Friday, Aug 20, 2010
Plummeting bond yields mean we are already in a liquidity trap
ETFguide.com: Why the Global Economy Is In a Liquidity Trap
Summary - Government interest rates have hit new lows in the U.S. and Germany recently. UK gilts are barely above their Credit Crisis lows and Japanese 10-years have fallen as low as 0.90%. This is taking place because central bank liquidity is not finding its way into the real economy. This is known as a liquidity trap.
Posted by mountain goat @ 12:58 PM (1439 views) Add Comment
14 Comments
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1. mountain goat said...
Also see this NY Times blog by Paul Krugman about this liquidity trap and what Central Banks can and can't do about this.
http://krugman.blogs.nytimes.com/2010/07/14/nobody-understands-the-liquidity-trap-wonkish/
2. mark said...
MG wow that is round in circles, catch 22 backward forward, low rates, helicopters, cash, we are where? Get me off this planet..lol
3. Wageslavex14 said...
The scariest part about the Krugman article is not the article itself, which is comparatively sensible compared to his previous pish, but rather the comments underneath where people all try and come up with further economists' wheezes to 'solve the problem'.
It is not a game. We are not dealing with hypotheticals, or someone's PhD thesis involving theoretical experiments - this is the real economy, where real people's motivations regarding work and productivity need to be taken into account. All the suggestions seem to implicitly accept that moral hazard was a quaint concept which was dispensed with a long time ago, and that fairness hasa no place in economics - all that matters is getting people spending again.
With these morons in charge of the levers, we are doomed.
4. icarus said...
Low gilt yields are also a flight to safety by investors since nobody knows the policy or the rules and business and consumer confidence is down.
5. hpwatcher said...
A liquidity trap is an ugly situation to say the least. Either a country continues to spend its wealth to support its lifestyle until all of it is dissipated and complete impoverishment occurs or it finds a way to get some of the liquidity into the real economy. The problem is that only small measured amounts of liquidity can be allowed to flow into the economy in any given time period, but this is not the likely scenario. If the central bankers were capable of making this happen, they would have already done it. More likely is that the floodgates will be open and too much liquidity goes into the real economy too quickly. Hyperinflation will then occur and prices could start to skyrocket almost overnight. Japan (NYSEArca: EWJ) has faced this situation for the last twenty years, now it looks like all the developed economies are going to be facing it.
Very nasty. Looks like it's the beginning of the end for a few currencies.
6. mark said...
Wish they would get rid of the Euro worst idea ever..
Europe became too expensive after that daft idea, also it took all the fun out of going to europe
7. drewster said...
From Krugman:
"So why not forget about open-market operations, and just drop the stuff from helicopters? Well, remember that at this point cash and short-term bonds are equivalent. So a helicopter drop is just like a temporary lump-sum tax cut. And we would expect people to save much or most of such a tax cut."
I disagree. Some people - especially the poorest - will spend whatever you give them. Even people in negative equity will be helped; they can pay off their debt and start spending again. (I'm not saying that's a good thing, but it would solve the liquidity trap and keep house prices high.)
Some of the comments also favour helicopters:
"In your helicopter example, the savings would nonetheless have a very fundamental positive effect: households would clean-up their balance sheet, reduce debt and start consuming again."
"To the extent that your helicopter drop of newly printed money fell on relatively poorer neighborhoods, the recipients would be more likely to spend rather than save, no? Therefore it stands to reason they will in fact spend some of their tax rebate to survive today (or buy a flat screen TV) and not hoard it."
"If you manage to strategically drop the stuff on unemployed people, they most likely will not save it, but rather spend it and increase aggregate demand."
8. mrmickey said...
Yes rather than us all going for a week in the sun to Greece because it nice and cheap we can't affort it because Greece is in the Euro, so Greece losses out on revenue and we end up with vitamin D deficiency.
9. mountain goat said...
Drewster - paying off debt with your helicopter money is essentially the same as saving it. It is removing money from circulation. In fact paying off debt is doubly negative because the banks were using that loan as an asset on their balance sheet for further lending. This is what a liquidity trap is about, people and companies going into cash hoarding because of economic uncertainty.
The response has been to print money but this will only be unleashed once there is a turn around everyone believes in. Where companies stop hoarding and start employing again. This seems a long way off because the global economy is slowing and there is excess capacity as a result. As Merv King observed every country wants to overcome their slowdown by exporting more. Money printing has circumvented a crash but the excess capacity needs to be worked off in a slower manner, with only the best companies surviving. This process will drive down asset prices during this period, at least in countries that have not experienced a big currency devaluation like the UK.
10. drewster said...
mountain goat,
Wow, thanks for the explanation. I'm kicking myself now for not realising that!
11. Goofball said...
Can't see how any meaningful recovery can take place until we hit the bottom, asset bubble has to burst, which won't happen until interest rates are set at a credible level. The cost of money is not the problem, so why are these rates persisting, it only delays the inevitable.
12. mark wadsworth said...
The funny thing is, Paul Krugman wrote something similar about ten years ago, and tried to predict what would happen if Japan pressed ahead with QE. It is quite spooky to read it now, he was one of the few economists who actually got most of it corrrect.
And somebody else linked to an article recently saying what a load of nonsense all this QE and low interest rates are - if fruit vendors are not selling as much fruit as they used to, what is the point in giving them free fruit? It will just sit on the shelves.
13. hpwatcher said...
As Merv King observed every country wants to overcome their slowdown by exporting more.
What about exporting everything to the same island, where eveything gets thrown into a massive hole?
14. inbreda said...
hpw...
...sounds like a reference to tax havens...