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BOE revives negative rates talk


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31 minutes ago, slawek said:

Increasing debt => faster economic growth. If we agree that rapid growth causes inequality then increasing debt also increases inequality,  indirectly through increasing economic growth. I think it is true that overall everyone is better off after a period of growth but rich are more better off, which was my point.  

I agree with that dynamic but I don't think that debt is the cause, rather its the symptom.

31 minutes ago, slawek said:

In 1950s/60s we had growing economy but improving inequality, between 1980 and 2008 the economy was growing but inequality was increasing. I think the explanation is a change of the way the system was balanced. Increasing inequality with growing economy is not self sustained.  Poor have less money relatively to growing economy as rich share of income/wealth increases. As a result poor consumption drops and the economy slows down. In 1950s/60s to counter this the rich were heavily taxed and the state redistributed income/wealth.

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.

31 minutes ago, slawek said:

In 1980s the new liberal policies reduced taxes and the state role in the economy, replacing taxes with debt as a balancing mechanism. Poor were borrowing a part of their consumption from the future. In this new model debt has to rise and inequality increases as rich accumulate claims on poor future income.

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?

31 minutes ago, slawek said:

I am not laying the blame, see my explanation above. Ultimately the uneven distribution of income/wealth is a problem. Debt is just a quick fix, which was deployed in the last 40 years.     

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.

31 minutes ago, slawek said:

Household and corporate debts are usually comparable. The problem is not only debt itself. CB are reluctant to remove the debt overhang as that would mean a period of lower growth or even a recession. They lower rates to stop deleveraging and to encourage to borrow more. As result debt grows even bigger. Lower rates lift asset prices, which also makes rich people richer.

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.

31 minutes ago, slawek said:

How do you then explain that since 90s, with a huge increase in the global trade, the global inequality has improved ?  

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.

31 minutes ago, slawek said:

That was an arbitrage between a CB rate and a yield of short term government bonds. This arbitrage makes yields to match the CB rates as they are fixed.  It doesn't force risk free rates to zero. You need a liquid source of 0% funding to force other short risk free rates to be 0%. I am not aware about any such source.

Its still an arbitrage though. And I wasn't talking about instant forcing, I'm talking about evolution over time.

31 minutes ago, slawek said:

I agree that arbitrage is not perfect, there are some frictions which allow different rates to diverge. There are also constraints/advantages which makes some rates higher/lower than others.  These differences are usually bigger when the market is in a stress as people executing arbitrages withdraw from the market.

What you are describing above is just a textbook demand-supply process. More demand for finite assets (risk free storage of money) implies a higher price (lower rate).  This has nothing to do with the liquidity premium as it concerns all risk free assets. Of course those more liquid will be a little bit more expensive as they have an advantage that you can sell them faster. 

Repricing risk free assets concerns only long term rates as they are not controlled by CBs directly. The short term rates are fixed by CBs and they change only when CBs change them.

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).

31 minutes ago, slawek said:

The governments are not issuing more bonds to provide risk free assets; they do this to have funds to simulate the economy. CBs are concerned with liquidity and they lend money or buy assets to increase liquidity.  Some, if not most, of the liquidity is only available to banks.

So what you described can maybe explain a buildup of government debt and reserve money. However you don't explain why risk free assets created during a recession are not reduced later.

You also make a claim that risk free rates go down every recession without providing any justification.  Short term risk free rates are lowered by CBs in a recession. After the recession CBs rise them. Why can't CBs rise them to a level before the recession so that next time they don't have to lower them more than in the previous recession?       

 

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.

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15 hours ago, scepticus said:

I agree with that dynamic but I don't think that debt is the cause, rather its the symptom.

What is the ultimate the source of the prpblem is dependent on how far you go back in the causality chain. Higher debt is a result of  debt booms, to which the current monetary system is susceptible  (higher debt => higher growth -=> higher confidence => higher borrowing => higher debt) and CBs intervention to avoid debt reduction in a recession, which causes debt to accumulate across cycles.

15 hours ago, scepticus said:

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.

This sounds like "I don't really know". I think it is important that your theory explains this period too.  

15 hours ago, scepticus said:

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.

 Private debt was rising in this period, see the exhibit 1 at the bottom.

15 hours ago, scepticus said:

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.

There was a significant reduction in inequality between rich and poor countries in that period. Before the world was visibly split (two peaks) now the poor countries have leveled up. See the exhibit 2 at the bottom.

