Why are global bond yields so low, despite the fact that central banks everywhere are increasing interest rates? Why does the dollar stay stable when the US is running a huge external payments deficit?
I have argued in previous columns that the main reason why global bond yields have not risen in parallel with interest rate increases is because there has been a glut of new sources of liquidity outside traditional monetary aggregates: namely securitized debt and the huge derivatives market. This liquidity has absorbed much of the impact of rising short-term interest rates. Thus the cost of long-term capital has remained low.
It is a key phenomenon of the past decade that the quantity and price of money are no longer controlled by central banks. Central bank-dictated reserve ratios no longer set the credit multiplier. So increases in policy rates have not affected the cost of capital.
| The currency accelerator |
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| Source: IMF, WTO, Independent Strategy |
This new form of liquidity has sustained financial markets but it also brings increased risk. As long as the cost of capital remains low, liquidity can expand.