth can have positive returns and even compound into very good long run returns but it is not a guarantee and there is nothing natural about it. It may not continue forever, particularly amidst an aging and retiring population in a world no longer as rich in easy to exploit natural resources.

Money should not act as an artificial backstop for savings because this prevents savings from materializing into something real. It limits the total amount of real wealth created in the economy. It replaces physicals manifestation of wealth with intrinsically worthless paper or electrons. Money is a very good tool to enable fluid transactions and contract negotiation, but it is detrimental when used as a long term aggregate saving vehicle.

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February 2, 2016 at 1:29 PM ×


Here is a story to help understand:

Imagine an isolated village where people farm for subsistence.

This is a primitive agrarian village disconnected from the world that has not up to now have had a currency. People rely on barter instead. In the fall villagers usually produce excess food to have something to eat in the winter, even if, the real returns on these investments are low. Because of spoilage, crops stored for the winter are only worth 90% of the initial investment required to produce them.

One day, this village mandates its government to create a currency that always keeps 98% of its real value (2% inflation) even when private savings assets can't retain this much. The government puts money into circulation by buying part of farmer's crop during the summer (politicians have to to eat).

Most farmers produce enough food for the summer, sell some of their crop and keep their money to be able to buy something to eat in the winter. They do not produce a crop to store for the winter since it would only return -10% on their initial investment and their central bank promised their money would be worth at least -2% (plus they may even get a bit of interest).

However, when comes winter, all farmers have cash but few have anything to sell because they didn't reinvest in the production of a crop to be stored!

In this situation, it's going to be very difficult for the government to control inflation because there will be too few goods for the amount of money people will want to spend.

If the government does manage to control inflation, it will be by depressing the nominal value of the crops of the few farmers who did store something for the winter. The central bank might do this by giving high enough interests payments on cash to prevent people from wanting to spend it immediately. In any case, people won't eat much during the winter.

This dire situation could have been prevented if the central bank had kept money devaluating sufficiently (in this extreme case, inflation above 10% in order to keep real interest rates bellow -10%). Farmers would not have kept most of their savings as idle cash but would have reinvested them into an extra crop stored for the winter and have continued to trade during the winter.

Note that there are parallels with farmers saving for the winter and a baby boom saving in preparation for retiring and stopping to work.

Suddenly because of high demands for savings without necessarily more supply of things that are good at carrying value into the future, assets that maintain their worth should naturally be worth more. We are talking about a future where there will be less available labor relative to population and things will be potentially more expensive to produce.

Central banks that allow money retain too much value, are doing like in the village example, they are allowing savers to keep pieces of paper as a claim on future wealth without anyone necessarily investing in the infrastructure and capacity to produce this future wealth. People that should have been building inventory, infrastructure or production capacity remained unemployed instead.

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Leftback
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February 2, 2016 at 1:38 PM ×

and speaking of main drivers... the main driver of US inflation is oil, and the price of $wti is falling again today, threatening another run at the $30 threshold. We are substantially in cash and once again looking to the security of the hammock. For the time being, the squeeze in crude and XLE is over, but there will be another, and perhaps another before the turbulence ends.

Surely the end point of all this competitive devaluation is a depression by any other name, a mild stagflation that persists for a decade or so, slow or zero growth, persistent underemployment via low participation rates, pernicious inflation in the things we need (food, health care, rental housing), deflation in some of the things we want (iPads).

We are all Japanese now, MM. Or as you yourself put it long ago:

Turning Japanese

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Bruce in Tennessee
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February 2, 2016 at 1:39 PM ×

If there is not a lower bound, and good thinking CB'ers are headed toward NIRP....well, if -.25% is a good idea, wouldn't -2% be even better? That would speed up the flushing of those stinkin' uninvested deposits...

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Anonymous
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February 2, 2016 at 1:48 PM ×

Japan is monetizing it's debt - pure and simple. Unfortunately this has negative consequences (to them and others).

As Japan continues down this path it is only a matter of time before the credibility of the BOJ is lost and the yen will plunge. The financial markets have seen time and time again it is far easier for a country to weaken its currency than support it. As investors in Japan's government bonds begin to believe that Abenomics will be successful in bringing back inflation it would be logical for owners of JGBs to move out of low yielding securities and buy foreign bonds or equities. The moment the Japaneses stock market fails to rise enough to offset inflation this will turn into a tsunami of money fleeing Japan and constitute the end of the line for those left holding both JGBs and the yen. This has been a long time coming and when the end becomes apparent to all, events will pick up speed and the situation spiral out of control. When Japan crumbles the shock waves will reverberate around the world.