15 hours ago, scepticus said:

Its still an arbitrage though. And I wasn't talking about instant forcing, I'm talking about evolution over time.

But it is an irrelevant arbitrage.  Still waiting for you to provide details of an arbitrage which forces risk free rates to zero.

15 hours ago, scepticus said:

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).

I agree partially. Every point on the curve represent a price of storing value risk free for a period of time corresponding to term of that point. Those prices are not bound by any arbitrage but are usually correlated. A yield curve is just a bunch of different prices parametrised by a duration of time you want to store value.   

15 hours ago, scepticus said:

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.

I would lie if I claim I understand your point here. Could you present your theory on a simplified model consisting of 

1) CB creating reserve money and setting rates paid on them

2) banking borrowing reserves from CB,  lending money to economy and creating/holding bank deposit 

3) the economy borrowing money from banks and keeping it on deposits at banks

I've excluded the government from the model because yields on short bonds don't change with demand, they are equal to CB rates through the arbitrage processed explained earlier.  Longer bonds are not really risk free assets for someone who wants buy them for a period of time shorter than their maturity. Yields on those bonds have practically zero impact on short rates, which are charged on bank loans and paid on bank deposits. 

Exhibit 1

taylor%20fig1%2017%20oct.png

Exhibit 2

Global inequality in 1800 1975 and 2015 

Edited by slawek
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2 hours ago, slawek said:

 

This sounds like "I don't really know". I think it is important that your theory explains this period too.  

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.

2 hours ago, slawek said:

 Private debt was rising in this period, see the exhibit 1 at the bottom.

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!

2 hours ago, slawek said:

There was a significant reduction in inequality between rich and poor countries in that period. Before the world was visibly split (two peaks) now the poor countries have leveled up. See the exhibit 2 at the bottom.

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.

2 hours ago, slawek said:

But it is an irrelevant arbitrage.  Still waiting for you to provide details of an arbitrage which forces risk free rates to zero.

Will address that in my response to your below.

2 hours ago, slawek said:

I agree partially. Every point on the curve represent a price of storing value risk free for a period of time corresponding to term of that point. Those prices are not bound by any arbitrage but are usually correlated. A yield curve is just a bunch of different prices parametrised by a duration of time you want to store value.   

Agreed.

2 hours ago, slawek said:

I would lie if I claim I understand your point here. Could you present your theory on a simplified model consisting of 

1) CB creating reserve money and setting rates paid on them

2) banking borrowing reserves from CB,  lending money to economy and creating/holding bank deposit 

3) the economy borrowing money from banks and keeping it on deposits at banks

I've excluded the government from the model because yields on short bonds don't change with demand, they are equal to CB rates through the arbitrage processed explained earlier.  Longer bonds are not really risk free assets for someone who wants buy them for a period of time shorter than their maturity. Yields on those bonds have practically zero impact on short rates, which are charged on bank loans and paid on bank deposits. 

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.

 

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6 hours ago, scepticus said:

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.

I will concentrate on your theory. After so many posts I still have no clue what you are proposing, which is frustrating.

Two points 

1) Duration of a bond matters. For someone who wants to store value at no risk for a year buying 10y bond is not a risk free asset. In a year time price at which he sells is unknown. You need to match a period time you want to store value with a term of bond you are buying. Of course 10 year bond will be most likely a safer asset than shares but still no risk free asset. 

2) There is nothing wrong with an inverted yield curve. Such curve is arbitrage free. This state of the curve is not preferred because it usually slows growth. CBs sometimes invert curve intentionally to cool down the economy.

Why bonds are required in your theory?      

 

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On 19/05/2020 at 16:33, Warlord said:

The professor in the video says the government becomes authoritarian and will ban cash/steal deposits. This is very concerning to me if the BoE do go ahead I will be forced to put my cash into physical gold or silver and HIDE it from the criminals.. which I should be doing anyway.

 

 

You could always buy a house. Buying gold.... doesn't the inland revenue get informed by law when you buy gold? So they will still steal it from you? Regards charges from banks to keep money in there, most countries around the world have banking with a fee. It's mainly a UK thing to have 'free' banking.

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5 minutes ago, bear.getting.old said:

You could always buy a house. Buying gold.... doesn't the inland revenue get informed by law when you buy gold? So they will still steal it from you? Regards charges from banks to keep money in there, most countries around the world have banking with a fee. It's mainly a UK thing to have 'free' banking.

