So yields on Germany's 10-year government bonds have gone negative. Put differently, investors are now paying the German government to take and hold their funds for ten years! Many are blaming this development on Brexit fears and the ECB's bond buying program. While this is a reasonable proximate explanation, the recent decline is part of a far bigger story: interest rates on safe assets across the world have been declining since 2008. This can be seen in the figure below.
This downward march of safe yields is a consequence of the safe asset shortage problem. What we are seeing in Germany is just the latest manifestation of it. What the above figure should make clear is that this safe asset shortage problem has been going on outside of QE programs and before central banks started doing negative interest rates. So don't blame central banks for the low interest rates.1
This downward march of safe yields across the globe is a big deal. It indicates the global economy needs more safe assets and lower interest rates to clear. However, at some point, the effective lower bound (ELB) will kick in and prevent rates from going lower. When that happens something else will have to adjust--output--and there will be a global race to the ELB. Here is Caballero, Fahri, and Gourinchas (2016) making this point:
In the open economy, the scarcity of safe assets spreads from one country to the other via the capital account. Net safe asset producers export these assets to net safe asset absorbers until interest rates are equalized across countries. As the global scarcity of safe assets intensifies, interest rates drop and capital flows increase to restore equilibrium in global and local safe asset markets. Once the ZLB is reached, output becomes the adjustment variable again.
In other words, be ready for more! If you think pension funds, banks, insurance companies are scrambling for yield now, you ain't seen nothing yet! More importantly, the Cabellero, Fahri, and Gourinchas analysis suggest a global growth slowdown is likely too.
So what are the solutions to the safe asset shortage problem? I will refer you again to the figure I used in my last safe asset post for the answers. My preferred solution is to try the 'shock and awe' approach to improve the economic outlook via a NGDP level target backstopped by Treasury.
US as a Banker to the World
1Though one can blame central banks for allowing us to get in this position in the first place. As I have argued elsewhere, the Fed and ECB could have done more to avoid the Great Recession. The did not and now the safe asset problem horse is out of the barn.