by Doug Casey, Casey Research:
It’s the top story in the investment world right now…
As we showed you yesterday, the S&P 500 just hit a new all-time high, topping 2,130 for the first time since May 2015. But it’s not just stocks that are ripping higher.
Bonds have quietly broken out to new all-time highs as well. Remember, a bond’s price rises when its yield falls. On Friday, the yield on the U.S. 10-year Treasury hit an all-time low of 1.37%. Yields on British (0.7%), German (-0.2%), and Japanese (-1.1%) 10-year bonds have also hit record lows over the past week.
With rates this low, bondholders are barely earning any interest income. In Europe and Japan, investors are actually paying to lend the government money. That’s because negative interest rates have taken over these economies.
In today’s issue, we explain how negative rates have turned the bond market into a giant Ponzi scheme. And we’ll show you the best way to escape it…
• Negative rates basically flip a bond upside down…
Typically, you earn interest when you own a bond. With negative rates, you pay interest.
Negative rates were unheard of until about two years ago. Today, $12 trillion worth of government bonds have negative rates. That’s up from $6 trillion in February.
This is possible because central bankers in Europe and Japan have dropped rates below zero. They thought they could get folks to spend more money by “taxing” their savings. According to mainstream economists, this would grow the economy.
As regular readers know, that hasn’t been the case…
• Negative interest rates don’t “stimulate” the economy…
Europe is growing at the slowest pace since World War II. Japan’s economy hasn’t grown since the 1990s.
Negative rates have failed to lift stocks, too. The STOXX Europe 600, which tracks 600 large European stocks, is down 8% this year. It’s down 19% since peaking in April 2015.
The Japanese Nikkei 225 is down 15% this year. It’s fallen 23% since topping out last June.
• Despite not working, negative rates are spreading like a plague…
More than one-third of the world’s government bonds now have them. In Japan and Germany, 80% of government bonds have negative rates.
Even countries without negative rates are affected by them. The Wall Street Journal wrote on Sunday:
The free fall in yields on developed-world government debt is dragging down rates on global bonds broadly, from sovereign debt in Taiwan and Lithuania to corporate bonds in the U.S., as investors fan out further in search of income…
As yields keep falling in these haven markets, investors are looking for income elsewhere, creating a black hole that is sucking down rates in ever longer maturities, emerging markets and riskier corporate debt.
“What we are seeing is a mechanical yield grab taking place in global bonds,” said Jack Kelly, an investment director at Standard Life Investments. “The pace of that yield grab accelerates as more bond markets move into negative yields and investors search for a smaller pool of substitutes.”
In other words, negative rates have forced investors to buy risky bonds to get a decent return. This has pushed down rates on those bonds. That’s encouraged investors to buy even riskier bonds, which again pushes down yields.
In a nutshell, negative rates have created a vicious cycle where investors are always “reaching for yield.”
• Interest rates aren’t some arbitrary number for governments to toy with…
They’re the price of borrowing money. And they’re supposed to convey important information to consumers, businesses, and investors. For example, a bond with a low rate should tell investors the borrower is creditworthy. It should mean there’s little risk of default.
At least, that’s how interest rates used to work…
With almost all interest rates near zero today, it’s almost impossible to know what’s risky and what isn’t.
Consider the government bond market, where most bonds pay next to nothing. With rates at all-time lows, some might think governments have become more creditworthy. According to The Wall Street Journal, the exact opposite has happened:
Sovereign credit ratings are on track for a record number of downgrades this year as declines in commodity prices hit emerging economies, according to Fitch Ratings.
The credit-ratings firm has downgraded 15 nations in the first half of the year, compared with a previous high of 20 downgrades for the whole of 2011. [Around the peak of the eurozone credit crisis.]
• Debt issued by developed countries is also far more dangerous than it appears…
Japan is a prime example. Its 10-year government bond has an interest rate of -1.1%. If you own one of these bonds, you have to pay Japan’s government 11 yen each year for every 1,000 yen invested.
Remember, Japan’s economy hasn’t grown in two decades. The country is also drowning in debt. Its government debt-to-gross domestic product (GDP) is a staggering 250%. That’s the highest of any major economy by far.
Yet, investors are paying to lend Japan’s broke government money.
The same thing is happening in Italy, where $1.6 trillion worth of government bonds have negative rates. If you’ve been reading the Dispatch, you know Italy is racing towards a full-blown banking crisis.
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