Latest / The Fiscal Policy Podcast with Fexingo: Government Budgets, Stimulus, and Public Spending / Why Government Bonds Sometimes Pay Negative Interest
Transcript
- Lucas: So Luna, here's a question that sounds like a riddle. When does lending money to the government cost you money? And the answer, weirdly, is when the government is Germany, and the year is 2019. Luna: You mean when they issued that five-year bond at a negative yield? I remember that. Investors actually paid the German government for the privilege of holding its debt. Lucas: Exactly. In August 2019, Germany auctioned five-year bonds with an average yield of minus 0.63 percent. So you hand over, say, 1,000 euros, and over five years, you get back less than that. It's a guaranteed loss in nominal terms, and yet the auction was oversubscribed. Luna: That just breaks my brain. Why would anyone do that? I mean, even if inflation is low, you're still losing money. Lucas: Well, that's the puzzle we're going to unpack today. Because negative-yielding debt isn't just a curious anomaly. At its peak in 2020, there was something like seventeen trillion dollars of negative-yielding debt globally. That's a huge chunk of the bond market. And it forces us to rethink what a 'safe' asset really means. Luna: Seventeen trillion. That's not a rounding error. So who is buying these bonds, and why? Lucas: Right, let's start with the mechanics. A bond's yield moves inversely to its price. When investors pile into a bond, the price goes up and the yield falls. If enough people want safety, the yield can go below zero. You're essentially paying for insurance. The German government is so stable, investors are willing to pay for the guarantee of getting their principal back, even if it's slightly less than they put in. Luna: So it's like paying a premium for a safety deposit box, except the box doesn't really hold anything. Lucas: That's a fair analogy. But there's more. For some big institutional investors, like pension funds or insurance companies, they may be required to hold highly rated government bonds regardless of yield. It's a regulatory or actuarial requirement. They can't just stuff money under the mattress. And in a low-growth, low-inflation environment, they might accept a small loss to avoid a bigger loss elsewhere. Luna: But wait, if they're losing money, wouldn't it be better to just hold cash? Like, literally, banknotes in a vault? No negative yield there. Lucas: You'd think so. And some institutions did explore that. But holding physical cash at scale has its own costs—storage, insurance, security. For a pension fund with billions under management, negative yields might still be cheaper than building a fortress for piles of cash. Also, cash doesn't help with collateral requirements or regulatory calculations the way a government bond does. Luna: Okay, that makes sense. But what about foreign central banks? I've heard they're big buyers of negative-yielding debt. Lucas: They are. Take the Bank of Japan, for instance. It has been a huge buyer of European government bonds, including German bunds, partly to manage the yen's exchange rate. And China's central bank has also held significant amounts of negative-yielding European debt. When you're managing reserves worth trillions, you might not be optimizing for yield alone. You're thinking about liquidity, diversification, and geopolitical considerations. Luna: So it's not that they're clueless. They have different incentives than a retail investor would. Lucas: Exactly. And here's another angle: negative yields are also a signal about the economy. When markets are willing to accept negative yields on long-term government bonds, it often means they expect deflation, or at least very low inflation, and possibly a prolonged economic slump. It's a collective bet that the future is going to be cheap, and that central banks will keep rates low for a long time. Luna: So negative yields are like a market cry for help, in a way. Lucas: They can be. And that's why central banks, like the European Central Bank, have actually pushed yields below zero deliberately. By setting deposit rates negative, they're trying to encourage banks to lend rather than hoard cash. And their bond-buying programs, quantitative easing, drive up bond prices and push yields down, sometimes into negative territory. Luna: But does it work? I mean, if negative rates are supposed to boost the economy, why did we see a decade of sluggish growth in Europe and Japan? Lucas: That's the big debate. Some argue negative rates prevented something worse, like outright deflation and a deeper recession. Others say they hurt banks' profitability, which can undermine lending. And there's a risk that negative yields create asset bubbles, as investors search for yield in riskier assets. It's not a free lunch. Luna: And for the government itself, negative yields sound like a great deal. You borrow and actually get paid. But is there a catch? Lucas: On the surface, it's a great deal for the issuer. Germany effectively got paid to borrow money. That reduces the cost of public debt, which is good for taxpayers. But it also creates a perverse incentive. If a government knows it can borrow at negative real rates, it might be tempted to borrow more than it needs, or to delay necessary fiscal consolidation. There's a moral hazard element. Luna: So it's like a tool that can be used well or misused. Lucas: Right. And here's where it gets even more interesting. Negative yields also challenge our basic understanding of saving and