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scepticus

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  1. The other problem Slawek with letting the curve invert and long investors flee to bank deposits is that it will become impossible to credibly insure all bank deposits to the same degree as before, and as a result, bank deposits, previously safe assets, will become risky assets. This is what happened in the great depression and many blameless folk lost all their savings, not just a couple of percent. The only result of this outcome is that the government is the only issuer of safe assets, and therefore ends up being the primary driver of investment throughout the economy. Hence WWII etc. Paradoxically, the exact opposite outcome most Austrian leaning folks will want to see. I have never believed in the left-leaning idea that in times of economic crisis the government must always lead. Far better IMO to have a system which provides the private sector a framework to continue to invest and allocate resources rather than leave it all up to the public sector. Which is another reason I don't favour more public issuance of safe assets as a solution to the current situation or other crises in future.
  2. In a contractionary deflationary scenario you won't buy a new car if you don't need one because you may be in fear of job security. Your current experience is "my income appears safe and my money isn't earning anything in the bank so I'll spend it on consumption". The point of NIRP is more along the lines of "my income may not be safe and my money is depreciating in the bank faster than prices so I'll invest SOME of it in some worthwhile project that is not risk free but will likely do better than bank savings and keep a bit by in case I loose my job". That project could be home improvements, education, a stocks and shares ISA etc etc.
  3. There are a number of possibilities here as to why in an economy with safe assets, demand will tend to outstrip supply. Here are a few, you pick which one you find most plausible and we can pursue that one Production of safe assets is more costly when the costs of producing information about individual assets is low. This is because an asset (such as a CDO) is only safe while the costs of finding out the details of its underlying composition and component risk factors is too expensive to be worthwhile. As IT and global digital connectivity increases, these information producing costs also fall, making safe asset production more difficult. Economies become more risky over time. Starting from a very low ebb after WWII, growth is fast. As economies mature and come close to their full potential growth rates must slow, rate of return in capital declines and risk premium rises. A more risky economy requires lower risk free rates. A steady state economy that on average neither grows nor contracts would be very risky. As an economy grows and pulls more households out of poverty so that they have some savings, risk aversion will grow since households favour riskless or low risk assets, not least because they don't understand economic basics. Risk aversion will be largest when a large quantity of just-out-of-poverty households are formed who have so little savings that they keep all their assets in risk free form. Whether higher rates limit safe asset production depends on the real growth rate of the economy. You cannot say that higher rates per-se constrain production. Also, there is no distinction between risk free and safe assets, the terminology means the same thing. No asset is truly risk free, of course. The main differences between safe assets are outside safe assets (public debt) and inside safe assets produced by private sector like uninsured bank deposits and CDOs. Now its my turn to ask you to provide a link to some more detailed academic paper or discussion about how such a thing is possible or whether it has any credibility, or for you to provide a deeper justification. Your argument is very simply to let a deflationary collapse with high real interest rates run its course, a scheme otherwise known as 'let it all burn'. Completely unrealistic in a democratic society full of risk averse households. In fact, people on average will prefer NIRP, or war (as evidenced by WWII and the great depression) to such policy. What is worse than this is what your policy prescription here would have in store for an economy which is likely to permanently faces these types of conditions whether through demographics, pandemics, climate change or simply as a result of changes in technology. Because in the face of such constraints, after burning everything one would find oneself back at the same point after perhaps another 30 years. It is also not a fair outcome for low net worth households and those with precarious employment. Its a scheme that favours the rich, and at its heart, a fantasy of Austrian Economics. We can enter negative territory without removing the cash bound to the tune of about -2%. Beyond that would need changes to the cash system. Which is why a NIRP which is not stimulative (because it allows the money supply to shrink) but which enables the economy to maintain its best possible output even when undergoing contraction is preferable to trying to create negative real rates via inflation. Never works. To make such re-distribution sustainable it would be required to confiscate the productive assets that the rich get their income streams from, not just tap off a fraction of the income stream itself. Re-distributive tax gets spent back into the economy as benefits and finds its way back to the rich via the income generating assets that they hold. The poor have no assets and no savings, thus NIRP does not hurt them. It does hurt the rich who do have savings, in particular it hurts risk-averse rich people. You said "redistributing wealth back to poor" but I think you meant "redistributing income back to poor". Re-distributing wealth requires asset confiscation.
