Negative-Interest-Rate absurdity is another “rabbit out of the hat.”
By Don Quijones, Spain & Mexico, editor at WOLF STREET.
For the second time this year, Spain’s caretaker government just managed to sell 50-year bonds in a €3 billion ($3.4 billion) deal. Despite maturing in the year 2066, when many of us won’t even be alive and the duty to pay back the debt (assuming it still exists) will have been handed down to our children’s children, the bonds will pay an annual interest rate of just 3.45%. Not only that, but the issuance was over-subscribed by €7 billion.
This is a mind-blowing turn-up for a country that just four years ago needed an unprecedented bailout from the Troika to save its saving banks and avert total financial collapse. It is also a resounding testament to the power of central bank policy to turn economic reality on its head.
Less than three years ago, when Draghi had only just begun doing “whatever it takes” to save the single currency, the Spanish government had to pay a 5% yield to get investors to buy their one-year bonds. Now investors are willing to take 50-year bonds off the government’s hands in exchange for an annual interest rate of 3.45%, despite all the attendant risks involved.
While the Spanish economy has improved somewhat since then, that is largely due to the fact that the government has sacrificed long-term stability for short-term growth, going so far as to plunder half of the nation’s social security reserve fund in order to keep spending at its current levels. The remaining half is exclusively invested in Spanish bonds. Even Brussels now admits that Spain’s public debt is out of control.
To make matters worse, Spain doesn’t have an elected government to speak of and could struggle to form one even after the next round of elections, on June 26.
None of that seems to matter, though. Global investors, mostly from Germany, Austria, Switzerland, the UK, Ireland, US and Canada, are now so desperate for yield that they’re willing to hold their noses, say a few Hail Maries and place millions of euros of their clients’ money on a half-century gamble.
The longer the maturity a bond has, the further its value will drop in response to a rise in interest rates.That hasn’t stopped investors snapping up super long-term bonds from a number of European countries. In April, the French treasury flogged €9 billion of debt, with one tranche maturing in 2036 and the second in 2066. The interest it paid on each tranche was just 1.25% and 1.75% respectively. Italy, home to banks that are stuffed with as much as €360 billion of bad debt, is also “evaluating” demand for a possible 50-year offering. Some Treasurys have gone even further, with Ireland and Belgium both selling €100 million of 100-year bonds this year.
Obviously, none of this would be conceivable if it weren’t for the ECB’s increasingly unconventional interventions in the financial markets. Thanks to its rampant government (and soon to be corporate) debt buying, free bank lending and negative interest-rate setting, the global stock of negative-yielding debt is estimated to have reached €8.26 trillion by May 1, up from €4.92 trillion at the start of the year.
This development has left pension funds and insurance companies facing an unenviable dilemma. Either they hunt for higher returns in the much riskier junk bond markets or they fish for super long-term government debt. The riskier the nation, the more lucrative the returns. “For investors like insurance companies and pension funds that need yield, this can be a natural hedge for their long-dated liabilities,” said Lee Cumbes, head of public sector debt at Barclays PLC.
At its last monetary-policy meeting, in Frankfurt in April, the ECB decided to leave policy unchanged, leading some investors to fear that the central bank may have run out of tricks.
Fortunately, ECB Governing Council member Vitas Vasiliauskas was on hand to allay those fears. “Markets say the ECB is done, their box is empty,” Vasiliauskas, who heads Lithuania’s central bank, said in an interview with Bloomberg on Tuesday. “But we are magic people. Each time we take something and give to the markets — a rabbit out of the hat.”
It sounds insane — and it is — but it’s also true: today’s markets, in particular Europe’s, have been reduced to central bankers pulling rabbits out of hats. A clown show, so to speak, with global investors and their algorithms waiting with baited breath for the slightest clue as to what the next trick will be.
The problem with running a huge, continent-wide financial system this way is that it tends to irrevocably change the nature of things, occasionally for good, mostly for bad. Fundamentals no longer apply (or at least their impact is delayed) and unintended consequences and unexpected distortions — such as triggering a stampede of normally conservative investors into inherently risky investments — abound.
Another consequence of the ECB’s magic quackery is that it completely undermines the traditional disciplinary role played by interest rates. Make interest rates ridiculously cheap for governments with a well-deserved reputation for over-spending (such as, say, Spain) and the inevitable result is that the government begins borrowing more, to the point where the nation’s public debt almost triples during an eight-year period. Yet despite all that, interest rates on Spanish debt continue to plumb new depths.
In the complete absence of any traditional financial disciplinary mechanisms, the EU is now resorting to political measures to keep eurozone economies in line. As Euractiv reports, the European Commission has just decided to launch sanctions against Spain and Portugal for not making sufficient effort to cut their deficits. Spain’s 2015 budget deficit was 5.1% and Portugal’s was 4.2%.
The Commission is also considering doing the same to Italy for failing to reduce its public debt (132.7% of GDP). According to EU rules, the fines could be up to 0.2% of GDP, which in Spain’s case would be the equivalent of around €2.6 billion.
Who will end up paying the fine? Why, Spain’s already cash-strapped taxpayers, of course. Naturally, the fine, no matter how large it is, will increase Spain’s public debt and budget deficit. In the meantime, the ECB’s magic men and women will continue driving interest rates on that debt lower, making it even cheaper for the government to borrow more. If, once again, the government goes overboard (which it no doubt will), the taxpayers will be fined anew, creating even more public debt.
Rinse and repeat, until, finally, fundamentals re-apply. In the meantime, sit back and enjoy the scary clown show. By Don Quijones, Raging Bull-Shit
Just shocking to Draghi that Germans dislike stocks, with the DAX down 21%. Read… Wrath of Draghi Hits Germans who Refuse to Blow their Savings
Enjoy reading WOLF STREET and want to support it? You can donate. I appreciate it immensely. Click on the beer and iced-tea mug to find out how:
Would you like to be notified via email when WOLF STREET publishes a new article? Sign up here.