And an NHS.

 

We are great.

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2 hours ago, slawek said:

I will concentrate on your theory. After so many posts I still have no clue what you are proposing, which is frustrating.

Two points 

1) Duration of a bond matters. For someone who wants to store value at no risk for a year buying 10y bond is not a risk free asset. In a year time price at which he sells is unknown. You need to match a period time you want to store value with a term of bond you are buying. Of course 10 year bond will be most likely a safer asset than shares but still no risk free asset. 

2) There is nothing wrong with an inverted yield curve. Such curve is arbitrage free. This state of the curve is not preferred because it usually slows growth. CBs sometimes invert curve intentionally to cool down the economy.

Why bonds are required in your theory?      

 

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?

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10 hours ago, scepticus said:

Thanks, sorry for the confusion, my aim is to improve my message. Appreciate your forbearance.

It could be me not your communication skills. 

10 hours ago, scepticus said:

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.

I guess you don't long dated bonds in your model then.

10 hours ago, scepticus said:

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.

Why can't an inverted curve be a long term phenomenon? What would happen if it was? ( I don't think answering those questions is important to understand your theory).

10 hours ago, scepticus said:

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.

Assuming all bank deposits are insured, do you need bonds in your model?

10 hours ago, scepticus said:

Did you review the links on safe assets yet?

Not sure what links you mean.

I've provided my commentary on those two

https://www.sr-sv.com/multiple-risk-free-interest-rates/
https://www.financialsense.com/contributors/matthew-kerkhoff/illusion-power

 

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1 hour ago, slawek said:

It could be me not your communication skills. 

I guess you don't long dated bonds in your model then.

Why can't an inverted curve be a long term phenomenon? What would happen if it was? ( I don't think answering those questions is important to understand your theory).

Assuming all bank deposits are insured, do you need bonds in your model?

Not sure what links you mean.

I've provided my commentary on those two

https://www.sr-sv.com/multiple-risk-free-interest-rates/
https://www.financialsense.com/contributors/matthew-kerkhoff/illusion-power

 

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.

 

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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.

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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.

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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.

 

 

 

 

 

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On 29/05/2020 at 11:20, scepticus said:

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.

 

Those two are not very relevant to our discussion

1) https://www.frbsf.org/economic-research/files/wp2019-28.pdf - An estimation of the on the run liquidity premium of the Swiss bonds

2) https://www.nber.org/papers/w18732 - about private safe assets and their impact on the fragility of the financial system (aftermath of 2008 crisis)

This one seems to be most relevant

https://pubs.aeaweb.org/doi/pdf/10.1257/jep.31.3.29

It presents a theory that demand for safe assets lowers long term bond yields. You can't argue with that but the paper doesn't really provide empirical evidence that explains rates going down since 1980, demand for safe assets higher than the supply.  The author blames the growth in the emerging markets for higher demand for safe assets making an adhoc assumption that demand for safe assets is proportional to global output,  providing no data to support this. As we know the main driver of the EM growth was China, which has a very tightly controlled capital market and demand for foreign assets is only limited to managing currency reserves.  Chinese buying was concentrated in 2000s and even then it was only 1-2 trillion, not really comparable with the growth of safe asset (Euro area bonds,  securisation in the US etc).      

 

 

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21 hours ago, scepticus said:

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.

I agree that demand for safe assets will definitely lower long term bond yields with constrained supply. The problem is to show that demand was higher relatively to supply and explain why there was as higher demand.

21 hours ago, scepticus said:

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.

Safe assets are not the same risk free assets. They are just much safer relatively to other assets. Safe assets growth is not constrained by the economy growth even if you restrict safe assets to government bonds. The only constrain is servicing cost relatively to GDP. You can't use too much GDP to pay for debt off. In theory a ratio of safe assets to GDP can go to infinity as you can back debt by income infinitely in the future. Servicing cost is depended on rates, so higher rates will limit the safe assets if you impose a maturity limit.

21 hours ago, scepticus said:

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.

There is nothing special about zero bound apart of that that is imposed on CBs by cash.  CBs could  keep short term rates at some level higher than long term yields (inverted curve). This would force safe asset buyers to use bank deposit or short term bonds instead. The shift in the demand would cause the curve to return its upward sloping state. The imbalance would be resolved by the wealth destruction due to a deflationary collapse. What CBs are doing is postponing this by lowering rates; they can do this until rates reach zero. They would need to remove cash zero bound to go further down into the negative territory.

