The Real Reason behind Negative Interest Rates
Central bank bond buying is crowding out Boomers, pension funds and other buyers of fixed income, destroying dreams of a secure retirement as a result.
Stimulating supply of investment grade bonds, especially environmental bonds, and halting central bank interference, will return markets to normal conditions, restore the promise of a secure retirement, and cut household costs and carbon.
Google “negative interest rates.” 48,100,000 results describe the myriad reasons attributing negative rates to a lack of confidence in central banks with the latest focusing on German bond yields and confidence in the ECB.
Are we living in the Idiocracy?
This pervasive primitive pecuniary punditry hurts my head.
Investor confidence or lack thereof does not change the yield curve, negative or otherwise. Negative yields are the result of excess demand for fixed income relative to supply in the market.
Think about that: Negative yields are the result of excess demand relative to supply.
Boomers around the world are retiring. Because so many Boomers demand income from their savings, drawing income from bonds is now more expensive than ever before, which means that the average Boomer now earns far less income than they would have if they retired in the 90’s.
The economics work like this:
1. Boomers want to convert their stock holdings and life savings into income producing assets.
2. This increased demand for fixed income drives down yields and creates downward pressure on stocks as they shift out of stocks and into bonds.
3. Unfortunately for Boomers, with the entire generation acting in concert, their demand has driven up the price of bonds, which has decreased the yield (income) to the investor.
So there we have it. More Boomers retiring than ever before is the cause of declining bond yields, right?
Yes, and no.
The Federal Reserve amassed a portfolio of $4.5 trillion of treasuries and mortgage-backed securities from 2008 to 2014. The European Central Bank is now buying corporate bonds and the Bank of Japan is buying everything in sight.
Central banks ostensibly claim to buy bonds in order to prop up the economy by way of lower borrowing rates for investors.
Nothing could be further from the truth.
The Federal Reserve, like the other central banks, is a privately held company. Just like any other privately held company, they have one primary objective: to make money.
(FederalReserve.gov claims that it is not “owned” and not a for-profit entity, but then explains in the last paragraph of the FAQ that they are owned by member banks that earn a dividend of up to 6% on their assets, in other words, a private for-profit company.)
Historically, central banks, including the Fed, invested in U.S. treasuries, which provided a yield of about 3% to their shareholders. With increased demand from Boomers, treasury yield and corporate yields have declined significantly. Like pensions and pensioners, central banks join in the reach for yield and provide false justification for bond purchases beyond traditional treasury assets.
Unfortunately for Boomers, central bank bond buying, popularly known in the U.S. as Quantitative Easing or QE, means that Boomers are competing with central banks for income-producing assets. As a result, Boomers earn less income from their savings, keep more of their money in riskier assets such as stocks and lower quality bonds, and worry throughout retirement about how long their money will last.
And that’s a raw deal for retirees.
Chairman Yellen, Draghi and Kuroda:
Please stop hurting Boomers with your bond-buying programs. If you really want to help, buy stocks, or better yet, buy nothing at all.
About the Author
Joe McHugh is an Investment Advisor specializing in clean, renewable fixed income for retirees, and Founder of Earth Loans, a direct lender for household geothermal heating and cooling systems; helping homeowners to cut costs and carbon. He also served as an Anti-Terror Force Protection and Logistics Officer for the United States Marine Corps.