A world drunk on debt | Fin24
 
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A world drunk on debt

Jul 23 2019 13:48
Simon Brown

One of the strangest things we’re seeing in global financial markets is negative-yielding debt. In other words, you lend money and when the loan is returned you get less than you lent them.

For example, you lend, say, R1m, but you only get R990 000 back, at a negative 1% yield.

One would expect to see this when there is fear in global markets. Investors typically want a return on their capital.

But, when scared, they merely want a return of their capital (or most of it in the case of negative-yielding bonds). We need to remember that buying of bonds pushes the ‘price’ higher and hence the yield lower.

 In mid-June a Barclays report stated that there was almost $12tr of investment-grade corporate and government bonds with negative yields, mostly in Japan and Europe.

In fact, over half of European government bonds have negative yields and we’re also seeing continued record-low rates from central banks.

The main issue is government buying of bonds in Europe (by the European Central Bank) and Japan (via the Bank of Japan).

So, we have outsized bond buying pushing rates lower – even Greek ten-year bonds are below 3%. This after they peaked at almost 40% during the Greek debt crisis of 2012.

Aside from the central banks, the question is why are investors so eager to invest in negative-yielding bonds when they could buy equity and get dividends and a potential for capital growth? Are they that scared?

Sure, there are some global economic concerns but nothing that would suggest this much fear?

Or is it just that central banks have skewed the system so badly that their outsized buying sees us in low or negative rates?

The central banks theory would be that negative (or even just very low) yields would see investors rather putting that money into the equity markets, keeping them higher, or borrowing at low rates, and then investing the money they would have been spending as consumers. Both good for the market and the economy.

The risks here are real. We’re drunk on debt. 

Typically, in a market crisis, central banks lower interest rates in order to get money into markets due to the lower yields. But now what happens when we have our next market crisis?

The US has just reached its longest period of economic expansion ever at 121 months, according to the US National Bureau for Economic Research. 

If a crisis where to hit now, central banks will have to drop already low rates. Basically, central banks will have to move into the negative, or further into the negative in some cases. 

The US Federal Reserve currently has rates at 2.5% with expectations that they will be cutting rates in the coming months.

Ahead of the 2008/9 crisis the rate was at 5% and they cut to zero back then. If we see a crisis from these levels, the Federal Reserve will surely have to go to negative rates – something I would never have expected to see.

For now, and certainly for the foreseeable future, low and negative rates seem to be the trend and I don’t see this going away any time soon. Further, I do think we can assume that the US will one day get into negative rates. 

The only way out of our drunken debt splurge is lower spending by governments, or higher taxes. None of these are palatable for politicians so the low rate merry-go-round continues with no end in sight.

The bigger question is how do we protect ourselves? Truthfully, I have no idea. I am going to give it lots of intense thought. If you’ve got any ideas, please let me know.

This article originally appeared in the 25 July edition of finweekBuy and download the magazine here or subscribe to our newsletter here.

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