The Great Monetization

In the world of economics, a certain phrase should be popping off like a young millennial who just chugged a White Claw at the Red River Showdown yelling, “It’s lit!”

But it’s not.

It has been happening beneath the surface for several years now. I have failed to really understand the significance of it. Regretfully, I am here to tell you I arrived late. At this point, I am only writing on what has already happened. The smart money has been made.

The Government sometimes needs money to fund new initiatives and keep its doors open. It raises money by issuing bonds. These bonds have an interest rate that they promise to pay investors for loaning them money. Okay this pretty Econ 101, but this stuff has been happening since Ancient Rome when emperor Diocletian was fighting inflation within a world of 15% interest rates.

Things have changed quite a bit since Ancient Rome. This is especially true for the Central Banking system. You could make an argument that the Central Bank you know today did not exist until 1931. That’s when a Central Bank, for the first time, ditched the gold standard (for the trivia squad out there it was Great Britain who did it first).

Prior to that, everything had been connected to gold in some way. What I’m saying is that the Central Bank you know today, is less than 100 years old. A gold standard Central Bank is entirely different from a non-gold standard Central Bank. This means your great aunt Cindy might be older than the most important institution to literally everyone’s economy, across the globe.

This is not your grandpappy’s Fed.

As the Fed and other Central Banks age, they discover new and interesting ways to conduct their business. And that’s natural. When my grandma hit 80, I remember her eating habits changed quite a bit. She was open to anything and everything! Put a plate of food down, and seconds later it was gone. We eventually nicknamed her, “The Wolf.”

Since the Financial Crisis, Central Banks have found new way to YOLO. The Bernank, jellin like Yellen, and Super Mario have been at the forefront of this change in Central Banking magic.

It starts with the countries these Central Bankers work for. They tend to have some glaring issues. One of those is debt. It’s hard to find a major country today that does not have debt. And a lot of it. I guess that’s just the way things are going at the moment. Excessive debt leads to worry, the worry leads to fear, and the fear leads to instability. This gets even worse when you’re trying to recover from something as serious as the 2009 Financial Crisis.

It’s a terrible situation to be in.

It’s like a student coming out of college with a boatload of student loans and no good job prospects. The only way they can survive is if they take another loan at a higher interest rate to fund their next steps. But now, the losses and debt are growing on top of each other. It hurts my mind just to think about.

The cycle gets more and more viscous.

Most Governments, in the last 10 years, have found themselves in this precarious situation at some point. In 2010, fresh from the Financial Crisis, the US 10-Year was nearing 4%. People were flat out scared! Today, it’s at 1.5%. What’s so strange about this is that things are magnitudes better now than they were then. You see, it’s supposed to be the other way around. We are taught that risk-free yields like Treasury bonds go higher in good times and lower in bad times. Because, for example, in really dire times, when all around you is melting down, people would rather own a risk-free asset like a Treasury Bond than a few shares of Beyond Meat.

This could not be more wrong at the moment. Burn the textbooks.

Enter stage left, The Great Debt Monetization. A time when Central Banks, not long ago, realized something. Why don’t they start buying their own Government debt? Buy the debt, collect the interest, return the profits and principle back to the country all while pushing interest rates down so that it becomes cheaper for the Government to borrow money in the first place. It’s giving your local Government the best refinancing terms imaginable. The Fed is saying, “don’t worry, even if markets get scared, we will be there to buy back your debt and fund you. Even better, we will make it cheaper for you to borrow. Heck, why don’t you borrow more money now to pay back your old debts that had higher interest rates!”

They are, “monetizing the debt.”

It’s why we have charts showing Spain and Portugal 10-Year Government Bond Yields drop from levels of 15% to almost negative today. Yes, from 15% to negative in under 10 years time. The Central Banks shot their shot and the crowd is going wild:

There’s no other explanation. Did people suddenly just get that excited about the Portuguese economy to swoop in and buy tons of their debt on the open market pushing it to nearly negative? Not a chance. Someone with infinite fire power did that.

This is also why an economics PhD and rising star in the bond management business is getting crushed today. Literally from hero to zero. His name is Michael Hasenstab.

In a normal world, interest rates should rise as an economy gets better. In a perfect PhD world, with the S&P 500 just near all-time highs, and GDP rocking, bond yields should be trending higher. But, they’re not:

It is a new world out there for economists and investors. For everyone. The old legacy ways of investing are dead. Because there’s a buyer you don’t want to get in front of or take the other side of. And they will be there as long as they have to be.

The following chart is presented without much comment – see all the bars going upward? That’s Central Bank holdings of public European debt. See the bars going downward? That’s every other sector and their holdings of public debt:

Chart from the Financial Times

Now here’s where things really get wild. Let’s talk about expectations for the future. There’s no reason not to expect Central Banks to monetize Government debt. In good times and in bad. Why wouldn’t they? I often look back at the PIIGS (Portugal, Italy, Ireland, Greece, Spain). Remember when every European country was about to go bankrupt? Now most of those countries are nearing interest rates on their Government debt that is nearing negative. That’s because the European Central Bank has their back. Super Mario Draghi is backing up the truck and loading up as I type.

You won’t find this in your macro textbooks from 99’.

Strangely enough, though, is that this might be the future of modern Central Banking. Monetize debt as often as possible. Perhaps in times of crisis push rates negative. Pump money into the Government by flooding them with cash, buying their bonds, and helping pay off their debts at cheaper rates. More funding at cheaper rates, more spending, more construction, more direct investment into the economy as opposed to boring alternative methods. I mean come on. Lowering the the Fed funds rate is so 2000s.

Negative interest rates on Government debt… what the!? Who would even buy those bonds!? That’s what most people are trying to wrap their head around. But you know who would help fund Government debt to the point of driving those interest rates negative, purposefully losing money on their investments to that Government body so it can spend more and stimulate its economy? I can think of a certain someone.

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