Latest / The Fiscal Policy Podcast with Fexingo: Government Budgets, Stimulus, and Public Spending / Why Government Bonds Can Pay You Negative Interest
Transcript
- Lucas: So Luna, here's a question that sounds like a trick: when does lending money to the government cost you money? Luna: Is this about negative yields? Because I feel like we've danced around this a few times. Lucas: Exactly. Negative-yielding government bonds. We've talked about the government's borrowing costs, the discount rate, all that. But I don't think we've actually drilled into the moment when the yield itself goes below zero. It's one of those things that sounds like a glitch in the matrix, but it's a real, persistent feature of several major economies. Luna: And the poster child is Japan. The ten-year JGB went negative in 2016, right? Lucas: Right. Japan's ten-year government bond yield dipped below zero in early 2016 and basically stayed there for years. And even now, in August 2026, after the Bank of Japan has been slowly normalizing policy, the yields are still extremely low — just barely positive, well under half a percent. But the period of negative yields gives us a perfect laboratory case. Luna: So walk me through the mechanics. When a bond is issued with a negative yield, what does that actually mean for the buyer? Lucas: So let's say the government sells a ten-year bond with a coupon of zero-point-one percent, but the auction clears at a price above par. Say you pay one hundred and two dollars for a bond that will pay you back one hundred dollars at maturity, plus a couple of tiny coupon payments. You're guaranteed to get back less than you paid. The yield to maturity is negative. Luna: So you're losing money in nominal terms. Why would anyone do that? You could just hold cash. Lucas: That's the puzzle. And the answer is that for a lot of big institutional investors, holding cash is actually more expensive or riskier. Banks have to hold reserves with the central bank, and in some periods, those reserves were charged a negative rate. So parking money in a government bond, even at a negative yield, was less bad than parking it at the central bank. Luna: So it's a relative cost thing. But what about pension funds? They need long-duration assets to match liabilities. Lucas: Exactly. A pension fund in Japan has to match its future payouts. Government bonds are the ultimate liquid, default-free asset. Even if the yield is negative, they're buying certainty. And in a deflationary environment, a negative nominal return might still be a positive real return. If prices are falling by half a percent a year, a negative half-percent yield is actually a wash in real terms. Luna: Right, so the real yield is what matters. And Japan's been fighting deflation for decades. Lucas: Precisely. The real yield is the nominal yield minus inflation. If inflation is deeply negative, your purchasing power is actually growing even with a negative nominal yield. So these bonds were attractive to anyone who needed a safe store of value over a long horizon — think insurance companies, foreign central banks, even some sovereign wealth funds. Luna: But it's not just Japan. We saw negative yields in Europe too — Germany, Switzerland, even briefly in the US in 2020, right? Lucas: Well, the US never went negative on the ten-year, but five-year Treasuries briefly traded below zero in the depths of the pandemic panic in March 2020. That was a flight to safety moment. Investors were so terrified they were willing to pay the US government to hold their money. In Europe, the European Central Bank pushed deposit rates negative, and that dragged government yields down across the continent. Germany's ten-year went negative in 2019 and stayed there for years. Luna: So what does a negative-yield bond say about the economy? Is it a sign of strength or weakness? Lucas: It's a sign of deep, structural weakness. You're seeing a market that believes the central bank will keep rates low for a very long time, and that inflation will stay stubbornly below target. In Japan's case, it's the combination of an aging population, persistent deflationary psychology, and a central bank that's committed to massive bond buying. The negative yield is essentially the market's way of saying 'we expect the economy to be stuck in neutral for a decade.' Luna: But doesn't that mean the government can borrow for free, or even get paid? That sounds like a good deal for the Treasury. Lucas: On the surface, yes. Japan's government has been able to issue debt at essentially zero cost for years. But the flip side is that it creates a perverse incentive to over-borrow. If the market is paying you to take their money, why not issue more bonds? Japan's debt to gdp ratio is over two hundred and fifty percent, the highest in the developed world. And some economists argue that the negative yields were partly a symptom of the Bank of Japan's massive bond-buying program, which effectively capped yields. Luna: So it's not a free lunch. It's more like a trap that lets the government kick the can down the road. Lucas: Exactly. The bond market is telling you that the private sector has no better