For those wondering why anyone would buy such a thing, consider:
- Many financial institutions are required to hold a certain percent of portfolio in safe assets. German bunds are among the safest in the world.
- A holder of a bond earns a capital gain (bond goes up in price) when interest rates fall. In that sense, zero is no limit at all because there can always be a buyer willing to accept an even lower (more negative) yield.
- Bond investors are well-aware of the two points above. When they sense that interest rates and/or inflation are headed lower, they know they can profit by buying, regardless of yield.
- Anticipated rate of inflation matters a lot because investors seeking return through yield focus on real interest rates (nominal rate - inflation). Inflation can be negative as well (deflation). If inflation is lower (more negative) than the bond's nominal return, that's a real positive yield. And that positive yield is locked in for the term of the bond, which in the case of the story is 30 years.
- The European Central Bank has repeatedly signaled its belief that zero is no barrier and that negative yields will be tolerated indefinitely. The ECB stands ready for quantitative easing (QE), in which the central bank buys bonds with money it creates from thin air. Investors know this and this compounds the incentive to pile on and buy bonds to enjoy the capital gains (and real returns if the investor believes that deflation is inevitable).
It's likely that all these factors combine to create the current environment. How long all of this can continue is anybody's guess because the situation is without precedent.
It's as if the financial crisis of 2008 was never resolved - just papered over through massive central bank purchases of treasuries and stocks (Japan's central bank owns a major fraction of the value of the Japanese stock market at this point).
> - Many financial institutions are required to hold a certain percent of portfolio in safe assets.
In practice this is turning into unnatural demand guaranteed by the law, which goes against free markets and will eventually implode upon itself. If you force the market to buy a certain product regardless of quality, then the underlying quality of that product will erode (as there is no longer an incentive to provide quality and quality implies cost), and the market will evaporate as stakeholders disappear and move to other markets which do assure real quality. That there was natural demand for such products in the past, and indeed that natural demand may coincide with unnatural demand in the present, is not a guarantor for demand levels staying natural in the future.
In context, this creates underlying pressure for investors to divest from Euro holdings. It's likely that investors are currently sticking with the Euro because they have few other avenues for escape, but this is not likely to hold - whether due to Brexit/Euroskepticism or some other external crisis which changes the playing field.
When you have a central bank that can control rates, no alternative money, and the bank can set rates negative, the equilibrium is for the government to own almost all assets. I'm not kidding. You will end up with communism, only via government regulation of rates, unless something breaks this up.
If our capital markets are so unproductive that having the government own the assets is considered a net economic gain, we'll need all the communism we can get.
The central bank does not "control" rates, they respond to the market signaling where rates should be.
Good post that covers nearly everything. The only thing I would add to this is that the ECB's deposit rate of -0.40% is the only thing that has enabled all of this.
This would explain negative bond rates down to -0.40%. Because if you need to park a very large amount of euros safely, banks will start to apply that rate to your deposits so it's better to get any rate that is less negative.
But curiously 10y german bund yields have recently hit -0.70%, and a couple other EU countries (France, Netherlands, Belgium) have also dipped below -0.40%.
So it must be more than the negative deposit rate. It's also the QE program which buys bonds (though it's on hold since the start of the year), and the expectation of lower deposit rates, and the expectation of more QE.
I agree with all of this and probably could have phrased my original post better. My main point is that none of this is really possible without ECB rates being set where they are. Successful monetary policy requires multiple tools to be utilized and the deposit rate is the main tool that anchors everything else. QE in itself does not mean rates are going to be lower. You need central bank rates to also be low in order to have lower government rates. Rates didn't suddenly skyrocket after the ECB announced the end of QE.
> Rates didn't suddenly skyrocket after the ECB announced the end of QE.
That's because the QE program only stopped increasing the ECB's assets. When bonds that are held by the ECB mature, the equivalent amount in new bonds is still being re-bought.
I don't think negative deposit rates are really needed to have negative bond yields. You only need a bond buyer (e.g. the QE program) who drives up bond prices beyond the face value + all coupons. Negative interest rates were just a natural step in the progression of lower rates, zero rates, negative rates, and QE. The next thing will be some form of helicopter money.
> That's because the QE program only stopped increasing the ECB's assets. When bonds that are held by the ECB mature, the equivalent amount in new bonds is still being re-bought.
Reinvesting maturing proceeds does not produce the same effect as net purchases. One, maturities are lumpy vs regularly scheduled net purchases. There have been rate shocks where idiosyncratic country events happened outside of maturities. Two, while the ECB can basically do whatever it wants, no new net purchases restricts its ability to act in an emergency. Three, size is much smaller.
>I don't think negative deposit rates are really needed to have negative bond yields. You only need a bond buyer (e.g. the QE program) who drives up bond prices beyond the face value + all coupons. Negative interest rates were just a natural step in the progression of lower rates, zero rates, negative rates, and QE. The next thing will be some form of helicopter money.