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Anonymous
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February 2, 2016 at 1:52 PM ×

I can imagine NIRP in the US causing a run on banks that try to pass NIRP along to savers. Now that would be hilarious!!!

Rossmorguy

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Anonymous
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February 2, 2016 at 1:52 PM ×

NIRP destroying EU banks:

http://www.zerohedge.com/news/2016-02-02/european-bank-stocks-plunge-cycle-lows-what-nirp-has-wrought

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CV
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February 2, 2016 at 2:35 PM ×

Re markets; yep LB. It's a shower of sh't out there, completely inverse to the Friday happy-clappy mood. Day trader environment ... for the rest of us. Snooze button really. No need to get your appendages chopped off here.

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abee crombie
admin
February 2, 2016 at 2:38 PM ×

Nice post MM and I agree with Benoit as well, I dislike how monetary policy is bieng used a covert fiscal policy but it is what it is. CV you bring an interesting view too, however I can guess that on once markets stop going down/stabilize, a lot of 'real money' will yield chase again bc that is what they do normally, and still no one likes to earn 1.9% in US Treasuries.

Cheer Nico for the IB warning, luckily my account doesnt meet those guidelines ;-)

With all the talk of deflation, I think there are 2 main causes 1) USD strength/EM weakness 2) Oversupply of everything, most especially commodities.

Quietly a lot of EM FX has stabilized (for now) and CRB indexes have bounced. However with oil dipping to $30 again and European banks leading indexes lower who knows.

Either way I think my take away is that you can only invest today in company's that have something that isnt a commodity. FB and GOOG prove there are still companies able to do it

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CV
admin
February 2, 2016 at 3:17 PM ×

Oh, and just to get a head start on everyone here. Bonds look smoking ... but I think longs are two steps away from a massive accident here!

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February 2, 2016 at 3:46 PM ×

Great post MM. Time to buy some Japanese REITS?

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Anonymous
admin
February 2, 2016 at 4:04 PM ×

Anyone "investing" in FB or GOOG is a clown.

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Anonymous
admin
February 2, 2016 at 4:10 PM ×

I don't really get how negative rates that push money out of nominally risk-free savings and state supported banks into riskier private investment, and might encourage zombie capital liquidation is a bad thing. Whether the cost of NIRP is passed onto savers (industry survival negative) or borrowers (tighter credit and growth negative), it's a problem for banks and probably those exclusively reliant on +ve asset yields and capital growth. It doesn't have to be a net problem for everyone else. It might be, but not necessarily avoidable if a reflection of demand, demographics etc.

Evidence of the corruptibility of authority is concurrent QE and asset boosting fiscal/regulatory measures while at zero or negative.

northshore

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washedup
admin
February 2, 2016 at 4:46 PM ×

Chris - I had the same idea (my forays into US rents haven't worked that well recently!), but not sure if there are decent vehicles.
The NIRP impacts really depend on whether the curve steepens or flattens - the knee jerk reaction has obviously been to flatten, but that is a symptom of risk aversion - if commodities stabilize sometime in the future it could result in decent steepening, and yes in that situation REITS would benefit.
If you know of good names to dig into in REITS in Japan let me know - do they even have mortgage REITS?

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BeanCounter
admin
February 2, 2016 at 5:10 PM ×

It seems to my feeble mind that the problem (in Japan at least) is lack of demand, low inflation expectations driven primarily by zero wage growth. Surely there are a few experimental options. For example

i) Govt slashes employee tax or/plus
ii) Govt subsidises flat x% salary increase - heavily skewed to younger people who perhaps are more likely to spend the result of the Govt largesse.

All paid for by new special debt issuance - the Govt essentially funds itself for free in any event, plus the BOJ will helpfully hoover up these new special bonds to ensure yields @ zero.

Too easy? Sure I can problems up the road, but is stagnation an option?

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CartedOut
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February 2, 2016 at 5:22 PM ×

Polemic thanks for linking the 2012 post, if for no other reason than it provided an opportunity to enjoy re-reading the sentence "Of course this has been the case with the Swiss Franc for some time, but TMM have coped with the logic of Swiss negative rates by confining all things Swiss to a little box that works in a parallel universe of finance on different laws of financial physics, where cuckoo clocks, expensive watches, hard cheese and mountain shaped chocolate bars operate in their own airport duty-free shop of unreality."

