Gualfin (“End of the Road”), Argentina

Dear Diary,

Not much to report from the financial markets.

And things seem to have settled down in our hometown of Baltimore, after they called out the National Guard.

So, we’ll return to our exploration of the Fed’s fabulous fantasyland…

Money for Nothing

Yesterday, we looked at the coming liquidity drain.

It is roughly what has been happening in California already. When more liquidity is being used than is available, things dry up.

But wait…

Do the feds have a still-untapped aquifer of cash and credit they can pump dry?

Short-term interest rates are already as low as they’ve been. But could they go lower?

Yes on both counts…

Ask your spouse: “What will you give me if I kiss you?” If the answer is nothing, you have established the value of your kiss: zero.

But suppose the answer comes: “If you take out the trash, maybe I’ll let you kiss me.”

Now, the value of your kiss is even lower – below zero. You have to add something to it to make it acceptable.

Likewise, it appears that lenders – mainly in Europe and Japan – must add something to their money each year in order to persuade the government to take it.

We have already been humbled and flummoxed by zero-percent interest rates. Even when we are in our cups… or deprived of oxygen… they make no sense.

How could something simultaneously have no value – or less than no value – and still be worth anything?

Money has got to be worth something, right?

Then how could it be lent out for nothing… or less than nothing?

Bonds Are a Liability

Let’s take one example…

Earlier this month, the Swiss government sold 378 million Swiss francs ($354 million) of bonds. Those that mature in 2025 carried a yield of MINUS 0.055% before accounting for inflation.

Does this mean what we think it means? That the value of the money lent is less than zero?

So, if you have a million francs’ worth of 10-year Swiss bonds, what is it really worth?

Well, if you had to pay a mortgage of 2%, you wouldn’t have an asset, but a liability.

So wouldn’t the portfolio of Swiss bonds also be considered a liability, not an asset?

And if it were a liability to you, wouldn’t it have to be an asset to the Swiss government?

So, let’s get this straight: The borrower gets an asset. The lender gets a liability.

In what kind of a universe does that happen?

In a negative interest world, money has no meaning. You could build automobiles that don’t run… airplanes that don’t fly… or computers that can’t add.

It would make no difference. You could stay in business for an eternity as long as lenders were willing to part with their cash for no return.

Attentive readers will realize that we do not live in a zero-interest world. We live in a world of flesh and blood. We live in a world where cash, kisses and credit still count for something.

And in this world, you still have to pay for what you get.

The Swiss Ban Cash

But little by little, day by day, the world we live in gets stranger – thanks to this funny money system.

And little by little, the more curious the financial world becomes, the more people want to hold on to cash to protect themselves.

One of the strangest things to happen recently was that the government of Switzerland, of all places, has refused to allow big depositors to withdraw cash.

According to Swiss news website Schweizer Radio und Fernsehen:

The Swiss National Bank confirms that hoarding cash to circumvent negative interest rates is not welcome. “The National Bank has been recommending that banks with cash demands […] act restrictively.”

And comments former banking insider Frances Coppola at Forbes:

The monetary policy of the last few years has been hampered by the supposed existence of the “zero lower bound” at which (it is assumed) everyone would opt for physical cash instead of bank deposits and bonds […]

But if investors simply cannot obtain large amounts of physical cash because banks won’t issue it to them, the slightly-below-zero lower bound cannot bind. In which case negative rates could be very negative indeed and no one would be able to do much about it.

Escaping the Fed’s Fantasyland

We have been predicting a “run on the dollar.”

Now, the Swiss are leading the way. Keeping you from holding cash appeals for governments for three reasons:

1. It is hard for them to control, track and tax.

2. It is fast becoming irrelevant as new technologies make electronic transactions easier. (Think Apple’s new iPay mobile payments system.)

3. As long as you can hold cash, you can escape the feds’ fantasyland. If you can stay in cash, they can’t enforce negative interest rates. You can just take your cash and hold on to it – paying nothing for the privilege.

Following the Charlie Hebdo attacks in Paris, France is planning to limit cash payment to €1,000 ($1,100). The logic being that the attacks were funded with cash…

Meanwhile, Citibank’s chief economist Willem Buiter has recommended taxing cash (a form of negative nominal interest rates). And JPMorgan Chase has sent letters to customers, telling them it will no longer allow cash to be stored in safety deposit boxes.

In the US cash is not yet illegal, but it is suspect.

Show up with a large amount of cash at a bank… and you will likely have some explaining to do. Let the police find it on you in a routine traffic stop… and they are likely to confiscate (thanks to the Justice Department’s Civil Asset Forfeiture rule).

It is just a matter of time before holding cash becomes illegal in the US too.

Will that be enough to raise liquidity levels and asset prices?

Stay tuned…




Market Insight:

Japanese Retail Sales Plummet

by Chris Hunter, Editor-in-Chief, Bonner & Partners

Poor Japan…

Despite the BoJ already buying around 90% of the bonds in the market, Japanese retail sales plunged 9.7% year over year in March.

That was even worse than the 6.8% fall Japanese economists were expecting.

And it’s the third straight month in a row in which retail sales have fallen.

Fortunately for investors, 40% of Japanese corporate profits come from exports. This makes the fall in domestic demand less of a problem for investors in the Nikkei.

But it’s bad news for Japan’s economy, where consumer spending accounts for 60% of GDP.

It’s true that last year’s sales tax hike from 5% to 8% hasn’t helped Japanese retailers. But according to the logic of “Abenomics,” QE is supposed to compensate for that by making stock and bond owners feel richer, causing them to rush out and spend.

This may work in theory… but there’s little evidence of it working in practice.