E Preserve Capital – Relentless Slide Toward Deflation And Negative Nominal Rates

I have talked a lot about demand for bonds, especially long bonds as collateral in derivatives markets. This demand has driven down yields and raised prices, so much so that Larry Summers fears a shortage of bonds, making the bond prices even more outrageous in a never ending bid for higher prices.

I have written about how the economy cannot boom, but only experience slow growth, in this regime of perma-low interest rates, with the Fed even predisposed to keep rates low. I wrote here about the four ways I see that the Fed is so predisposed:

So, we need to look at the ways in which the Fed has set things up to predispose it to keep rates low.

1. Grumpy’s friend says the Fed can’t afford to pay the treasury interest if rates are significantly raised. That is almost a hostage situation.

2. The banks have bet on low rates, taking the floating low side of the swaps bet when they issue loans.

3. The Fed pays interest on the excess reserves in order to restrain lending.

4. Long bonds are in massive demand as collateral, the new gold, and there are shortages, even with BRICS nations selling into a deep market.

So, rates are predisposed to stay low barring some unforeseen circumstance.

[Tracking the
behavior of TIPS, which had their day but still have reasons for some demand, can help with understanding bond investing in these low interest rate environment. For those simply seeking capital preservation, there is a recommendation at the end of this article]

I shared solutions to the above Fed propensity, from Dr. Werner, to solve the problem of the conundrum of the long bond low yields in times of recovery, resulting in very slow recovery for main street as banks don’t lend to consumers or each other. But number 3 will be difficult to implement as is discussed below:

1. Banks should not lend in non GDP transactions at all. No speculation of that sort should be allowed.

2. Central banks should bail out troubled banks by taking the bad loans off the books and nursing them to maturity or until there is a market for the assets.

3. Governments should stop the issuance of government bonds. Governments should borrow from banks in their own nations, instead.

4. Fiscal stimulation should come through bank borrowing, not the issuance of bonds.