Return-free risk

Voltaire said it best: ‘Doubt is not a pleasant condition, but certainty is absurd.’ Investors seeking certainty — safety, in other words — are in for a shock: there is no longer any such thing.

How did we get into such a terrific mess? Rather than rehash the causes of the financial crisis and the current depression, there is a two-word answer: central banks. There was once a more innocent age when central banks performed a sole function: they acted as lenders of last resort to the banking system. To avert a banking panic, central banks would lend to solvent institutions, backed by solid collateral, in times of need. Note those key phrases: solvent institutions, solid collateral. They no longer really exist either. And somewhere along the line, over-mighty central banks succumbed to ‘mission creep’. In the words of veteran financial analyst Jim Grant, the US Federal Reserve, for example, now finds itself not just backstopping American banks, but also ‘steering, guiding, manipulating the economy, financial markets [and] the yield curve… it manipulates and pegs interest rates; it is all over the joint, doing what so signally failed in the old Eastern bloc.’

You can say the same thing of the Bank of England, the European Central Bank and the Bank of Japan. With their economies in recession or worse, and companies and households busily deleveraging (paying down debt), the world’s central banks have now gone all-out for quantitative easing, less politely known as money-printing. This experiment has never been tried before on such a scale, and it will not end well.

In a more innocent age, investors valued the safety and reliable income — the risk-free return — of government bonds. Today, government bonds issued by western industrial nations offer return-free risk.