Monday, July 18, 2016

The Magic of Compound Negative Interest Rates?

Capitalism 101's first lesson is the magic of compound interest rates.  But what about compounding of negative interest rates?  Well, the negative interest rates are on bonds and only zero-coupon and some bond funds offer compound interest.

On the other hand, the growing pool of negative interest rate bonds has crossed ten trillion worldwide...
The $10tn pile of negative-yielding government bonds is a “supernova that will explode one day”, according to Janus Capital’s Bill Gross, underscoring therising nervousness over the previously unthinkable financial phenomenon.
And that is not about to stop.  How might it end?
Even a relatively modest rise in yields could cost investors dearly. Goldman Sachs recently estimated that an unexpected 1 percentage point rise in US Treasury yields would trigger $1tn of losses, exceeding the financial crisis losses from mortgage-backed bonds.
What we badly need is a crash in real estate, in fact we cannot have an economic recovery without it.  The asset inflation in real estate prices is central to the false economy,  and usually commercial has risen higher and falls farther than residential when the crash comes.

With low, and now negative interest rates, land-banking has been common, using hot money to buy real estate and then just leave it idle.  If interest rates go up, it forces those land-bankers to sell, causing prices to fall.  But who knows?

Negative interest rates reflect a bet that other assets, stocks, real estate, gold, etc will crash more than the  2% you'll lose on negative interest rate bonds.  Who knows what will happen, but 2% bonds corresponds to timing and size of the loss anticipated is exponential in say stocks.  $10 trillion means a whole lot of smart money thinks losing 2% for sure is better than 30-50% maybe in stocks.

With inflation, you want to be paid what you are owed as soon as possible.  With deflation, you want to wait to be paid as late as possible.  To encourage people to pay later, we may see compounding of negative interest rates?  Impossible?  Negative interest rates were "impossible" but they are here.  Mortgage lenders paying borrowers on their loan was impossible, but we have it.  So why not compound negative interest rates?

And note how capitalism cares not a whit what happens to people on pensions whose yields are largely in bonds.

Just rent.  if you have paycheck, pension or property, the next 40 years is ugly.

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