investing. When a government bond yields negative, it turns the traditional notion of a risk-free rate on its head. The risk-free rate becomes a cost, not a return. That has implications for how we value stocks, real estate, and even how companies decide to invest. Luna: How so? Lucas: Well, if the risk-free rate is negative, then the discount rate used to value future cash flows drops. That means future earnings are worth more today. It can inflate asset prices across the board. It also makes it cheaper for companies to borrow money for long-term projects, which could stimulate investment. But it also punishes savers, especially retirees who rely on interest income. Luna: So it's a transfer from savers to borrowers, in a sense. Lucas: Yes, and that's a politically sensitive point. Negative rates are essentially a tax on savings. That's one reason they're so controversial. And yet, in the post-pandemic period, we saw a global rise in yields as inflation surged. So negative yields are not a permanent state. They're a product of specific economic conditions and policy choices. Luna: But I'm still stuck on the individual investor. Suppose I'm a German citizen in 2019. Should I buy a five-year bond at negative yield? What would you advise? Lucas: Well, for a retail investor, it usually doesn't make sense to lock in a guaranteed loss unless you're extraordinarily risk-averse. You might be better off with a bank account, even if it pays zero, because at least you can access your money. Or you might consider other assets like dividend-paying stocks, but that comes with risk. So the answer is: it depends on your alternatives and your risk tolerance. Luna: And the fact that we're talking about a negative yield on a supposedly safe asset says something about how distorted markets can become. Lucas: Absolutely. And that's the deeper lesson. When you see negative yields, you're seeing the market's expectations for the future, not just a number. It's a window into the collective psyche. In 2019, the market was essentially saying, 'We are terrified about the future, and we will pay to be safe.' That's a powerful signal for policymakers and investors alike. Luna: So if we see negative yields again, we should probably brace for some tough economic times. Lucas: Or at least, we should ask what the market knows that we don't. But here's the thing: negative yields can also become a self-fulfilling prophecy. If everyone expects a deflationary slump, they buy bonds, which pushes yields down, which reinforces the expectation. Central banks have to be careful not to get trapped in that mindset. Luna: So, what's the takeaway for a normal person listening to this? Should we be worried about negative yields, or is it just a weird market phenomenon? Lucas: I'd say it's a signal worth understanding, but not something to lose sleep over. For most of us, the direct impact comes through our pension funds, insurance policies, and mortgage rates. When yields go negative, it can mean lower mortgage rates, but also lower returns on our savings. It's a mixed bag. The key is to be aware of how these forces shape the economy around us. Luna: And speaking of pensions, I have a quick thought. We talk a lot about how the government's fiscal policy affects our daily lives, and this episode is a perfect example of how a seemingly abstract concept like bond yields matters to all of us. Lucas: That's a good point. And you know, it reminds me—if walking through the economy with us has made something click for you, we really appreciate that. I know we don't ask often, but if you've ever thought about supporting the show, there's a link at buy me a coffee dot com slash fexingo. It's just a small way to keep this podcast ad-free, and it honestly makes a difference. Luna: Yeah, no pressure, but if you enjoy these deep dives, that's the best way to help. And we genuinely mean it when we say every little bit counts. Now, back to negative yields—there's one more angle I want to explore. Lucas: Sure, what's that? Luna: What happens when negative yields start affecting government budgets? Like, does Germany end up spending less on interest, and what do they do with that savings? Lucas: Good question. When a government issues debt at negative yields, it actually reduces its interest costs. In Germany's case, they were able to issue debt at negative rates for years, which meant they were paying less in interest than they would have otherwise. Some estimate that negative yields saved the German government billions of euros. That's money that could be spent on other things, like infrastructure or education. Luna: But that also creates a dependency. If yields rise later, those costs come back, and the budget gets squeezed. Lucas: Exactly. And that's the risk of relying on negative yields. It's like a crack in the foundation. As soon as inflation picks up, as we saw in 2022, yields rise, and the government's interest bill jumps. So fiscal policymakers have to be careful not to assume that cheap borrowing will last forever. Luna: So, to wrap up, negative yields are a fascinating but tricky phenomenon. They reflect deep economic distress, but they also create opportunities and risks for governments and investors alike. Lucas: Well said. And I think the key takeaway is this: when you see negative yields, don't just shrug it off. It's a sign that the economic environment is unusual, and it's worth asking why. Whether it's a blessing for the government or a curse for savers, it's a reminder that the economy is always full of surprises.