  4. This one https://voxeu.org/article/safe-asset-shortage-rise-mark-ups-and-decline-labour-share (can't recall whether I alreayd posted it or not) provides one answer to the above (which chimes with your point about chinese buying in the 2000s): Finally, we offer a narrative centred on the secular evolutions of safe and risky expected rates of return as depicted in Figure 2. Very broadly, we identify three phases, which we analyse in our papers.3 The first phase occurs from 1980-2000, in which the expected rate of return on equities declines in tandem with safe real rates, the former falling more than the latter. In the second phase, from 2000-2008, the expected rate of return on equities is more or less stable (with some ups and downs), but risk-free rates keep falling. The equity risk premium is increasing. In the third and final phase, from 2008 to now, the expected rate of return on equities is more or less stable (with some ups and downs), and the risk-free rate declines to the zero lower bound. The equity risk premium is increasing. In phase one, the decline in interest rates is driven by general supply and demand factors affecting all assets (safe and risky). In phases two and three, the decline in the risk-free rate is driven in large part by specific supply and demand factors affecting safe assets. The stable expected return on equities in phases two and three is consistent with the stable return on productive capital over that period. Phase two corresponds to the intensification of the ‘global savings glut’, China coming online, and the rise in international reserve accumulation across emerging markets in the aftermath of the Asian financial crisis. It seems that a substantial share of the desired demand for assets was for safe assets, explaining the divergence between safe and risky returns.
  5. And finally Slawek, we have this: https://voxeu.org/article/role-safe-asset-shortages-secular-stagnation I have been hunting for a third party article that articulates the first part of my thesis so I don't have to try and write it, and so that you can see that there are others in the finance/economics space (I am an engineer, not an economist) with similar view to me. The key bit is: "The demand for safe assets (Knightian wealth) increases with the real interest rate because a high real interest rate increases the growth rate of safe wealth." The Knightians here are mainly households who want to hold riskless assets. I don't think this literature on safe assets can be considered speculative, its pretty well accepted now I think in financial professional circles. The second part of my argument, which is more speculative, is that with increasing wealth the demand for financial risk free assets will always tend to exceed the real rate of growth, which leads to a safe asset shortage because risk free assets can only increases in supply in line with real growth - any faster and the quality of those new risk free assets becomes questionable. Why can the supply of safe assets not keep up with growth? My general view on this is that for this to be true, one would need a perfect economy with no frictions, which does not suffer from any kind of financial entropy. If risk free assets can increase automatically in line with growth it would imply there is no additional cost in producing risk free assets, which cannot be true unless you believe in financial perpetual motion machines. The last part of my argument is that at the zero lower bound, to restore equilibrium it is required to make safe assets less desirable. At the zero lower bound, I think this can only be done with NIRP. By charging a negative interest rate on risk free assets when no more such assets can be produced (or at least not enough to satisfy demand), you restore economic output. From the above link: In this simple model, when the economy falls into a safety trap, output is entirely determined by equilibrium in the safe asset market. Output can only be stimulated by reducing the demand for safe assets or by increasing their supply. This is either achieved by Knightians (households) losig enough wealth that they no longer have the savings required to demand safe assets, OR by reducing the demand for safe assets among the Knightians. Yes, this turns some Knightians into Neutrals (who hold risky assets in preference to safe assets). But crucially it does so without generating a fall in welaht due to wasted/idle economic output.
  6. To add to my above, this link is useful in backing up my point that deriving a portfolio of assets to approximate a risk free rate using CAPM or similar is not reliable in times of crisis or fast change in market conditions: https://valuesque.com/2020/03/28/coronavirus-some-thoughts-on-the-cost-of-capital-during-the-crisis-part-1-equity-parameters/ It finishes: And, finally, while we also expect that one day equity parameters on average will find back to their long-term value, this does not mean anything for single businesses. And business valuation is clearly about single businesses. Averages do not help us at all here. The famous Oaktree Capital founder Howard Marks described this point nicely in the context of insolvency risks: “Never forget the six-foot-tall man who drowned crossing the stream that was five feet deep on average. It’s not sufficient … to survive on average. We have to survive on the bad days.” There is nothing to add from our side in terms of why it is necessary to bring your valuation parameters always up to date. A bad day is when you get your margin calls or your taxes become due. Its not good if your special portfolio is having a down day that day, even if it might get back to the norm later. This is where the most risk free assets (public debt) become a super important part of the market structure.
