Central Bank Maneuvers

Is 2015 going to be the year of central bank fireworks?

On Thursday morning the Swiss National Bank (SNB), Switzerland’s central bank, shocked everyone by eliminating the floor on the Swiss franc and will start charging a negative interest rate (0.75%) to anyone holding their national currency.

In response the Swiss franc exploded upward, up almost 30% against the euro and other global currencies. This move was one of the biggest currency shocks since the collapse of the Bretton Woods system in 1971, as many financial columnists have pointed out.

So let me be clear…. if I had $1 million Swiss francs on deposit at a Swiss bank, the bank is now charging me $7,500 francs per annum for the pleasure of holding these Swiss francs. The result? Individual and global institutions lining up Thursday to purchase Swiss francs!


Global finance has gotten a little crazy these days, don’t you think?

The other little thing – tongue in cheek – that is going on is nominal interest rates on any and all government debt has been falling like a stone over the past year. Except for Greek government debt, and who knows whether a bondholder will eventually get paid back in Greek euros or drachmas, all sovereign bonds yields have had a big move in price (upward) and yield (downward). Shouldn’t interest rates be going up by now?

I have to say these bond moves (big moves by historical standards) have become the 800-pound gorilla in the room of all portfolio managers and investment strategists. Nobody, it seems can explain it (lower yields) but better still nobody can say where the yields are going and certainly nobody wants to extrapolate what this means for the global economy.

So what is the end game here, I continually ask myself… in terms of global bond yields?

And let me go further to posit the question: Will nominal yields on all sovereigns go to zero? (Germany, Japan and a few other European countries have negative interest rates on their government bonds – up to 5 year and less – why not Canada?)

Here is screen shot of one of my favorite screens from the Bloomberg website showing 10-year yields of the major countries in the world and how much the yields have fallen during the year.

Screen Shot of Bloomberg Website Page

Screen Shot of Bloomberg Website Page


As Paul Krugman writes in his column, “Francs, Fear and Folly,” in the New York Times, “What you need to understand is that all the usual rules of economic policy changed when financial crisis struck in 2008; we entered a looking-glass world, and we still haven’t emerged.”

Can Model Price Theory explain what is going on here?


First I want to show you two charts. The first graph I tweeted out back in November 2014 showing the global total debt (excluding the financial sector) for advanced economies plus major emerging market economies. As you can see debt has been growing at healthy rate over the last 12 years. Of course most of this increased debt is national and territorial governments issuing large amounts of debt to supplement increased economic activity.

Global debt to GDP

Global debt to GDP

The second chart is our Solvency Curve that I introduced to you back at the start of this blog and one of our ‘Key Concepts’.

Solvency Curve from Model Price Theory - See Key Concepts

Solvency Curve from Model Price Theory – See Key Concepts


It’s the dynamic of what the economic actors are doing along our ‘Solvency Curve’ in each national country over a period of time is what I’m pointing out here. First, each national government, since the financial crisis of 2008, has substantially increased their national debt – some larger than others. This Keynesian national debt increase helped individual and together globally national economies sustain and increase economic growth to correct substantial drops in global demand that occurred around the world because of the financial crisis of 2008.

As government debt increased, all national governments moved down our ‘Solvency Curve’ – left side – to a more insolvent state. All the other economic actors in each society see this, individuals and corporations, etc., and increase their own solvency to brace for future of tax increases (to repay the national debt accumulated) and reduced capital investment plans or projects to conserve cash as future growth looks uncertain.

For example, in Japan where the government has tried to lift the country out of its economic malaise and deflation, after its own financial crisis, for over the last 25 years has spent enormous amounts annually (budget deficits) to increase nominal demand and has increased the national debt to a staggering 229% of GDP – the largest of any country in the world today. Unbelievably, as the national government debt has risen, total cash held by individuals and corporations have also grown to a staggering 44% of GDP. Hope you see the dynamic going on here. The national governments going one-way (down our ‘Solvency Curve’ and everybody else is shifting (becoming Super-Solvent) to the right of our curve in response.

I know and would like to emphasize our concept – Solvency Curve – and movement along our ‘Curve’ is not the cause (not fully) of our current interest conundrum. It’s just until world governments and their respective central banks slow down this cycle or movement along the curve – each side of the curve moving away from each other – that lack of global growth and dis-inflation bordering on deflation is going to continue to occur.

Resulting in ever lower interest rates.

When and if these ‘Solvency Curve’ trends start to slow down or better still reverse (having national governments become more solvent allowing individuals and corporations to spend their cash and move up the right-hand side of the ‘curve’) do interest rates have the slightest chance of moving upwards.

Or is something going on here that is more prophetic with regards to interest rates.

Sometimes when I view this Bloomberg 10-year government webpage I feel it’s more like a countdown. I’m I witnessing a secular fall in interest rates that will last for a generation? Will global long-term interest rates in the western world and Europe go to Japanese levels and perhaps stay there, again, for a generation? What happens to western society, business investment and retirement plans if and when we have low interest rates for a prolonged period of time? Do these questions make any sense? Am I scarring you?

How are we in the west, the developed nations, supposed to retire if interest rates go to zero? Want to earn $100,000 in interest income? Well, at the current interest rate of 1.53%, a Canadian resident currently needs $6.5 million invested in a 10-year Government of Canada bond. Who has this amount of loose change lying around to retire on? But, I guess, the good news is that interest rates are 1.5%! What happens if they go to zero?

Just asking.





One response to “Central Bank Maneuvers

  1. cobbiangrant January 20, 2015 at 4:54 pm

    Sounds like all the bridges are going to be full, I better jump now!!

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