There are a lot of people out there for whom the persistence of very low negative interest rates is no particular surprise. The rise of robotics, the ageing global population, the oversupply in most industries, the horrible overhang of post crisis debt, the weak oil price, the weakening Chinese currency all these things can be used to argue that we will be stuck in a low interest deflationary environment for a long time to come.
It has then been no surprise to these same people that there has been a bond boom (bond prices rise as interest rates fall). What is more of a surprise is the extent of the bubble that has followed that boom. As Gavekal's Louis-Vincent Gave points out, "there are lows in bond yields, and then there is the reality of a third of outstanding OECD government bonds offering investors negative yields this latter proposition makes no financial sense whatsoever".
Investors can and do rationalise anything in any market as it suits them (see many bubbles past) but in a world without benchmarks and groupthink, who would really be willingly to "pay a percentage year after year to have money taken off them"? Particularly when there is a perfectly viable alternative to holding government bonds: holding cash.
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Look at it like this. When you buy a financial asset you have to ask yourself three questions: how much capital might you lose, how much could you make and what income will be earned from the asset along the way to making those gains or losses. You figure out where to put your money by comparing the answer to these questions across the asset classes (please do not write in to say that this is oversimplifying things it really is this simple).
With that in mind, M&G's Richard Woolnough made a useful point on cash earlier this week. Bonds come with the potential to make capital losses (if interest rates rise) and gains (if they fall) but the risks have been offset to a degree by the fact that they offer an income. That is changing: we are now at the point "where the income on a ten-year Bund and a 100-year euro note is exactly the same zero".
So while the risks of owning a Bund remain (if rates rise you will lose money) the yield advantage of owning that Bund is gone. So why then would you hold Bunds over actual cash? How can something be a haven when your best hope is that your returns will be either very low or negative and that is only if today's extraordinary conditions continue. That is very, very far from a given, by the way: after a super calm summer, government bond yields have jumped sharply in the past few weeks, taking US and German prices in particular back to pre-June 23 levels. So right now, surely a better haven is an actual safe jammed with cash?
You can browse for a safe at www.safe.co.uk or www.totalsafes.co.uk but be warned, it is tough to find a home safe that insurers will agree can take much more than £150,000.
Sure, it costs a little to buy a safe and get your hands on all the cash in the first place (my bank would not even issue large cash sums). But if it costs you to hold bonds too, what is the difference?
There are a few reasons for caution here. The first is neatly exemplified by the new fiver. The media coverage so far has focused on their durability. They are made out of polymers (you can wash them but not burn them); Mark Carney reckons it is OK to dip them into hot food on street stalls; bored journalists have checked their toughness by dropping them in wine glasses and running them over with steamrollers and they will, we are told, last 2.5 times as long as the old fivers. But more interesting is their size.
To make this point, I turn you over to Adrian Hull of Kames Capital. The note, he says, has shrunk. Again. Back in 1945, a five pound note measured 8 inches x 5 inches (211mm x 133 mm). The new one measures just over 4in x 2in (125mm x 65mm) or just under one-third of that. That rather spookily mirrors the exchange rate between the pound and the US dollar. At the end of the second world war, £1 would buy you $4.03. Today it buys you about a third of that: $1.32.
My point is that if you hold sterling the risk of nominal capital loss might be zero, but the risk of loss of purchasing power is pretty high (note too that total inflation since 1945 is more than 3,000%).
This brings me to the second reason to be cautious of holding too much cash: governments hate it. They say they hate it because it allows the black economy to flourish (letting people have financial privacy is the same as facilitating crime in the mind of a government). But they really hate it because it makes extreme monetary policy tricky: if people hold physical cash instead of deposit accounts or government bonds, as they have clearly started to do in Switzerland in the past year, negative interest rates cannot work as a policy (the idea being to force us to spend by taking our money away if we do not).
So they are doing their best to get rid of physical cash. In the eurozone, the €500 note is to be phased out; there are mutterings against the $100 note in the US; and in the, UK the Bank of England website lays out a timetable for the introduction of new polymer £10 and £20 notes but none at all for the introduction of a new £50 note.
The world's monetary authorities will not be happy until all high denomination notes are gone and each member of the population has a bank account directly under the control of the central banks. We will be allowed to keep pound coins for use at school fetes. But bank notes that have face values that in any way reflect the real cost of things or allow you to save in size? No.
You might think that as long as you have a huge pile of fifties stashed somewhere now (as Mike Ashley clearly does he pulled out rolls of the things at the Sports Direct AGM) you will be fine. But the key here is to remember the value of cash lies entirely within the gift of the state. It tells us what is legal currency and what is not. Old paper fivers will stop being legal currency on the fifth of May next year. How long before all fifties go the same way?
This article was first published in the Financial Times