use for its money. When you have negative yields, it's a signal that investment opportunities are scarce, that growth is weak, and that the private sector is so risk-averse it's willing to pay for safety. That's not a healthy economy; that's a savings glut with nowhere to go. Luna: And that feeds back into fiscal policy. Because if the government can borrow for free, it's tempting to ramp up spending without worrying about the bill. Lucas: Right, and that's the fiscal angle. We've talked before about how low rates make debt less burdensome. But negative yields take that to an extreme. The Japanese government has been able to run massive fiscal deficits without market discipline kicking in. The bond market just absorbs it all. But that's also why Japan's debt load keeps growing — there's no cost to issue, so no incentive to stop. Luna: So what breaks the cycle? Japan is only now starting to see yields creep up, and the central bank is slowly tightening. But how do you get out of a negative-yield world? Lucas: The exit is usually driven by inflation expectations. If the market starts to believe that inflation will pick up, nominal yields have to rise to maintain real returns. That's what we're seeing in Japan now — with inflation finally running above two percent, the Bank of Japan has allowed the ten-year yield to drift up from near zero to around half a percent. But that's still a very low number, and the transition is delicate. If the central bank tightens too fast, you risk sinking the economy back into deflation. Luna: So negative yields are kind of like a fever — they break when the underlying infection clears. Lucas: That's a good metaphor. And I want to tie this back to the US, because a lot of listeners might wonder if we could ever see negative-yielding Treasuries. In August 2026, the ten-year Treasury is yielding around four and a half percent, so it feels like a distant possibility. But in a severe recession, with the Fed cutting rates to zero and deflation threats, it's not inconceivable that short-term Treasury yields could dip below zero. Luna: Though the Fed has said they're not a fan of negative rates. Lucas: They've been quite clear about that, but markets don't always care what the Fed says. During the pandemic, the five-year Treasury auction actually cleared at a negative yield for a moment. So it's not a theoretical abstraction. It can happen here. Luna: And that would be a huge deal for money market funds, pension funds, anyone who uses Treasuries as a cash equivalent. Lucas: Absolutely. That's why central banks and regulators watch the zero bound so closely. Negative rates are a symptom of a very distressed economy, and they have real consequences for savers and financial institutions. But for the government, it's a double-edged sword — it lowers borrowing costs, but it also signals that the economy is in deep trouble. Luna: So when we look at Japan's experience, what's the one thing you want listeners to take away? Lucas: I think it's that negative yields are not a sign that the government has cracked the code on free money. They're a red flag that the economy is struggling to generate growth and inflation. And for investors, they're a reminder that sometimes the safest asset is one that still loses money in nominal terms, because the alternative is even worse. Luna: That's a sobering thought. And it makes you appreciate the times when you actually get paid to lend. Lucas: For sure. With the ten-year at four and a half percent, the US is in a very different place. But the lesson from Japan is that you shouldn't take positive yields for granted. They reflect a belief in future growth and inflation. If that belief ever cracks, the math changes fast. Luna: Speaking of things we shouldn't take for granted, if you're getting real value out of these episodes, the way we keep the show ad-free is through listener support. It's a small thing, but if today's deep dive on negative yields gave you something to chew on, you can head to buy me a coffee dot com slash fexingo. Lucas: Yeah, that genuinely helps us keep doing these deep dives without any ads or sponsors. But okay, back to the bond market — I want to leave you with a question. If you were the finance minister of a country with negative yields, would you issue a hundred-year bond? Because Japan has actually done that — a century bond back in 2017, and it was oversubscribed. Luna: A hundred-year bond? That's wild. And it shows you the other side of negative yields: the government can lock in that ultra-cheap funding for a century. Lucas: Exactly. And that's the kind of decision that fiscal policymakers face when borrowing costs are so low. It's tempting to take the money, but you're committing future generations to a debt that might not look so cheap if the economy recovers and inflation picks up. It's a bet on the future, and negative yields are the market telling you it thinks the future is pretty bleak. Luna: So the next time you hear about a government bond auction, and you see a negative number in the yield column, you know it's not a miracle — it's a warning. Lucas: Well put. That's the takeaway. Thanks for joining us.