Wednesday, April 22, 2015

Twilight Zone: Reality Breaks Down at 0%

The year is 2015. People are looking to lend away their money to make a return. In return for lending the Swiss government your money for 10 years, you will be rewarded with a return of -0.17% per annum.

No, there is no need to blink your eyes. It is correct, NEGATIVE 0.17%.

If you have heard of the Stanford Marshmellow experiment and about delaying gratification, you would realize that this scenario is put on all backwards. Instant gratification should be heavily discounted to future/delayed gratification. In other words, instant gratification should cost a whole lot more than delayed gratification.

The financial world is currently sailing in uncharted territory where banks now pay people interest for having taken up housing loans with them.

Imagine that! Getting paid to borrow money. Not only do you get the money that you borrowed, you are also receiving, not paying, interest!

Now that the Euribor just went negative, banks will pay each other for borrowing money from each other.... wtf?

How does that make any sense?

It shouldn't.

Most people are at a total loss of why this is even happening and can't explain it. David Merkel from the Aleph Blog breaks it down fantastically why rates can go negative. To me, the way I see it is that negative rates are pretty much the same as negative GOFO rates for gold, where banks actually pay people to keep gold with them, rather than the normal situation, where people pay banks to keep their gold for them.

While the worded theory makes sense, I am definitely sure that negative rates is causing all sorts of hell to break loose on many financial models used by institutions.

I understand why negative rates are happening, but that doesn't make me comfortable that it is happening.

It's like knowing that a tsunami is about to hit. Hell yeah, you know what caused it in theory. Would you feel comfortable if you were standing on the beach?

To my knowledge, I have no exposure to any of these bonds with negative yield. I'm out on the mountain watching news about the tsunami on my TV.

Where are you?

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