We just saw this post from Pragmatic Capitalism’s Cullen Roche on the supply of assets.
It offers a nice chart showing net issuance of “safe” assets, from Citi’s research team:
The amazing revelation, of course, being that QE is taking out safe assets from circulation, which is contracting the net supply of assets (safe and otherwise) available in the market.
As Roche (surprisingly) notes while introducing Citi’s “excellent” commentary (which in our opinion does not actually advance the safe asset debate very far):
In other words, the supply of asset issuance continues to run at a level well below pre-crisis levels. That might explain at least some of the broad upward pressure on assets in general.
In fact, Citi conclude:
We think this ‘supply effect’ on financial markets of central bank interventions is widely underestimated.”
At which point FT Alphaville breathes a collective sigh of frustration.
Seriously? Is this how far we’ve got? Even after this BIS paper?
FT Alphaville (and many others) have, of course, been banging on about the impact of safe assets, and the free-float supply thereof, for years now.
In fact Richard Duncan, author of the Dollar Crisis (2006), was one of the first people who observed that GSE issuance rose mostly in response to the shortage of alternative government-guaranteed safe asets, and rising demand for such assets from Asia.
As we’ve always maintained — and this hoarding problem applies to almost any asset, even commodities — it’s not the total supply that matters, but the amount that is freely available for sale at any given point. That is, the amount which is not being hoarded (on purpose) or encumbered in other ways.
There can be a million umbrellas in existence in the world. But if when it rains there are no umbrellas to hand, then the person with just one umbrella can dictate prices at very extreme levels.
And in the current market, a central bank can use its monopoly power of banknote and ultimate money creation in exactly that way.
This, by the way, is exactly how the price of gold is determined too. Its value depends entirely on how quickly it is being reburied and hoarded compared to how quickly it is being extracted and released, because guess what — its global supply is actually one of abundance relative to consumption need.
Thus, gold’s value is dictated entirely by the hoarding discipline of the collectively-aligned but disintermediated global Emperor’s New Gold Cartel.
Part of the Asian savings glut problem, meanwhile, was also related to the fact that these countries hoovered up all the bonds in a very similar way. In doing so they collectively undermined the power of the domestic central banks by influencing the free-float supply more greatly than the Fed itself and also by effectively entrapping demand (the deferred demand which is crystallised in those bonds) rather than spreading it back to the countries of origin.
Last and not least, this hoarding free-float effect may also be why the original ECB LTRO actually caused the fragmentation of eurozone bond spreads. That is, by offering long-term liquidity in exchange for sound eurozone collateral, distressed/or liquidity hungry parts saw fit to deliver the cheapest bonds available. A lot of these were bonds of the periphery, especially Greece. All of which reduced the free-float available to ordinary (at the time non-distressed) Greek banks, who were using these as repo financing raised from private markets.
A sudden entrapment of bonds at the ECB limited the pool of bonds available for repurchase — then caused something of a repo squeeze for those who had financed greek banks and rehypothecated the collateral. Settlement fails rose. The market froze. And Greek banks were suddenly left without willing counterparties in private markets because the cost of providing financing against Greek bonds had increased greatly.
Which leads us to the problem with QE, and a number of other counterintuitive effects which we fear many people are still “missing”.
Here’s a small tally of points we’ve been making for a while.
1) Because of the safe asset problem there is a diminishing return — or even negative return — to QE at some point. In fact, rather than being inflationary, it becomes deflationary.
2) Interest on reserve policy is actually designed to counteract this deflationary — and negative rate inducing — effect. In fact, IOER, or the ability to hold reserves at the central bank for no negative interest cost, shows that central banks are effectively supporting short-term rates rather than depressing them. If not for the ability to hold reserves at the central bank, then rates could very well be negative.
3) The crisis is in many ways a deposit crisis not a debt crisis. There are simply too many deposits seeking principal protection and not enough safe assets to protect against capital destruction by negative rates.
4) Negative rates are a function of global abundance (brought on by technological advances), and a trend that cannot be stopped even by the strongest central bank — unless society regresses backwards (like many goldbugs would seemingly desire). For rates to stay positive we have to hoard almost everything in the world form the people that need it, if it is to have value. The artificial scarcity tactics that have been used through the ages to achieve this, are getting harder to execute because of technological liberation — which is enabling the emergence of collaborative economy which bypasses rates of return.
5) Central banks taking charge of digital money and issuing it directly to consumers is one way to ensure deposits can always be protected from negativity.
6) Value in the capital system, and our definition of growth, is very likely being transformed as a result.
7) Greater efficiency and abundance may also eventually lead to the end of arbitrage.
That said, even though the flow of technological abundance is great, there are ever greater attempts to prevent that flow from overspilling everywhere, at least without extracting any capital value from that flow. The system’s last stand is creating barriers and dams — which purposefully fragment distribution — in order to squeeze as much value out of it as possible. But the fragmentation only actually creates more efficiency in an increasingly complex world.
We can even state that this crisis is most likely a technology crisis, sewn from the computer revolution and the dotcom bubble (if not the industrial revolution itself). Though crisis may be the wrong word, since it’s much more likely to be the reemergence of Greenspan’s New Economy, which was temporarily sidetracked (or sabotaged) by opposing interests, misunderstanding and legacy paradigm bias.
Closing thought: If you arrive, armed, on a primitive island whose inhabitants only value a rare domestic shell and have no love or appreciation of dollars, gold or precious metals — so your gold has no purchasing power with them — are you more likely to get them to cooperate by shooting at them with your extremely more sophisticated death tools or by sharing technology that can make their lives less of a burden?
Either way, technology and know-how are what really represents value.
Related links:
The perils of releasing the repo rate – FT Alphaville
Are western central banks having an existential crisis? – FT Alphaville
When a government bond becomes a Giffen good – FT Alphaville
The ‘high-powered money’ problem – FT Alphaville
One Eurobond to rule them all – FT Alphaville