Long read: Expectations behind the negative yield curves

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Miguel Navascués | The slope of the interest rate curve has become negative in several countries, among them the most important. As we know, whenever this happens there is a high probability that it is anticipating a recession, in this case global. Some countries will come out of this better than others, but the recession is highly likely.

The negative indicator means that long term public bonds return less than short term bonds. There is a story of expectations behind this phenomenon. If people are willing to lend money in the long term for lower returns than in the short term, something rare is happening. Even rarer when long term rates are not only lower than short term rates, but even negative, as is the case, for example, in Switzerland. In that case, the saver is willing to pay money to lend it, something certainly irrational in normal circumstances.

This means that the saver is so pessimistic that he believes that even so he is better rewarded by paying to lend than keeping his money. Pessimism about what? Firstly about the state of the economy which anticipates, as we have said, a recession. But the saver does not have a clear vision to calculate risks, but a nebulous scenario which causes him to exaggerate his pessimism.

Secondly there is an excess of savings in the world – badly distributed, with countries like Germany with major assets accumulated compared to abroad – but that only this can explain the fall of interest rates to levels never seem. The lack of confidence of these savings towards risk can be seen in the following graph, where it can be seen that there is less confidence in corporate bonds. The distance between the rates for corporate and private bonds is double, and constant.



The differential has had more moderate moments. These voluminous global savings explain why productive investment has been so stingy, affecting future growth expectations. Savings have preferred to be enclosed in the closed circuit of financial investment, and listed companies have preferred to spend their income on buyback of their own shares, to compensate their shareholders, instead of expanding the company and the workforce. In short, the policy of “quantitative flexibility” has unintentionally created a closed circuit in which the money has circulated, but without exiting from this circuit.

The way in which central banks have carried out their expansionary policies has contributed to this, through bank, buying treasury bonds in exchange for bank liquidity which has not been converted into credit. It was expected that the banks, with more liquid money, would lend more, but it has been difficult to find reliable lending opportunities. From the beginning there was a mistake: the theory that the Central Bank creates money to give liquid money to banks, when it is exactly the reverse: money is created by banks when they create concede a loan, with which a supplier is paid, which increases its bank balance. This is the increase in liquidity. But the increase of the liquidity retained in the banks is not an increase liquidity.

Facing the recession which is coming, the central banks have announced that they have an arsenal of measures prepared to deal with it, but they would do well to change some aspects so that the money would not remain in the banks. They should ensure that this money reaches “ordinary people” (not only people but also SMEs), not just the giants of the circuit, and gives them the confidence to spend, thus increasing demand and reducing the mania to save.

In any case, we have a burgeoning global recession, whose solution will not come from trade wars which increase uncertainty, and have been the original cause of the recession which is coming. All these negative curves are the reflection of the uncertainty created by Trump, when what is needed is a scenario clear of unnecessary noise which unnerves investors and consumers and encourages caution and savings. To the extent of paying money to lend it, a measure of the fear that it exists. Here we need only recall that the Austrian liberals sanctified savings, whatever, because of a crass error (Say´s law) which led them to identify the with investment, when the motives and risks are totally different.

We could show in a very simple graph the causal chain which has led to this state of fear and recession: Trump › fall of global trade > increase of fear and savings > fall in interest rates > abundant indications of a burgeoning recession. In national accounting, indeed, savings are always equal to investment, but this is only the consequence of double entry book keeping. But they are savings and investment effectively realised, not desired. Savings do not create investment. Savings are good, of course, but an excess of savings and its distribution between sectors and countries lead to the current situation, in which the motivation for saving is fear, fear which is the main cause of the weakness of investment.





About the Author

Miguel Navascués
Miguel Navascués has worked as an economist at the Bank of Spain for 30 years, and focuses on international and monetary economics. He blogs in Spanish at: http://http://www.miguelnavascues.com/