  7. Hopefully it has been worth the price of admission...
  8. So to kick off we have this from the most famous writer on safe assets, Gary Gorton: "Safe assets play a critical role in an(y) economy. A “safe asset” is an asset that is (almost always) valued at face value without expensive and prolonged analysis. That is, by design there is no benefit to producing (private) information about its value. And this is common knowledge. Consequently, agents need not fear adverse selection when buying or selling safe assets. Safe assets can easily be used to exchange for goods or services or to exchange for another asset. These short-term safe assets are money or money-like. A long-term safe asset can store value over time or be used as collateral. Much of human history can be written in terms of the search for and production of safe assets. But, the most prevalent, privately-produced short-term safe assets — bank debt, are subject to runs and this has important implications for macroeconomics and for monetary policy." https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2770569 A critical thing here is the part in bold. While CAPM tells us that a "risk free rate" can be synthesised from a portfolio of assets of appropriate attributes (asset beta, sharpe ratio etc), as you alluded to earlier in our discussion, this can only be achieved with expensive and prolonged analysis, and further, that analysis is uncertain due to simplifying assumptions of CAPM, or may break down when asset correlation in the portfolio changes due to a crisis. This CAPM risk free rate is therefore not the same as the rate of return on a safe-asset which retains its safe-asset properties at all times. The private-produced safe asset he refers to is an attempt by the private sector to make viable safe assets using inside money (e.g. money assets issued by private sector) only. CDOs and MBS are another example of privately produced safe assets, which acted like safe assets only until the GFC hit. Therefore my first assertion is that the risk free rate on government issued safe assets (whether short or long duration) must be lower than the theoretical market rate derived from a portfolio of risk assets. This is supported by all these links on safe assets, which describe the additional value that these government safe assets (or maybe something like gold) as the 'convenience yield'. Lastly, while the longer duration safe assets may not in theory be money due to their duration, they are critical as collateral to obtain money, thus have an effect on money velocity and other measures of the money supply, and thus must also affect prices in the real economy to some degree. That is in addition to their utility as a store of value.
  9. This one: https://www.frbsf.org/economic-research/files/wp2019-28.pdf These ones (not posted in this thread till now) are also most useful: https://pubs.aeaweb.org/doi/pdf/10.1257/jep.31.3.29 https://www.nber.org/papers/w18732 I think the reason we have been talking at cross purposes a bit is likely because our basic assumptions about operation of the monetary system, definition of terms and views on causal effects is not aligned. We should clear that up first, starting with what is meant by a safe asset. A permanently inverted yield curve is problematic in the first instance since it implies that the market believes short term yields will fall in future, but actually they never do, why would the market continue to hold this belief? I suppose it could also occur for example if economic contraction is occurring but the CB is persistently too slow in reducing its own short rate correspondingly. This in turn could occur if the CB refuses to reduce its rate below 0 to restore and upward sloping curve. The outcome of that would be that the real interest rate on cash and bank reserves would be strongly positive relative to everything else, everyone would dump equities and real world assets and try and move to cash. Would be a deflationary spiral.
  10. Thanks, sorry for the confusion, my aim is to improve my message. Appreciate your forbearance. Of course bond duration matters - if you want to save long term buy a long bond, or short term, buy a short duration bond. But as well as buying and selling to match desired saving term, there is important information conveyed by durations. If you buy a long bond and sell next year really you are speculating, not saving. Savers and speculators don't have the same required return, in the real world. An inverted yield curve is OK for a short time, but not as a long term phenomenon. After all, investing long should pay higher rates usually. Therefore a persistent inverted curve forces the CB to lower the short rate sooner or later. If they don't the yield curve will invert further. Bonds are required simply because participants (individuals and institutions) with large value of wealth need to store value risk free sometimes, and if you have billions or trillions under management you can't just invest it in a bunch of Marcus bank accounts. Did you review the links on safe assets yet?
  11. The simple answer is the we owe the extra debt to ourselves. And maybe a few foreigners but mainly ourselves. Don't forget that all public debt is essentially the savings of the UK non government sector (and maybe a few foreigners). So we have a bunch more debt than we had before, but we also have a bunch more savings we didn't have before. Also, government debt basically is money, or a kind of money. The differences between base money/cash and government debt is not that much when the economy is at ZIRP and peak debt already.
