Latest / The Fiscal Policy Podcast with Fexingo: Government Budgets, Stimulus, and Public Spending / How Government Bonds Pay Negative Interest
Transcript
- Lucas: So, Luna, have you ever lent someone a hundred bucks and been thrilled to get ninety-nine back? Because that's essentially what was happening in the government bond market a few years ago, and it could happen again. Luna: You mean negative yields? Where investors pay for the privilege of lending to a government? Lucas: Exactly. In 2019, over seventeen trillion dollars of global debt was trading at negative yields. That's a staggering number. And the epicenter was Europe, where German ten-year bunds — basically the gold standard of safe assets — were yielding negative 0.7 percent at one point. Luna: So you're buying a bond for more than it's worth at maturity. Why would anyone do that? Lucas: That's the question that confuses a lot of people. And the answer ties back to central bank policy and the mechanics of bond prices. When the European Central Bank, under Mario Draghi, launched massive quantitative easing and even pushed its deposit rate into negative territory, it essentially cornered the market for safe assets. Investors had so much cash and so few safe places to park it that they were willing to accept a guaranteed loss. Luna: It sounds like a bubble in safety itself. But wasn't the ECB trying to stimulate the economy? Lucas: Right. The goal was to push investors out of ultra-safe bonds and into riskier assets like corporate bonds or stocks, to spark lending and spending. But the side effect was that the bond market became a kind of mirror world where the usual rules didn't apply. You weren't lending to get a return; you were lending to avoid a bigger loss elsewhere. Luna: Like paying for insurance. But what made this different from just a temporary blip? Lucas: It persisted for years. Germany's entire yield curve went negative in 2019 — every maturity from one month out to thirty years. Even the European Investment Bank issued a fifty-year bond at negative yields. That's a fifty-year loan where the borrower is paying you for the privilege of holding their debt. Luna: And it wasn't just Europe. Japan had been at this for decades. Switzerland too. Lucas: Exactly. Japan's ten-year yield went negative in 2016 and stayed there for years, as the Bank of Japan kept buying government bonds under its own quantitative easing program. Switzerland's entire curve was negative for ages, with the ten-year hitting negative 0.5 percent. So this wasn't a one-off anomaly; it was a structural feature of a world where central banks were the biggest buyers of government debt. Luna: But what does that mean for the average person? If I'm a saver in a country with negative rates, my bank might actually charge me to hold my money? Lucas: That was the fear, and in some cases it became real. Some European banks did start charging large depositors, especially institutional clients, a storage fee. But for ordinary retail savers, banks usually absorbed the cost to avoid a customer revolt. Still, it meant that savers were effectively subsidizing the financial system. Luna: So the government, in a way, was getting paid to borrow. That sounds like a dream for finance ministers. Lucas: It was, for a while. Italy, which had been struggling with high debt and rising interest costs, saw its borrowing costs drop dramatically. It could issue ten-year bonds at yields below one percent. That's a huge relief for a country with a debt to gdp ratio above 130 percent. But it also created a kind of dependency — if rates ever rose, the interest bill would balloon. Luna: And that dependency is exactly why the European Central Bank had so much power. It could essentially dictate the cost of borrowing for whole countries. Lucas: Right. This is the point where the fiscal policy podcast gets a little uncomfortable. When central banks buy government bonds, they're financing public spending through the back door. It's not like direct monetization — the ECB never buys at auction — but it's close enough that the line between monetary and fiscal policy gets blurry. Luna: I remember there was a lot of debate about that. Some people called it financial repression. Lucas: Yeah, that's the term. Negative yields are a form of financial repression — a hidden tax on savers. Instead of raising taxes or cutting spending, the government inflates away the value of its debt or pays you below inflation, so you're losing purchasing power in real terms. And because it's not an explicit tax, it often goes unnoticed. Luna: So we're taxing savers to support the government. But who actually buys these negative-yielding bonds? It's not like mom and pop investors are lining up. Lucas: It's mostly institutional investors: pension funds, insurance companies, banks. They're often required by regulation to hold a certain amount of high-quality liquid assets. And if the only safe assets are negative-yielding government bonds, they have no choice. They're buying not for return, but for capital preservation. Luna: And for pension funds, that's a nightmare because they need to earn a certain return to meet their obligations. Lucas: Exactly. A pension fund with a two percent return assumption can't get there with negative-yielding bonds. So they're forced to take more risk in equities or private assets, which could backfire if there's a downturn. That's how negative yields can actually increase systemic risk in the financial system. Luna: So the ECB's medicine may have had side effects worse than the disease. But wasn't there also a point where negative rates