Inverted Yield Curve indicates European Depression – and shows why Pure Time Preference Theory of Interest is Wrong

If you want to spot a turning point sharp downwards in an economy look for that rare occurrence an inverted yield curve.

As Sandy Chen of Cenkos Securities has pointed out Eurepo securities now have an inverse curve.  See Pesto today picking up on FT Alphaville last week.

At many points in the past  the inversion of the yield curve has signalled a turning point dowards in the business cycle.

Ok to the non wonkish what is a yield curve and why is it important?

A yield curve is the curve of interest rates on borrowings of various terms.  Under normal circumstances the shorter period you borrow for the lower rate you pay.  If you believe that interest rates are a return on waiting alone then this would be an explanation – the so called pure time preference theory as held to by most modern Austrian school economists.   But the fact that the yield curve can and does reverse blows this out of the water, there has to be something else other than just ‘waiting’ which governs the price of lending.  That other thing is the desire for holding assets in liquid form.

There can be several reasons for wanting to increase the liquidity of your assets.  Keynes covered a number of them.  This can include motivation to realise assets because there are more profitable investments or because  investments are going bad or are expected to go bad and transferring to money caps losses at the rate of inflation.  Each of these is related to the different functions of money, means of exchange, store of value etc.  and what is most important in different economic conditions and degrees of uncertainty.  Also when you have a high ratio of  liquid assets to illiquid assets you will be less willing to pledge your illiquid assets as collateral for medium to long term loans as this will highly risky in stressed conditions.

As Pesto explains:

 in stressed market conditions, if you are a bank in need of cash, it is saner to borrow for a day or a week rather than for a year. Because over the course of a year, there is a danger that the bank that you’ve borrowed from – and is holding your assets as security for the loan – could go bust.

And since the assets you’ve pledge would be worth considerably more than the loan, that risk of the so-called counterparty collapsing isn’t worth taking.

Which means there is much more demand for overnight loans on the repo market than for year-long loans. So the cost of year-long loans is much lower than for overnight loans.

So a reverse yield curve on the repo market is a sign of illiquid stressed banks and a looming credit deadlock/crunch.

As I said the existence of this condition alone blows PTP theories of interest out of the water as interest rates can be shown to be set by a complex interaction of profit and risk expectations and the profitability/liquidity of lenders.

I have been searching for any explanation of inverted yield curves within PTP and ABC (Austrian Business Cycle) theories – I cannot find any.

Interesting Reason for Planning Objection – Lettuce has too Few Calories to be considered Food

Reading the interesting case of a campaign against a ‘monster’  52ha Greenhouse in West Sussex covered in the Telegraph

Novel reason for objection from the campaign website which says

Lost agriculture: 80 acres of prime agricultural farmland would be lost for ever, at a time of forecasted world food shortage (you cannot live on lettuce!).

8 calories per 200g portion.  No you can’t live on it, or celery, watercress etc.  But there is nowhere in planning law which says ‘agriculture’ requires production for staple food. After all in English Planning law (though not always in other jurisdictions) it includes breeding of stock commercially, such as horses.  As food serves more than solely a function of putting on calories.  One imagines many people consuming it are trying to take it off, unless like the French you are dosing it in Mayonnaise or Olive Oil and treating it like an accompanying vegetable.

Not a good argument.  Not a material planning consideration.

Jeremy Heywood – SPADS should report to Mandarins not Ministers

Paul Goodman ConHome

The civil service has never been comfortable with Spads.  Some mandarins welcome them, because their presence can minimise disagreements about what is and isn’t political work and, therefore, rows about what civil servants should and shouldn’t be asked to do by Ministers.  But most have always been suspicious of Spads, for the bottom-line reason that they don’t and can’t control them.  This is exactly what Jeremy Heywood, the Cabinet Secretary, apparently wants to change.  To cut a long story short, the Times (£) has reported that he has seized on the errors of Adam Smith, Jeremy Hunt’s former, over the BSkyB bid to push for Spads to report to mandarins rather than Ministers.  And hey presto, the problem of those pesky political appointees answering to Sir Humphrey rather than Jim Hacker would thus be solved.

… the issues raised by Sir Jeremy’s move are not merely academic or historical.  After all, he has been labelled “the man who really runs the country” – on the cover of the Spectator, no less.

To Quentin Letts – the author of the piece – “the worry for Conservatives, and the rest of us, is that this shrewd murmurer, this eminence grease, has acquired unprecedented power over not only the Prime Minister but also Nick Clegg, Cabinet, the coalition and much of the rest of the state apparat”.  Evidently, the article wasn’t conjured out of thin air.  Mr Letts quoted a Cabinet Minister as saying: “We cannot have a referendum on who runs Britain because the answer will be the same whether we leave the EU or not: Jeremy Heywood.”

‘Within CPRE we are having a serious debate about the role of onshore wind’ Sean Spears

Indy Letter

Dr Robin Russell-Jones (letter, 5 June) is wrong to say that CPRE’s “opposition” to wind turbines is “becoming irrationally anti-environmental”.

Onshore wind poses a genuinely difficult challenge to those who want to tackle climate change but also want to prevent unacceptable damage to our beautiful countryside. As your Environment Editor Michael McCarthy says (“Ghastly, lethal to birds – but a necessary evil“, 4 June), this is an issue “where both sides have right on their side”.

Within CPRE we are having a serious debate about the role of onshore wind and how we can ensure that, in McCarthy’s words, “turbines only go in the appropriate place”. It would be good if that debate could take place more widely.

Instead we have a policy framework that gives precious little guidance on the right and wrong places for onshore wind. The consequence is that energy companies and landowners take a punt on local authorities and planning inspectors deciding that national targets trump concerns about heritage or landscape. Local communities faced with giant wind turbines in much- loved countryside feel increasingly powerless, and the growing backlash against onshore wind risks undermining other necessary action to tackle climate change.

Shaun Spiers

Chief Executive, Campaign to Protect Rural England, London SE1