"Draghi’s Doom Loop(s) – More Than Just the Euthanasia of the Rentiers"

From naked capitalism:

The recently adopted quantitative easing (QE) approach by the ECB, in concert with the negative deposit policy rate (NDPR) introduced last summer, has set off a number of nested disequilibrium dynamics that may unwittingly introduce a material increase in systemic risk for the eurozone, and perhaps beyond.

Lord Keynes anticipated what he termed a “euthanasia of the rentiers”, as he expected active monetary policy would be successful in reducing long-term interest rates, and the share of the population living off of bond coupons would eventually just wither away. By way of contrast, if the following assessment is correct, Draghi may have signed a mutually assisted suicide pact with finanzkapital in the eurozone.

The logistics of implementing QE (including questions about whether there are enough bonds for the ECB to purchase, as well as the related market “liquidity” concerns), or whether or not QE represents what Lord Turner refers to as “open monetary financing”, are not the real problem, or at least not the most compelling ones. Rather, the implementation of QE with a large and increasing share of the bond market displaying negative yields to maturity (NYTM) presents a number of serious challenges to financial stability in the eurozone.

To cut to the chase, the ECB’s QE and NDRP measures may be setting investors up for a discontinuous price event, much like what was experienced in the equity market meltdown back in October 1987. Even if a disruptive yield spike is avoided, or even contained and reversed by ECB heroics, pursuing QE under NYTM market conditions may lead to a significant dampening down of bank and insurance company profitability. In the extreme, the solvency of key eurozone financial institutions could once again come under question. This could further complicate the ECB’s chances of achieving their 2% inflation goal, as it may dampen the bank lending channel as a key transmission mechanism for unconventional monetary policy.

The entire set up, in other words, begins to take on many of the characteristics of Andrew Haldane’s Doom Loops. In this case, however, the ECB may unintentionally be setting off nested Doom Loops that will feed on each other, and thereby magnify systemic risks quicker than investors and policy makers might otherwise imagine possible. Below is a concise sketch of the main elements of the Doom Loop dynamics the ECB may have set in motion.

1. NYTM bonds still pay positive coupons, but the price of the bond has been bid so far above the par or face value that over the full life of the bond, the holder of the bond will face a certain loss when the bond matures. NYTM bonds are therefore never likely to be willingly held to maturity by private investors, as they guarantee a loss. No client of institutional investors is likely to ever have a nominal loss as their target return on their assets – especially on assets meant to be managed to cover future nominal liabilities that tend to grow over time, like corporate pension fund liabilities....

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