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washedup
admin
February 2, 2016 at 5:28 PM ×

BeanCounter - in fact Its not clear to me at all why stagnation is not an option for Japan - they have a high standard of living - their per capita GDP is the same as the best of the OECD - Shinjuku station where 8 MM people pass every day is cleaner than my living room (in my defense, I have a 4 Yr old) so infrastructure and services is not a problem - and they are getting the good kind of deflation for a commodity importer.
Central bankers are fighting the ghost of 1937 with $30 TN bazookas while a $1 TN market (oil) has everyone's nuts in a vise - quite astounding.

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Anonymous
admin
February 2, 2016 at 6:26 PM ×

http://www.wisdomtree.com/etfs/fund-details.aspx?etfid=97

DXJR

An ETF for Japanese real estate companies ... not a recommendation, just an FYI

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Nico G
admin
February 2, 2016 at 6:41 PM ×

just back from Japan, go there every year

Japan is just experiencing '1st world fatigue' - did you know that current 18-28 year old generation just abandoned sex? they have some hug rooms, ladies pay ($$$) for 'male friend experience' but no-one can be bothered with relationshiT. Consequently more of gruesome Japanese demographics are in the making

imho it always pays to go full microeconomic/societal analysis if you want to invest long term in a country. That is, if anyone gaijin could understand Japan at all. This country has always been a 'weird' place and personally favorite place on earth for so many reasons as washed mentioned you have 30m peeps living in the Tokyo region without a noise without littering etc

and an obscene level of politeness. So fond of Japanese culture but growing uneasy with Japanese millennial' abysmal lethargy. Nothing seems to interest them other than the occasional shopping and trip to Hawaii. And you have a central banker gone absolutely godzilla apeshit throwing trillions at them you know, trying to show them a good time

this is bloody scary. All those years i thought China would bring us down, but their little neighbor is doing its fair share to fuck everything up.

USDJPY is still a big short in my opinion. If more trillions of bullshit fail to send a currency to new lows you know where the next trade is.

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Anonymous
admin
February 2, 2016 at 6:58 PM ×

@nico

So agree with your last sentence. made the same point a few days ago. USDJPY looks like an epic short to happen. Hope I am not too naive on this one.

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algoman
admin
February 2, 2016 at 7:02 PM ×

Have just bought 500 contracts ES.

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Bruce in Tennessee
admin
February 2, 2016 at 7:23 PM ×

http://www.cnbc.com/

Fed's George: Dec rate hike 'a late start'
Esther George, president and chief executive officer of the Kansas City Federal Reserve Bank.
"Recent volatility is unsurprising, and the Fed will keep hiking rates unless the outlook changes, the Fed's Esther George said."


...Esther, hooooney, you can't hike here...I've read on the internet that that would be impossible....

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Anonymous
admin
February 2, 2016 at 7:53 PM ×

"All those years i thought China would bring us down, but their little neighbor is doing its fair share to fuck everything up."

There you go with the potty mouth again. My twin 13 year girls read this blog.

Tell me, how many Japanese citizens sought asylum in other countries?

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Polemic
admin
February 2, 2016 at 7:54 PM ×

algoman. I just bought a billion, feels offered.

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Nico G
admin
February 2, 2016 at 7:59 PM ×

after all that nonsense let's remember that big savings in energy cost will help households deleverage further. Highly funny that the best news ever (falling energy + common prices) would make the whole world panic - what the hell is wrong with deflation?

and one simple question that is NOT doing the round: why the heck did we pay so much for energy, for so long? it looks like Goldman and Co. which was given permission to 'trade' oil in the 90s and squeeze futures from $10 all the way to $200 (target) no, $148, finally succumbed to the Law of demand and supply

the episode of massive obnoxious wealth transfer from the whole world to a happy few Saudis and neighbors has finally been reversed, it was about time. This is the biggest story of world economics for the last decade, much bigger than the FANG bullshit.

Lastly, the diversification investments made worldwide by Saudis Qataris etc who could not believe their luck above $60 crude were absolutely brilliant. They now own real estate/corporate treasures and let's face it, with the help of Goldman etc WE gave it to THEM.