Note how I didn't mention anything about negative rates in particular; just low rates and that the deposit rate anchors things. Whether rates are negative or not really doesn't matter in isolation. What matters is the spread vs other less risky assets for the goals of the central bank. If a central bank indiscriminately purchases bonds without regard for existing yields or the deposit rate, they will quickly lose control over the market.
The ECB printing money is a factor in stabilizing rates but it in itself does not create conditions where governments are able to borrow for 30 years at negative rates. For example, if the deposit rate was at 3.00% instead of -0.40%, governments would not be able to issue at negative yields; QE or no QE. Additionally, the ECB stopped net QE purchases at the beginning of the year and negative rates are still a thing.
>- Many financial institutions are required to hold a certain percent of portfolio in safe assets. German bunds are among the safest in the world.
Can you explain how this can possibly beat cash? If I say to you "I'll let you pay me ten cents to hold onto your $100 bill for a while, and give you a paper showing the obligation to repay your $100" (the meaning of a negative yield bond), how can the offer to let you pay ten cents to let me hold your $100 possibly be less risky than just holding the $100?
Why would a bond with a negative yield ever be a safer asset than just holding the cash?
Holding cash usually means putting it in a bank account. The banks are going to put a significant portion in their country's central bank; the European central bank and member central banks are currently charging banks to store money; at large balances, those banks will charge customers.
Now, you could put cash into a USD account at a US bank, where interest is still currently positive, but if you were storing Euros, you now have currency risk and jurisdiction risk. Negative rate German bonds have less risk than that.
Of course you could take physical cash and put it in a safe or something, but that doesn't scale well. Although maybe it does suggest a lower limit on negative interest rates, where it would actually be cheaper to store large amounts of physical cash...
You have to buy a safe, you have to have a location to store it, you need to secure the location. You need to ensure that the safe is temperature and humidity controlled, so that the currency doesn't mold, rot etc.
These costs add up. Once you've done all of those things, you're essentially a bank.
+this. As a thought experiment, assume you need three full-time guards to store 100M €. Two physical and one watching the video. (why two? Less likely your guard steals all the money).
Salaries of 30k €/year. 8760 hours/year, one FTE works 2080 hours/year, so that's 4.x times 3x redundant guards, or about 500k €/year with overhead.
That's half a percent negative return.
Presumably, the physical storage cost creates a lower bound on how negative the inflation rates can go, but I'm sure I left off a bunch of other things that would add to the bottom line costs of this proposal, such as insurance.
Instead of having a vault with just 100M euros, it probably makes more sense economically to build a huge vault that can store billions of euros, and then charge people to use the vault.
It seems absurd that the cost of storing physical notes should have an impact on workable interest rates. Surely if the government wanted to allow you to sock away vast sums of money, they should provide a secure electronic sock and avoid the destruction of wealth that is your security costs.
And conversely, if they didn't want to provide the bed for you to keep your money under because it would defeat their interest rate policies, they should (and might) make putting money under beds illegal.
It just doesn't make sense for the sizes of socks and beds and cash denominations, and the security of locks, and the wages of security guards to determine macroeconomic policy.
Cash is universally considered the most liquid asset because it can most quickly and easily be converted into other assets.
If the amount of physical cash is huge however, say 1 billion euros, it can be less liquid than German government bonds. There is cost of moving, counting, securing it and significant delay for buying and selling. If you try to buy something for 1 billion EUR in cash, it might cost 100k EUR to do so and few days until you can buy anything.
But you are correct, there is probably a limit after wich banks start to convert some part of their assets to cash.
Indeed. 500€ bill was known as "Bin Laden" because it was so hard to find one. It was estimated that 90% of the bills were held by drug dealers, money launderers and other criminals.
They're gorgeous though. Because they're so low circulation, when you do get to see one they look brand-new. My father got one from a currency exchange this year and when he mentioned that I had to take a picture of it: https://imgur.com/a/aiaZmP2
Edit: I suppose since it was an exchange outside of Europe, they probably wanna put them in circulation before they lose legal tender status.
They will maintain their legal tender status. ECB just stopped printing more and existing notes will be removed from circulation when they enter the banking system.
The world is different when you're dealing with really large amounts of cash. You can't just store it yourself; your mattress isn't big enough. And if you ask a bank to store it for you, the bank will charge you for the service. (Banks that work in this line of business are known as 'custodian banks'.) Consequently, the effective interest rate on cash for large amounts of cash can be negative.
You can argue safety (bonds you have sovereign default risk vs cash will have bank credit risk) but your math is not incorporating how a transaction in this case would actually take place. It's not as simple as just holding onto $100. You have a deposit rate of -0.40% at the ECB. So instead of -0.40%, you settle for -0.14% which is what these newly issued Bunds are yielding.
