Scott Sumner writes
People who read economics blogs live in a sort of bubble, where there is widespread understanding of the failure of monetary policy. But out in the real world things are very different. Ever since NGDP collapsed in 2008, the profession has largely ignored monetary policy. In the previous post I pointed out that our profession was to blame for the severe recession. Every day that goes by brings more and more evidence supporting that sad conclusion.
The bubble is getting thicker by the day. This morning I was walking a dog and my podcast player qued Bill Gross’s Feb, investment outlook. I remember reading it at the time and finding it confused, but in a well-I-think-you-are-just-missing-this-one-thing sort of way.
I listened to it today and simply could not believe what I was hearing.
The most awesome – in the original meaning of the word – part:
What perhaps is not so often recognized is that liquidity can be trapped by the “price” of credit, in addition to its “risk.” Capitalism depends on risk-taking in several forms. Developers, homeowners, entrepreneurs of all shapes and sizes epitomize the riskiness of business building via equity and credit risk extension. But modern capitalism is dependent as well on maturity extension in credit markets. No venture, aside from one financed with 100% owners’ capital, could survive on credit or loans that matured or were callable overnight. Buildings, utilities and homes require 20- and 30-year loan commitments to smooth and justify their returns. Because this is so, lenders require a yield premium, expressed as a positively sloped yield curve, to make the extended loan. A flat yield curve, in contrast, is a disincentive for lenders to lend unless there is sufficient downside room for yields to fall and provide bond market capital gains. This nominal or even real interest rate “margin” is why prior cyclical periods of curve flatness or even inversion have been successfully followed by economic expansions. Intermediate and long rates – even though flat and equal to a short-term policy rate – have had room to fall, and credit therefore has not been trapped by “price.”
Which is akin to saying, “No wonder no one shops here. Everything is on sale!”
I am not even sure where to start.
But, maybe this will help. So, presumably Bill Gross is not saying that no private investor holds long dated securities. If so, then someone is willing to buy them at almost no yield. Which means someone could sell more of them at almost no yield plus a tiny amount.
Which means that you could fund a 30 year project on the cheap.
Superfluousness notwithstanding, prices are low because more people want to save than to lend. It is not that more people wish to save than to lend because prices are low.
All that having been said, I do appreciate Gross’s attempt to weave both elegant prose and metaphysical considerations into financial analysis.