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Polemic
admin
February 2, 2016 at 8:01 PM ×

Nico . you are on a roll!
Great material enough recently for your own blog

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Anonymous
admin
February 2, 2016 at 8:02 PM ×

"The global financial system is benchmarked to a myth. A ghost rate. A rate that exists only in the minds of the participants that in their most private moments know they could not fund at. A rate that were it to quake governments from developed and mercantilist nations would jump to stabilize. The global term structure of rates is based on a sanctioned fraud. But somehow it works."
https://contrariancorner.com/2016/01/29/16490/

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Anonymous
admin
February 2, 2016 at 8:03 PM ×

Econ 200 Money and Banking

Revised Edition. Chapter 5 Quiz

What is the purpose of a Central Bank?

A: To create excess reserves for its constituents.

What is the basis of modern monetary policy?

A: To penalize said constituents for holding created excess reserves.

Why do Central Banks raise the IOER?

A: To create a pool of funds to pay the future penalty with.

https://contrariancorner.com/2016/02/01/econ-200/

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Nico G
admin
February 2, 2016 at 8:17 PM ×

anon7:53

apologies to your daughter for the F word.

Regarding asylum abroad history has shown the diaspora that left Japan to take a chance in other counties is highly despised.
Japanese are incredibly racist and proud of their unicity. Ask any 'nikkei' who made it in Brazil (or Peru or even the US) how poorly they are welcome whenever they return to motherland. Treated as treators, no less for Japanese are nationalistic beyond belief. Read the pamphlets of Toshio Montoya when you find time (under pen name of Meiji Fuji) they are a good example of Japanese sake sorry, psyche.

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Macro Man
admin
February 2, 2016 at 8:23 PM ×

My internet picked a fine day to pack it in....

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negative volatility
admin
February 2, 2016 at 10:35 PM ×

nirp isn't going to do anything for europe when fins there are running 10-15% npls (italy). the entire european banking system is kaput at the moment and no amount of rate cuts is going to fix that. not quite sure why the market is so fixated on China and has completely ignored the more immediate threat at hand. Mario is eventually gonna have to buy bank debt to prop up the system. the recent accord with the EC isn't going to bring out distressed buyers the way its currently structured imo.

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Nico G
admin
February 2, 2016 at 10:58 PM ×

Mario is worried about Deutsche Bank... DB is as opaque as China on a smog day

last year i said European banks are kaput and everyone laughed

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hipper
admin
February 2, 2016 at 11:01 PM ×

Really interesting point on bank NIMs. No doubt another one of those unintended consequences, along with NPL rises in PIIGS. NPL rise just might be related to the idea that low rates really did nothing in terms of employment or aggregate demand growth IMO. The lowering unemployment could be related to people dropping out of unemployment status and creation of low wage jobs which might be 70-80% paid through public finances. Another thing with these rather closed economies in the case of the housing market is that they are getting saturated. When rents are tied up to housing prices (which in turn tied up to housing supply scarcity) and not other stuff like wages or employment, living costs will turn into a major drag for the general economy through lower household net income.

The ugly duckling mREITs suddenly turned into a shining star, most likely related to deteriorating hike expectations. The steepener would still feel better for the long term even though they might gain some book value for now, since in the end that's what they are, income vehicles. And is it already too late to go all in TLT?

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Anonymous
admin
February 3, 2016 at 12:40 AM ×

The argument about low interest rates leading to lower inflation via expectation was done by J. Cochrane and a couple other right wing economist bloggers.

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Anonymous
admin
February 3, 2016 at 12:56 AM ×

Might we see a new all-time high on TLT before April Fools?

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abee crombie
admin
February 3, 2016 at 12:57 AM ×

NICO I agree that ib and stupid pension diversification into commodities as an asset class probably helped push oil up but I think it's more a function of how markets work, especially under perfect competition. Financial markets are all made at the margin. And whem we needed more oil, it cost a boat load more than what we were used to. But with enough capital, technology and time market forces found a lot more supply and the market response has been brutal, as it is with commodities. However the situation with steel and lots of other base metals is mugh worse imo.

This market is trading heavy. Feels like it just wants to dump. Funny how 2 years ago how everyone was calling for the yen to devalue to something like 200. Now it's gonna strengthen. Who knows. But shorting Europe just feels right from price action.

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abee crombie
admin
February 3, 2016 at 12:57 AM ×

NICO I agree that ib and stupid pension diversification into commodities as an asset class probably helped push oil up but I think it's more a function of how markets work, especially under perfect competition. Financial markets are all made at the margin. And whem we needed more oil, it cost a boat load more than what we were used to. But with enough capital, technology and time market forces found a lot more supply and the market response has been brutal, as it is with commodities. However the situation with steel and lots of other base metals is mugh worse imo.