  12. Not really, because this period is prior to end of Bretton Woods, with no floating exchange rate and a limit on safe asset production thanks to the so-called gold standard of this period. If you like, the situation in the 50/60's can be considered the 'initial conditions' for my hypothesis. Private debt is not the same as consumer debt. I don't know for sure but I think the majority of this private debt is not retail consumer debt like credit cards and mortgages! I am happy to accept that inequality is a complex aspect of current and past economy, but it is somewhat orthogonal to the main point of my hypothesis. The only thing I really have to say about it is that I don't think debt per-se is the root cause of inequality. Will address that in my response to your below. Agreed. You can't exclude the government I'm afraid. Did you review any of those links to papers on safe assets I posted? The primary avenue for safe asset creation is government debt, of all durations. Certainly the literature on safe assets considers all government issued nominal bonds to classify as safe assets. They are central to my hypothesis. Also I strongly disagree that long duration yields - set by the market as we have agreed - don't affect short term yields. If market bids up bond prices, then unless the CB lowers its overnight rate a yield curve inversion will result, so the CB is forced to follow a sustained drop in long duration yields with a drop in its own rate, or to somehow try to prop up the long duration end of the curve. That said, a main part of my reason for posting this stuff here is so people who know what they are talking about can challenge it and help me find more clear and succinct ways to outline by hypothesis, and to refine it where appropriate. So I will try and rise to your challenge above but it must include government debt.
  13. I agree with that dynamic but I don't think that debt is the cause, rather its the symptom. The 50's/60's were a period of extraordinary high growth coming of an extremely low ebb after WWII. Many things are possible with real compound growth of 3% that are not practical in normal times when growth should be 0.5-1%, including punitive tax rates. The same thing happens in the period leading up to WWI, where inequality is at a high not reached again until the GFC this century. However the period prior to WWI is not characterised by widespread consumer borrowing is it? An as per my above, consumer debt for the poor was not a feature, as far as I know, of the 1900-1914 period. We agree though that inequality is bad for the economy and bad in general. Removing the debt overhang requires a deflation, since reducing debt will need a reduction in safe assets. When the real rate of return falls below 0, and rates cannot go lower than 0, then you get a depression which does not remove debt because although debt reduces, debt-to-gdp does not so the economy becomes more indebted. Debt overhangs cannot be reduced except through real growth, or using a deflation coupled with NIRP. It has improved a bit according to the gini co-efficient. However this period also sees the emergence of new income distributions in which the wealthy incomes and wealth follow different mathematic distributions than the bulk population. Bulk population has an entropic distribution and the high rollers get some power law. Power law distributions are expected result of extreme network effects. So Gini is not the only useful metric for inequality. Its still an arbitrage though. And I wasn't talking about instant forcing, I'm talking about evolution over time. The risk free rate exists at all durations. Thats what the yield curve is. It is not always the case that the short duration risk free rate is more important than the long duration one - the long duration reflects expectations. The yield curve only carries information because it exists over all durations. The market prices the long end (and medium at least). Simply because issuers of risk free assets (mainly advanced economy governments) ability to issue risk free assets is constrained by their rate of growth. Their rate of growth must be able to match the demand for risk free assets because otherwise the risk-free nature of their liabilities is called into question. Recently, emerging market demand for western risk free assets has increased thanks to china's (+others like japan/germany) surplus etc, and this has also increased faster than US/UK/Europe can grow. Also, you mentioned before that the debt-overhang is never dealt with after a recession, which is true. Therefore, the ability to issue risk free assets declines a little with each recession, since the old debt is still there. Possibly also, if the inequality that builds in domestic society is also not addressed, this makes things worse by depressing the potential future growth rate. The inability to create sufficient safe assets then sets the stage for the next crisis and next decline in rates. So why not simply get rid of some of the risk free assets that underpin the debt overhang after a recession? Because the risk free assets basically are the money supply (and/or the supply of collateral required to get money). So shrinking that supply must make prices fall, and that means deflation, whether the economy is growing or not. You cannot realistically expect the private sector debt to fall if the safe-asset supply that underpins it does not also shrink. So instead what happens is that to match the demand for safe assets without issuing as many as a require at the pre-recession rate, those assets have to be worth more after each recession, which means lower rates. Another effect is that wealth that has been stored in risk free assets during the recession (the wealth of the wealthy, mainly) is not destroyed during the recession, just temporarily re-valued. So unless you forcibly remove some of this recession-proof wealth stored in safe assets, the debt burden cannot reduce. Whereas the bulk of the population who rely on income see their wages and employment get slashed. This is a permanent hit and loss to the wage earners, but the hit in wealth to the wealthy is only temporary. To fix this, now we are at the lower bound of 0, during each recession NIRP must destroy some safe assets of wealth inline with reduction in real wages. Then after the recession, new safe assets can be created as needed to fund growth. Then rinse and repeat. Prices would not be stable fully in this scenario but the debt level could be contained, and so could inequality. In fact this fiat regime is very like the gold standard, since gold-standard constraint total safe-asset debt (and by extension all private sector debt), just like this NIRP/PIRP cycle does. Prices were not stable during the gold standard, and also would not be during this fiat regime. However prices would be controlled reasonably within some bound, so no hyper inflation of hyper deflation. But I think this NIRP/PIRP cycle cannot happen at an average risk free rate much above zero, since there is no justification to destroy money (or theft as some people call it) when instead you just lower rates a a bit and carry on. However now there is an opportunity.