QE helps by lowering long term yields more and creating more bank deposits, which pushes safe asset investors into bank deposits. CBs can also buy risky assets, which can provide put for their prices, making  them less risky. This creates an everything bubble and destroys the currency at the end.

Another way to rebalance is to tax rich, redistributing wealth back to poor.        

 

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22 hours ago, scepticus said:

:

"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.

 

That rings with my experience - "my money's not earning anything in the bank so I'll buy a new car"

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3 hours ago, slawek said:

 

It presents a theory that demand for safe assets lowers long term bond yields. You can't argue with that but the paper doesn't really provide empirical evidence that explains rates going down since 1980, demand for safe assets higher than the supply.  The author blames the growth in the emerging markets for higher demand for safe assets making an adhoc assumption that demand for safe assets is proportional to global output,  providing no data to support this. As we know the main driver of the EM growth was China, which has a very tightly controlled capital market and demand for foreign assets is only limited to managing currency reserves.  Chinese buying was concentrated in 2000s and even then it was only 1-2 trillion, not really comparable with the growth of safe asset (Euro area bonds,  securisation in the US etc).      

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.

 

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2 hours ago, slawek said:

I agree that demand for safe assets will definitely lower long term bond yields with constrained supply. The problem is to show that demand was higher relatively to supply and explain why there was as higher demand.

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.

 

2 hours ago, slawek said:

Safe assets are not the same risk free assets. They are just much safer relatively to other assets. Safe assets growth is not constrained by the economy growth even if you restrict safe assets to government bonds. The only constrain is servicing cost relatively to GDP. You can't use too much GDP to pay for debt off. In theory a ratio of safe assets to GDP can go to infinity as you can back debt by income infinitely in the future. Servicing cost is depended on rates, so higher rates will limit the safe assets if you impose a maturity limit.

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.

2 hours ago, slawek said:

There is nothing special about zero bound apart of that that is imposed on CBs by cash.  CBs could  keep short term rates at some level higher than long term yields (inverted curve). This would force safe asset buyers to use bank deposit or short term bonds instead. The shift in the demand would cause the curve to return its upward sloping state. The imbalance would be resolved by the wealth destruction due to a deflationary collapse. What CBs are doing is postponing this by lowering rates; they can do this until rates reach zero. They would need to remove cash zero bound to go further down into the negative territory.

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.

2 hours ago, slawek said:

QE helps by lowering long term yields more and creating more bank deposits, which pushes safe asset investors into bank deposits. CBs can also buy risky assets, which can provide put for their prices, making  them less risky. This creates an everything bubble and destroys the currency at the end.

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.

2 hours ago, slawek said:

Another way to rebalance is to tax rich, redistributing wealth back to poor.        

 

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.

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2 hours ago, Si1 said:

That rings with my experience - "my money's not earning anything in the bank so I'll buy a new car"

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.

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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.

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  • 2 weeks later...
On 27/05/2020 at 15:43, longgone said:

Worldwide, the annual manufacture of high-tech products (PCs, cell phones, tablet computers and other electronic and electrical devices) uses some $21 billion worth of gold and silver (320 tons and 7,500 tons, respectively).

how much do you think of that is recovered and if it is how is that audited ?

digging gold out the ground measuring it and saying hey look there is 200 more tons added to the pile we already have is a stupid way to look at it. 

My point was you don`t know how much gold is in circulation after its been used in production as nearly all of it is wasted. 

geologists will study the ground for minerals which will indicate gold same as diamons opal what ever but they can only guess to the amount in any mine. there is plenty in mines under the sea but quite difficult to reach ?

So that's +-8000 tons in electronic and electrical devices annualy that you allege is "destroyed" or somehow (silently) being siphoned off by Russian oligarchs?

That, frankly, would be a pretty dumb way to (if you will excuse the irony) "sink" their ill-gotten gains. And it would take a very very very long time since most electonics stay in circulation for between 3 and 10 years.

The US national debt represents more or less 454 600 tons, or more than 56 times as much of the annual "consumption" of gold in electronics world wide. If you could syphon off (even) 10% of that gold it would take 560 years to get to an amount of gold even close to what the US national debt is in 2019/2020.