actually helped the real economy? Lucas: There's a good case that it kept the eurozone from deflation and supported the recovery after the debt crisis. Borrowing costs for businesses and households fell, which encouraged spending and investment. The eurozone did avoid a Japanese-style lost decade. But the longer rates stayed negative, the more distortions built up. Luna: And then the inflation spike happened. Suddenly, central banks had to reverse course and hike rates. What did that do to all those negative-yield bonds? Lucas: They got crushed. When yields rise, bond prices fall. So all those investors who had accepted negative yields took enormous losses. German ten-year bunds went from negative 0.7 percent to positive 2 percent or higher. That's a massive capital loss. The very people who had bought negative-yielding bonds as a safe haven ended up eating losses. Luna: So the strategy backfired badly. But is there any chance we'll see negative yields again? Lucas: That's the big question. As of August 2026, rates are still elevated compared to the 2010s, but there are signs that central banks are starting to ease. The ECB and the Bank of Japan are still dealing with high debt loads and weak growth. If a recession hits, they might be tempted to push rates back below zero. Some economists argue that negative rates are a tool that should stay in the toolbox, even if they're not the first choice. Luna: But wouldn't that just repeat the same cycle? Savers get punished, pension funds struggle, and eventually the exit hurts more. Lucas: Probably. But the alternative might be worse. If a government can't borrow at reasonable rates, it might have to cut spending or raise taxes during a downturn, which would deepen the recession. So negative yields are a symptom of a deeper problem: a shortage of safe assets and a lack of fiscal space. Until governments address that, the temptation to use monetary policy to suppress borrowing costs will remain. Luna: So it's not just about bond math; it's about the fundamental structure of our financial system. Lucas: Absolutely. And that's why it's so fascinating — and a bit scary. We've built a world where the price of safety can go negative. That tells you something about how distorted the system has become. Luna: You know, it reminds me of something I read about how people are willing to pay for security in other ways. Like, I remember when we were discussing the idea of insurance, and it's similar — you pay a premium to avoid a bigger loss. Lucas: Exactly. It's the same logic. And that's actually a good segue to something we've been thinking about. We love diving into these topics and making sense of the fiscal and monetary maze. If you find these conversations useful, consider supporting the show so we can keep doing it ad-free. You can help us out at buy me a coffee dot com slash fexingo. It's a small way to keep the lights on, and we really appreciate it. Luna: Yeah, every little bit helps us keep the podcast independent. And we're not just saying that — we genuinely rely on listener support to cover our costs. Lucas: So going back to the broader picture — what do negative yields mean for the average taxpayer? When the government borrows at negative rates, it's essentially getting paid to borrow, which can reduce the tax burden. But that benefit disappears if rates rise, leaving the government with a higher interest bill. So it's a double-edged sword. Luna: And it also affects how much the government can spend on public services. If interest costs are low, there's more room in the budget for education, healthcare, infrastructure. Lucas: Right. In the 2020s, many governments took advantage of low rates to borrow cheaply and invest in long-term projects. But that only works if you use the money wisely. If you just use it to fund recurring spending, you're building up debt without creating assets to pay it off. Luna: That's a key distinction. It's the difference between good debt and bad debt. Lucas: Exactly. And that's the lens through which we should look at negative yields. They're not inherently good or bad; it's about what the government does with the opportunity. If they borrow for free and invest in productivity-boosting infrastructure, that's a win. If they just pad the budget with spending that doesn't yield returns, it's a recipe for trouble. Luna: So what should a smart taxpayer be watching for? Lucas: Watch the real interest rate — the nominal yield minus inflation. If you're getting negative 0.5 percent on a ten-year bond but inflation is 2 percent, you're losing 2.5 percent in real terms. That's a hidden tax on your savings. On the fiscal side, watch the debt to gdp ratio and the average maturity of government debt. If a government has to refinance a lot of short-term debt, it's vulnerable to rate spikes. Luna: And on the global scale, if central banks start cooperating to keep rates low, could we see a return of negative yields? Lucas: Possibly, but there's more awareness now about the side effects. Central banks are more cautious about using negative rates as a first resort. They'll probably try other tools first, like forward guidance or yield curve control. But if a major crisis hits, don't be surprised if they dust off the negative rate playbook. Luna: So it's not a dead concept. It's just in hibernation. Lucas: Exactly. And that's why it's worth understanding now — so when it happens again, you'll know why the bond market is doing something that seems to defy common sense. Luna: Well, I think we've given our listeners plenty to chew on. Thanks for joining us, and we'll catch you next time.