This market is trading heavy. Feels like it just wants to dump. Funny how 2 years ago how everyone was calling for the yen to devalue to something like 200. Now it's gonna strengthen. Who knows. But shorting Europe just feels right from price action.

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Anonymous
admin
February 3, 2016 at 1:08 AM ×

1Yr Tbills 0.455% and 6Month Tbills 0.45% almost trade on top of each-other

"Bernanke says Fed likely to add negative interest rates to recession-fighting tool kit"

http://www.marketwatch.com/story/bernanke-says-fed-likely-to-add-negative-rates-to-recession-fighting-toolkit-2015-12-15

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Anonymous
admin
February 3, 2016 at 1:42 AM ×

At the end of 2014, Japan’s net foreign assets — the sum of all foreign assets held by Japan, minus the value of all domestic assets owned by foreigners — stood at nearly $942 billion, placing Japan among the world’s largest owners of foreign assets. Still a safe haven?

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Anonymous
admin
February 3, 2016 at 2:09 AM ×

The Nikkei225 is down 570 points (3.2%) ...

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Anonymous
admin
February 3, 2016 at 2:53 AM ×

http://www.coppolacomment.com/2016/01/japans-negative-rates-china-connection.html

Argues that Japan's neg rate scheme is nothing more than a disguised competitive exchange rate devaluation, explicitly structured to have little impact on banks or incentives to lend.

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Anonymous
admin
February 3, 2016 at 4:00 AM ×

the quality of the blog posts is second to none in the blogosphere (or anywhere!) i wonder how much time do you spend a day on them on average? yours- long time reader.

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NoE
admin
February 3, 2016 at 4:13 AM ×

Well they don't want to 'tax' the mums and dads ...
Report from Nikkei:
"The planned March sale of 10-year Japanese government bonds through banks to retail investors, municipalities and others will be canceled amid expected below-zero yields following the Bank of Japan's recent move to adopt negative interest rates."

They had already previously done this for 2yr and 5yr notes, so now all sales will end to these investors.

Stay long USTs and other "high-yielders"

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Anonymous
admin
February 3, 2016 at 5:00 AM ×

"Brown Brothers Harriman currency strategists calculated that the Kuroda's new negative rate will only apply to between ¥10 trillion ($82.4 billion) and ¥30 trillion of the more than ¥250 trillion in reserves held by the BOJ."

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Anonymous
admin
February 3, 2016 at 5:11 AM ×

Kuroda yesterday: “If we judge that existing measures in the toolkit are not enough to achieve (our) goal, what we have to do is to devise new tools. I am convinced that there is no limit to measures for monetary easing.”

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Nico G
admin
February 3, 2016 at 5:29 AM ×

abee

you know we love each other but i beg to differ regarding oil - commos ramp up was ARTIFICIAL

do you remember how rice futures doubled in January 2008 - yes, in one month

all those wild swings on anything commo today

it has nothing to do with supply and demand, all to do with idiots with excess leverage being squeezed out by some very heavy hands (IB and some partnering HF)

do you remember the PEAK OIL imbeciles? where are they hiding now?? with their fancy theory that convinced everyone's mother that expensive oil was here to stay

they are responsible for the trillion of oil debt today, talk about a collective illusion... look at British BP now, shot in both knee, you'd think its management would be uber smart and see through speculation but hell, not.

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Anonymous
admin
February 3, 2016 at 7:16 AM ×

Oil - Chris J Cook (@cjenscook) was writing about the financialisation of oil a long time and how it would eventually unwind. Formerly of what became ICE exchange.

2009: http://www.theoildrum.com/node/5606
Oil: the Market is the Manipulation

2012: http://www.nakedcapitalism.com/2012/02/chris-cook-the-oil-end-game.html
Chris Cook: The Oil End Game
Posted on February 27, 2012 by Yves Smith

By Chris Cook, former compliance and market supervision director of the International Petroleum Exchange. Cross posted from Asia Times

"As I have outlined in previous articles, the culprit for the high oil prices between 2009 and 2012 – with the exception of the speculative “spike” between March 2011 and June 2011 driven by Fukushima and Libyan price shocks – has been passive investment by risk-averse investors, which enabled producers to support oil prices at high levels.

Much of this passive money underpinning the market and enabling producers to monetize inventory pulled out of the market in September 2011, and another wave pulled out in December 2011"

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