Low Rates Will Create Bad Habits in Germany, Eventually
Money for nothing should be a nein on the Rhine.
Me? I decided to ask simply whether German yields were falling faster than their Spanish and Italian (X710.MI) counterparts' yields were rising.
The simple fact that I am discussing the topic should be your first and only clue as to the answer: German 7-10 year yields (DBXB.HM) have declined at a daily log-linear rate of 1.01% since they reached a local maximum on March 20, 2012. Spanish and Italian 7-10 year yields have increased at 0.61% and 0.67%, respectively.
This is equivalent to saying the panic to flee into German bonds exceeds the panic to get out of Spanish and Italian bonds.
I have plotted these yields below along with the 7-10 year option-adjusted spread between the Spanish and Italian bonds and what is purported to be a high-quality European index. Please note how Spain is worse off than Italy in the option-adjusted spread (or, OAS) department; whether they give out prizes for "less bad" I know not.
On one level this may seem to be a statistical plaything. I disagree. If we have learned anything over the past quarter-century, a dubious proposition, it is that every credit bubble begins as an interest rate bubble. It reminds me of a long-ago conversation I had with a self-made billionaire wherein he confessed to having done some stupid things when he first got to that level, "Because I could." The Greek and Irish austerity programs of today are the direct result of their debt binge resulting from their ability to borrow at a narrow spread to German rates.
How can Japan afford its 200%+ debt/GDP ratio (and please do not tell me because the Japanese lend to themselves)? How can the US finance its expanding debt/GDP ratio at a net interest/GDP ratio near decade-ago levels? The answer seems to be, in all cases, a low debt service cost does not lead to lower debt levels; it leads to an expansion of underlying debt in a perverse twist on Say's Law that supply creates its own demand. Think of how the Bill Clinton surpluses turned into the George Bush deficits, and the Bush deficits, enabled by an increasingly profligate Federal Reserve, turned into the Barack Obama deficits.
I think this process will happen in Germany if low rates persist. Everyone likes to pretend they are virtuous until the freebies are passed about; then we find out how few aesthetes really exist. Just as absolute power corrupts absolutely, free money destroys prudence.
The information on this website solely reflects the analysis of or opinion about the performance of securities and financial markets by the writers whose articles appear on the site. The views expressed by the writers are not necessarily the views of Minyanville Media, Inc. or members of its management. Nothing contained on the website is intended to constitute a recommendation or advice addressed to an individual investor or category of investors to purchase, sell or hold any security, or to take any action with respect to the prospective movement of the securities markets or to solicit the purchase or sale of any security. Any investment decisions must be made by the reader either individually or in consultation with his or her investment professional. Minyanville writers and staff may trade or hold positions in securities that are discussed in articles appearing on the website. Writers of articles are required to disclose whether they have a position in any stock or fund discussed in an article, but are not permitted to disclose the size or direction of the position. Nothing on this website is intended to solicit business of any kind for a writer's business or fund. Minyanville management and staff as well as contributing writers will not respond to emails or other communications requesting investment advice.
Copyright 2011 Minyanville Media, Inc. All Rights Reserved.
Daily Recap Newsletter