The Market Price of Corruption: Real Rates, the Real Yield Curve, and the GDP Gap

"Gentlemen! I too have been a close observer of the doings of the Bank of the United States. I have had men watching you for a long time, and am convinced that you have used the funds of the bank to speculate in the breadstuffs of the country.

When you won, you divided the profits amongst you, and when you lost, you charged it to the bank...You are a den of vipers and thieves. I have determined to rout you out, and by the Eternal, (bringing his fist down on the table) I will rout you out."

Andrew Jackson, Andrew Jackson and the Bank of the United States (1928) by Stan V. Henkels

What is the market price of policy error, careerism, and corruption?

The charts are simple, but the implications are profound.

seign·ior·age  

/ˈsānyərij/

Noun Profit made by a government by issuing currency A thing claimed by a sovereign or feudal superior as a prerogative.

US Treasuries - Negative Returns Almost As Far As the Eye Can See

These charts compare the Nominal and Real Treasury Yield Curves provided by the Treasury Department.

The 'real' return is the return on the debt less expected inflation. A note on how the Treasury calculates this is below. Since they use TIPS the real yield are only done for notes of 5 years or more duration.

The comparison is between February 22 data from this year and last year.

As one can see, the Fed's "Operation Twist" has had a profound effect on the real returns achieved by holders of US sovereign debt.

The real yields turn positive about the 15 year mark. The real return these days on a 30 Year Bond is about .76%. And that is probably using rather optimistic assumptions about inflation risk.

What this implies is that savers are by and large paying the US government to borrow from them.

Is this an effective economic stimulus for the real economy, or a sophisticated form of seignorage being performed by the Fed on behalf of its member Banks?

Interesting experiment. I hope Benny's model has the right risk parameters plugged in. If not, as Fed policy errors go, this one could be memorable.

No wonder certain alternative stores of wealth are rallying as a haven from this soft confiscation.

"Treasury Real Yield Curve Rates. These rates are commonly referred to as "Real Constant Maturity Treasury" rates, or R-CMTs. Real yields on Treasury Inflation Protected Securities (TIPS) at "constant maturity" are interpolated by the U.S. Treasury from Treasury's daily real yield curve. These real market yields are calculated from composites of secondary market quotations obtained by the Federal Reserve Bank of New York. The real yield values are read from the real yield curve at fixed maturities, currently 5, 7, 10, 20, and 30 years. This method provides a real yield for a 10 year maturity, for example, even if no outstanding security has exactly 10 years remaining to maturity."

What is a "Nominal" Stock Market Chart Versus a "Deflated" View?

Lots of interesting questions in the email bag over the weekend.

A reader asks 'What exactly is a nominal or artificial stock market rally as you use the terms?'

Nominal is used to mean "being such in name only; so-called; putative." This is an example of a nominal, or artificial stock market rally that someone had posted over at Alphaville earlier this year. (Hat tip to Rasputin of WSB for reminding me of where I had seen these charts.)

The Zimbabwe Industrial Index



I would have preferred a logarithmic chart for this extreme view of a hyperinflation in action, because the final moonshot tends to crush the detail of the prior action by skewing the scale so high. Still on the surface that looks pretty good right? Enough to get Jimmy C. to pound some teak on the table on Mad Money?

Another way to show the detail is to deflate the nominal chart.

The 'deflated' view is when you take the index and show what its value would be in terms of some other value, in this case the US dollar.

The Zimbabwe Industrial Index Deflated by the US$



Here is an example of the SP 500 viewed from two perspectives.



"Oh this is all very well and good Jesse, but when I go to the grocery store or to the gas station or the convenience store to buy my instant Lotto tickets I pay in dollars and not gold or euros."

Yes, but when your suppliers go to buy their goods that are imported, they pay in dollars that are depreciating. You know that some prices are moving higher despite slack demand overall. This is what we call 'selective inflation.' This is how it starts.

The trick of course is to get off Bernanke's monetary hamster wheel. If you are not in the US, reducing exposure to the dollar is more straightforward. If you are a Yank, then generally you would look to add exposure to contra dollar hedges to lessen your currency risk. You might also wish to begin to secure some essentials for your future.

Having said all this, as you may recall we are dubious on the hyperinflationary and severe deflationary scenarios for the US. It seems that a severe 'stagflation' is most likely based on current policies. Obama and crew are inflating the currency, but it is selectively being applied to the FIRE and Health sectors, resulting in a very slack stimulus to overall employment and the median wage.

The worst of both worlds: Inflation and Unemployment.

This is the policy mistake made by Japan in trying to reflate a status quo that was broken beyond all sustainable repair. But what can you expect when you reappoint the same team of Timmy and Larry to key economic positions, the crew that started the mess in the 1990's under Robert Rubin?

Continuity of error you can believe in, it appears.