No less than $11.7 trillion is tied up in bonds that pay out negative interest rates, according to Fitch Ratings. Here is your question for today. What happens if rates go up?
Here is the short answer: if rates go up we could see losses to make the sub prime crisis of 2007/08 seem mildly disquieting.
Here is the caveat. Actually, if rates go up, that may mean things are going on below the surface that are very good news indeed.
And here is the detail. There are in fact 3.8 trillion reasons to fret.
Take a deep breath, here they all are, listed in alphabetical order:
Reason number one out if 3.8 trillion: one dollar.
In fact the reasons are all the same. According to Fitch if bond yields rise to their 2011 level, total losses could hit $3.8 trillion.
Bear in mind that the price of bonds has an inverse relationship with its yield. The lower the yield, the higher the price. And vice versa.
This century has seen bonds return more money to investors than equities, largely because their price has gone up and up.
Yet low interest rates, which are what created the explosion in bond prices, are a function of aggregate demand being too low across the global economy. If demand rises, the economy would grow faster, companies would make higher profits, and wages would rise, at least theoretically.
So here is the dilemma. Bond prices return to the 2011 level and that is great, the conditions are in place for it to be like it used to be. But if that happened, massive losses will follow.
Actually it is not rocket science, imagine what would happen to the UK’s £8.8 trillion worth of net wealth, of which dwellings make up around a two thirds, if rates rose and house prices crashed.
That’s the real dilemma, if the economic development we need to happen, namely a sharp rise in demand, did indeed happen, then the economic shock waves would be severe.
It won’t happen right? Low rates are here for good. Maybe, but suppose that when the baby boomers retire they stop saving and spend, suppose they dig into the capital in their homes, suppose China does what it says it wants to do, and saves less, but spends more, and suppose competition from technology disruptors forces corporates to invest more and wages across the economy rise.
If that happened would we see economic boom or debt Armageddon?