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Less Than Zero

In the latest twist in the global economic crisis, the yield on roughly $2 trillion worth of bonds has turned negative. That means that anyone who buys those bonds has to pay interest to own them, rather than receiving interest from owning them. This unprecedented phenomenon paints a very alarming picture of the health of the global economy. It tells us that the owners of $2 trillion worth of wealth are willing to buy bonds with negative yields and thereby lock in small losses because they have no confidence they could invest that money anywhere else without incurring even larger losses. There could be no clearer sign that an enormous amount of wealth is going to be destroyed over the years immediately ahead. Let’s review how this dire situation came to pass.

In 1968, the United States stopped backing its money with gold; and the rest of the world followed suit. Credit growth exploded producing decades of rapid economic growth. Countries pursuing export-led growth thrived by selling more goods every year to the United States, which bought those goods on credit. As part of this process, US factories either closed down or relocated to countries with much lower labor costs. Lower wage costs pushed the price of manufactured goods lower and drove the inflation rate steadily lower, too.

So long as the Americans borrowed more and imported more, the rest of the world built more factories, produced more commodities, exported more and prospered. By 2007, a dozen or so of the most successful exporting nations had accumulated roughly $7 trillion as foreign exchange reserves; and they had invested that money in US dollar-denominated assets like government bonds, Fannie and Freddie bonds, other corporate bonds and stocks. Those investments drove up US property prices, stock prices, and bond prices and pushed down US interest rates, causing an enormous asset price bubble in the United States that allowed the Americans to continue borrowing and spending even though the country was going through a process of de-industrialization.

But then in 2008, the American borrowing binge hit the wall. Millions of Americans could no longer repay their debts. Consequently, they were cut off from additional credit, they bought much less, the US imported much less and the rest of the world exported much less. Factories around the world closed, unemployment soared and a tremendous amount of credit that had been created during the preceding quarter century came very close to being destroyed in a 1930s-style Depression.

But that did not happen because governments around the world intervened on a war-like scale, borrowing, printing and spending trillions of dollars to keep the global credit bubble inflated. Consequently, most of the credit that had come into existence during the boom years was not destroyed. Nearly all of it, plus trillions more created since 2008, is still around. That money is now frantically looking for viable investment opportunities, meaning any investment that will not result in a loss. The thing is, it can’t find any – or, more precisely, it can’t find enough such opportunities to absorb all the funds looking for a positive investment return.

Meanwhile, the global economy has remained so exceptionally weak that central banks have felt compelled to continue creating even more money to prevent it from collapsing back into the near-depression state of 2008-9. The European Central Bank and the Bank of Japan are running their printing presses on overdrive. But, while that Quantitative Easing supports the economy in the short-term by pushing up asset prices, it creates an even larger pool of money looking for somewhere to be invested profitably. Now we’ve reached the point where at least $2 trillion worth of that pool has given up any hope of earning any profit and has become reconciled to the inevitability of incurring a loss. So the owners of that money buy bonds with a small negative yield so that their losses will be only small ones instead of potentially much larger losses that they fear would result from any other investment they could make.

This is the sorry state that “Capitalism” has come to and this is how we got here. Central banks are going to continue doing everything in their power to keep asset prices and the global economic bubble inflated for as long as possible. But don’t be surprised to wake up one morning and discover that stock prices and property prices have crashed. Between now and then, just make sure that the assets you own crash less than those owned by other people. That way, in a world of losses, at least you will be relatively better off.

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