"When the accumulation of wealth is no longer of high social importance, there will be great changes in the code of morals.
We shall be able to rid ourselves of many of the pseudo-moral principles which have hag-ridden us for two hundred years, by which we have exalted some of the most distasteful of human qualities into the position of the highest virtues"

( JM Keynes, "Economic Possibilities for our Granchildren" 1930 )

Saturday, January 14, 2012

Negative German Yields and Eurospecticism

 From the Wall Street Journal
"In an auction Monday, Germany sold €3.9 billion ($4.96 billion) of six-month bills that had an average yield of negative 0.0122%, the first time on record that yields at a German debt auction moved into negative territory". (WSJ website  , “Germany yields south of Zero" , January 10th , 2012)
A nominal negative yield is very rare event, and for a good reason: As an alternative to the investment the purchaser  can always store her cash in a current account, or just keeping it in a safe with all the possible advantages: Cash is   safer, it offers  100% liquidity and in that case there is no dilemma as  , that case, it earns more money than the alternative investment ! ....(1)
So from an economic logic, (whatever weird theory is built on that matter) there is no point to buy such obligations that FOR SURE will yield less money than the original outset.

True, there were episodes when short term obligations in the American secondary market were traded in the negative territory. During the 1930s and early 1940s U.S. Treasury bonds and notes had negative nominal yields as they approached maturity but that was a special case (Stephen G. Cecchetti NBER Working Paper No. 2472). Another case is Japanese bonds which yielded in the negative zone in the mid 90 for short periods. I may have forgotten other cases, but it´s out of questions that these were exceptions, not the rule.

Economists and experts are trying to understand the logic of such apparently inconsistency ( Google “Negative German Yields “ and you ´ll have a sort of free seminar on monetary and banking theory) but they may miss a simple  point. Lets put it this way : German obligations are a special case as the country is part of the Euro, so the question deserves a special treatment. Let me ask : What happens in case the Euro, for some reason, breaks down? We can say with absolute certainty that the German “Euro” (or Dm) will appreciate comparing to the Actual Euro. In such a case, it is logical to assume that German obligations will be denominated in the new currency, so they will appreciate if compared to the Actual ( and to the lets say to the future “PIIGS2) Euro….( and obligations)  . Still ,  the open and interesting question is  why would investors invest in obligations instead of depositing the cash in German banks. Maybe there could be a different treatment to obligations and cash in case of a possible Euro breakdown?  

In other words, the nominal negative yields include an implicit option for keeping German obligations if the acteual Euro currency regime breaks down and a new currency emerges . What is the price of the option value? What are the probabilities to a Euro Breakdown as priced in these yields?How negative yields can be explained is related to the alternative to deposit directly in German banks ( i.e. the  I admit that these questions deserve more rigorous analysis ( and besides I must leave some open questions for future posts… :-)

Please note that negative yields became a realty more or less after December 2011 summit. Nevertheless , it is still too early to jump into conclusions , but such rare phenomenon should be followed closely .

(1) The post deals  with foreign  ( i.e.. non German ) citizens or institutions. The assumption is that the status of foreign current accounts and cash in case the Euro breaks into many currencies will be different than local deposits.  

No comments: