How does Government Debt go negative?

Today came the news that short-term German government paper was following the Swiss example and turning negative, not only that but its expected that it won't be very long until the 10-year Bund follows suit.

Quizzical isn't it? Why would anyone pay for the privilege of lending someone money?

Friends and colleagues of mine, having a hunch that I know a little more about finance than they do have been asking me about this quite a bit recently and to be honest I have struggled to give them an answer they could happily digest. Well it certainly is a "new normal" and set to spread throughout the developed world as things get worse but how and why is it happening?

In short this is what Quantitative Easing has wrought. Institutions paying for the privilege of lending their money to insolvent governments. Not because those borrowers are such low risk counterparties, but rather because now real investors must compete with totally price-insensitive Central Banks hoovering up sovereign debt with freshly 'Printed' money.

If you want to understand this mechanism in a little more detail here is an excellent blog post by David Stockman who is examining a fascinating new blog by none other than the architect of this mess, Ben Shalom Bernanke.

This is the crux of his conceit:

A similarly confused criticism often heard is that the Fed is somehow distorting financial markets and investment decisions by keeping interest rates “artificially low.” Contrary to what sometimes seems to be alleged, the Fed cannot somehow withdraw and leave interest rates to be determined by “the markets.” The Fed’s actions determine the money supply and thus short-term interest rates; it has no choice but to set the short-term interest rate somewhere.

He doesn't even know what this mythical rate should be, but whatever figure he comes up with I'm sure it will be agreeable to the bankrupt sovereign states of the West.


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Boing!

Dow and FTSE back up again. Thought so. But unlike 1987, I don't think this will be over by Christmas. Bear market rally, don'tcha know?

Super post by Denninger today, too. He points out, among other things, that the Dow started falling yesterday when everyone (himself included) expected the Bill to pass. And as he says, Bernanke upped the money in the system by vast amounts anyway, and it still hasn't fixed the problem. Just how much petrol do you need to throw onto a fire to put it out?

China Olympics: Starter's Gun For Inflation

Image from the Summer Olympics of 1904 (St Louis, Missouri)

Robert Gottliebsen in Australia's Business Spectator (Thursday) gives thanks for Ben Bernanke's inflationary rescue of the banking system, but points out that the flight from devaluing US securities is driving demand for assets elsewhere. And there are longer-term consequences to face:

Before the latest US crisis developed my friends in China told me that many Chinese manufacturing businesses would try to raise prices by 10 per cent in 2008 -- probably after the Olympics. That determination will now be intensified because the manufacturers are not only receiving lower returns but are being forced to pay more for oil and commodities. Those seeking shelter from the US dollar will drive up prices.

Bernanke’s actions, even though they are justified, are going to inflame US inflationary pressures. So later in 2008 and in 2009 he will need to reverse the current process and increase interest rates. That will not be good for stock markets or commodities because it will reverse the current forces. But just how serious it will be for the US will depend on whether the current Bernanke medicine worked and the banking breakdown was repaired.

I think there is a chance it will work because rising stock markets are a powerful drug. But no one can be certain, and this is a very dangerous period.