August 05, 2016

At what point do negative rates on government debt become absolutely incompatible with its zero % risk weight?

Sir, in reference to Dan McCrum’s “Fire up the printing presses for a useful jolt to the economy” August 5, this is what I have to say.

Government issues bonds, the public buy these, and central banks, wanting the economy to grow, then buy these from the public.

Then the public does not know what to do with that purchasing power given to them by the central banks and, wanting to play it “safe”, looks to buy government bonds, and so the interest rates on public debts goes further down.

And so then Martin Wolf and other recommend the government to take advantage of these low rates, in order to invest in infrastructure. And if government follows their advice, it will issue more bonds, and the public will buy these.

But since the economic punch from infrastructure investments vanishes quite fast if there are no one willing to use and pay the right price for it, the central banks will then buy more government bonds from the public… and on and on it goes.

And, to top it up, banks and insurance companies are told by their regulators: “If you do not buy 0% risk-weighted government bonds, then you have to cough up with more equity”. And so banks (and insurance companies and alike) buy more government bonds, and the rates on these keep falling and falling… where does it end?

At what point do negative rates become absolutely incompatible with a 0% risk weight? How much capital will banks then need to hold against government bonds? How do we get off this not at all merry merry-go-round?

And to top it up, meanwhile, if SMEs or entrepreneurs, those who could perhaps best help to get the real economy going, want the opportunity to a bank credit, banks are told that “since these clients are risky you need to hold more capital against their borrowings”. And so banks do not lend these clients the money, or, in order to compensate for the higher equity requirements, charge higher interest rates, making the “risky” riskier.

How the hell did we land in this hole? I know!

PS. With respect to their future pensions, are central bankers and regulators isolated from their decisions? Should they be?

@PerKurowski ©