  14. Here is another paper, from the FED, on safe asset scarcity and the 'convenience yield' aspect of risk free assets: https://www.frbsf.org/economic-research/files/wp2019-28.pdf What the existence of this convenience yield means, is that the market price of a risk free asset (where risk free is determined by the market, and perhaps may be whatever the least risk asset happens to be), will be lower than a risk free rate that can be constructed synthetically from a basked of uncorrelated risky assets. Which matches exactly my intuition that the return, in normal times, of risk free assets must be negative. [Edit, should say the return, in normal times, of risk free assets must be lower than the market rate of return on the market portfolio]
  15. So its hard to say whether increased levels debt is a cause of inequality, or a side effect/symptom of rapid growth, where the growth is what generates the inequality. After all during a period of rapid growth and increase in GDP, that increase has to evenly spread over the population to not change inequality. But given that the rate of return is positive in these scenarios and those returns compound to the holders of assets - not just debt - but all assets like property and the means of production, one would expect quick growth to increase inequality, even if it makes everyone better off. But like I say above, the wealthy don't just hold debt, they hold more equity in the means of production. You seem to be trying to lay the blame for all societies ills on debt, rather than at the uneven distribution of wealth generally. This is a common view in certain right-leaning political views, but I'm not sure it has any basis in reality. And how much debt is owed by poorer individuals, versus that owed by the entire corporate sector for example? The former would need to be much higher than the latter for your view that debt is the prima facie cause of social unfairness to be plausible. Also, with interest rates very low, surely the debt component is less important than other assets? The link between trade, growth and inequality has been studied extensively and various studies have come to different conclusions. The way I see it is quite simple, if you increase the size and scope of a system by establishing more linkages between more players, then the network effects will allow a greater absolute difference between the richest and poorest nodes in that network. The network effects of human interactions have a good mathematical basis that I think supports this. I think you identified yourself that the monetary system offers banks a method to make free money with no risk, on the same assets that are offered to other market participants who do not get this same opportunity. So that could be one. Also see this links talking about arbitrage resulting from risk free assets: https://www.sr-sv.com/multiple-risk-free-interest-rates/ In particular I think these passages are pertinent: "Put simply some “safe assets” have value beyond return. U.S. government bonds, in particular, seem to provide a sizable consistent convenience yield that tends to soar in crisis. This suggests that there are arbitrage opportunities for investors that are flexible, impervious to convenience yields and tolerant towards temporary mark-to-market losses." “In frictionless asset pricing models, [the risk-free rate] is determined by the investors’ time preference. However, recent literature has questioned whether the time preference of money is the only determinant…providing evidence that the scarcity of safe assets drives up their price and lowers the corresponding interest rate.” “The time preference of investors can only be inferred by measuring the risk-free rate implied by the prices of risky assets, where the spread between this implied risk-free rate and the observed return on safe assets measures the convenience yield that these safe assets provide… The risk-free rate implied by the pricing of risky assets lies strictly above the rate earned on safe assets, where the difference is often interpreted as a measure of the severity of financial frictions.” I think that your view you have presented on the nature of risk free rates is implicitly assuming basically frictionless markets, which of course is not the reality. The key point of my thesis here is the bit in bold above. If risk-free assets (cash, reserves and gov-bonds) were provided to the private sector such that anyone who wants one can buy one then there would be no scarcity. However, because this is not the case, with every financial crisis or recession an additional return due to liquidity premium accrues to the holders of safe assets above and beyond the risk free return in normal times. This additional return is not reflected in the price paid by the holder of said risk free asset. So not only does this drive risk free rates to zero, it also induces the issuers of risk-free assets (Cbs and governments) to try and mitigate temporary safe-assets scarcity issues by issuing more of them. This makes them temporarily not scarce, and the market can return to "normal". But as soon as the next crisis hits, they become scarce once again and now more safe assets must be issued. If this is not done (exactly like was done in the stimulus post 2008) then risk free rates will turn negative as market players fight to get into the risk free assets. So above I have offered a reason for debt (in safe assets) to increase which is baked into the market structure.
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