Here's a point: electronics and it's widespread use in electronics hasn't even been around (at today's rate) for anything much more than 30 years ... and a *lot* of work is being done to minimise the need for more (dust-collecting/unused boards, chips, memory, batteries) [hint: it's called virtual machines and time slicing] ... so I can't see how you could think there is anywhere near as much gold in all the electronics we have ever used in the last 100 years. Heck, mainstream use of electricity (let alone gold-'consuming' electronics) is irrelevant beyond say 1925 (approx when half of US homes had electricity).

If you think geology is as inexact a study as to make your point relevant than I truly believe you underestimate (even insult) the whole discipline and everyone dedicated to that work.

And you don't address 1 key point: all the gold you claim is being ferreted away would take up a lot of space and be very difficult to move - and, probably more importantly, be very very visible.

So it all boils down to 1 question:

Where is this gold you claim is spread all over the world? Gold has mass, and it takes up space, and it cannot be replicated the way a row in a database can.

The laws of physics are a hard task master when validating thinking.

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23 hours ago, Aidan Ap Word said:

So that's +-8000 tons in electronic and electrical devices annualy that you allege is "destroyed" or somehow (silently) being siphoned off by Russian oligarchs?

That, frankly, would be a pretty dumb way to (if you will excuse the irony) "sink" their ill-gotten gains. And it would take a very very very long time since most electonics stay in circulation for between 3 and 10 years.

The US national debt represents more or less 454 600 tons, or more than 56 times as much of the annual "consumption" of gold in electronics world wide. If you could syphon off (even) 10% of that gold it would take 560 years to get to an amount of gold even close to what the US national debt is in 2019/2020.

Here's a point: electronics and it's widespread use in electronics hasn't even been around (at today's rate) for anything much more than 30 years ... and a *lot* of work is being done to minimise the need for more (dust-collecting/unused boards, chips, memory, batteries) [hint: it's called virtual machines and time slicing] ... so I can't see how you could think there is anywhere near as much gold in all the electronics we have ever used in the last 100 years. Heck, mainstream use of electricity (let alone gold-'consuming' electronics) is irrelevant beyond say 1925 (approx when half of US homes had electricity).

If you think geology is as inexact a study as to make your point relevant than I truly believe you underestimate (even insult) the whole discipline and everyone dedicated to that work.

And you don't address 1 key point: all the gold you claim is being ferreted away would take up a lot of space and be very difficult to move - and, probably more importantly, be very very visible.

So it all boils down to 1 question:

Where is this gold you claim is spread all over the world? Gold has mass, and it takes up space, and it cannot be replicated the way a row in a database can.

The laws of physics are a hard task master when validating thinking.

only 15% of gold used in electronics every year is recovered there is destruction it somewhere ! work out gold used in production and minus 85% and thats for starters.. Nothing to do with virtualization a load of servers is not the only place gold goes.  how many bloody phones are made every year and junked millions if not billions same with tv`s laptops the most disposable electronics. not much use for gold in appliances. 

https://globalbullionsuppliers.com/blogs/blog/who-are-biggest-private-owners-of-gold-in-the-world

not sure what you are trying to prove exactly ? the average oligarch does not have a stash of gold somewhere ?

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On 12/06/2020 at 14:21, longgone said:

only 15% of gold used in electronics every year is recovered there is destruction it somewhere ! work out gold used in production and minus 85% and thats for starters.. Nothing to do with virtualization a load of servers is not the only place gold goes.  how many bloody phones are made every year and junked millions if not billions same with tv`s laptops the most disposable electronics. not much use for gold in appliances. 

https://globalbullionsuppliers.com/blogs/blog/who-are-biggest-private-owners-of-gold-in-the-world

not sure what you are trying to prove exactly ? the average oligarch does not have a stash of gold somewhere ?

What I am saying is: the total stock of gold is nowhere near the levels of fake money "resgistered" in the wider system.

Any discussions about recycling levels and amounts of gold in electronics (etc etc) is largely irrelevant. Because there just isn't that much gold in the whole world until it magically jumps in price by several orders of magnitude ... until *then* it will be little other an an "extra" item of interest on the boudnaries of all the debt spewed by the ECB(s) of the world.

And if the gold price does indeed jump to those levels (100s or 10s of thousands higher than currently) all sorts of other things would change in the world.

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