Of course if interest rates go up, you have to keep the bond until it matures (earning less interest than you would with a new bond), or sell it for a capital loss. But this is always a risk with long-term bonds, and institutions still hold them.
You really don't want $10 billion in a bank. Laws mostly guarantee a few hundred thousand per account holder if the bank itself has financial issues. You would have to spread that amount over quite a few banks if you wanted it secured.
As some people already mentioned, the problem is the amount of cash you would have to keep safe somewhere. As far as I know, there are companies that use tunnels in mountains to act as huge cash depots. But such a storage also comes at a price. Also to prevent this kind of business, the European Central Bank already considered dismissing the 500 Euro bill. With that the physical amount to store would be even bigger. (The german economics professor Hans-Werner Sinn mentioned this once in a talk)
A lot of commentators are discussing the drawdowns of storing cash bills. However, who buys bonds by paying with physical cash bills? Most of us have a number in our bank account that reflects some sort of wealth? (Ownership of a security elsewhere or an I Owe You?) People with a salary directly deposited and big companies do not need a bank to store their physical cash bills.
I’m still trying to understand how this all happened.
The ECB charges banks -0.40% to deposit money with them. These bonds are currently yielding -0.14%. Rates are not low enough to the point where physical cash is a thought. Rough estimates are a deposit rate of -0.75% where you would make more by holding physical cash.
OK, so you have a bank balance of $1m, rather than paper bills. Your bank can go bust -- it does happen -- and you'll probably find that the Government only insures/guarantees something like the first $100,000 of that. However, the government here are selling you 30 year storage and guarantee of your balance at a small cost (the negative interest).
> - Anticipated rate of inflation matters a lot because investors seeking return through yield focus on real interest rates (nominal rate - inflation). Inflation can be negative as well (deflation). If inflation is lower (more negative) than the bond's nominal return, that's a real positive yield. And that positive yield is locked in for the term of the bond, which in the case of the story is 30 years.
But for this and the other reasons you mention, wouldn't cash be in any case better than the bonds?
The best explanation I've heard for negative rates is this:
Imagine you have a million dollars worth of cars. If you want to store that in a bank, you'd pay them money to do so. Why? Because the car has no value to the bank. The only thing they can do is store it in the vault, which requires security personnel, space, climate control, etc.
Now instead you have a million dollars in cash. In the current environment, where more people want to put money into the bank than take it out, the cash also has no value to the bank. They can't loan it out again because no one wants to borrow that much. So they charge you for storing your money. This is how they make a profit. By slowly taking your balance, since they can't make money loaning it out.
A negative interest rate basically means more people want to save money than spend money. When the government offers negative rates, it's because they want people to spend money instead of save it. When a bank does it, it's because more people are putting money in than taking it out.
I have some visibility to a tiny community bank started by some folks and then grew into a larger bank over time. They were mostly a consumer bank (consumer banking, small business type loans, etc) with some side banking related activity.
Paradoxically (well seemingly so) the best time for them to buy or merge with other small community banks was if there was an area they wanted to be in ... that was doing well economically. That was the time to look around at the local banks that they might want to pickup, or those banks actually came to them.
Local small (usually rural / suburban) community banks would find themselves in a bad spot as the locals were doing well financially, paying off loans early, not really borrowing much, and the locals with their extra money started stuffing it into the local bank. Businesses expanded, but they were able to do so with short term or very limited loans.
The local small bank found itself flush with cash, and nobody who wanted it (well not nobody but you get it). That was the time for the other bank to swoop in and save them as they could provide a larger regional reach (and some side businesses that benefited from being backed by all that cash) to areas that still wanted that money for loans.
> They can't loan it out again because no one wants to borrow that much.
Which is why this is a signal that the economy is failing. The underlying behavior which drives the value of currencies is that the currency is being used. If people just stockpile cash then the value of that cash is eroding as people find fewer uses for it.
Since the productive use for debt is as an engine for growth, if there isn't anybody looking to secure debt for growth then we're seeing the long-term effects of a loss of dynamism in the economy, which is detrimental pressure on the underlying economy itself. It's not sufficient to try to persuade people to spend more on consumption (people are always incentivized to consume) - people need to be incentivized to take risks for growth, which they currently are not.
What the central banks will realize is that you can't incentivize people to take risks by holding a financial gun to their heads - that only incentivizes people to seek further safety. You need to, perhaps paradoxically, make it safer to take risks. If the ordinary control for doing so (reducing interest rates) isn't working, then there's a compounding factor which is preventing that safety from being felt.
I feel like I still don't understand negative yields, despite really trying to.
Negative yields means that I put in $X (or euro/whatever germany is using) and I later am guarenteed no more than $Y out of the exchange, where Y < X. I am literally guaranteed to lose money. I could just hold on to my money, "keep it under my mattress" and still make a better ROI than bonds with negative yields. Why would anybody buy these bonds?
A lot of financial transactions and central clearinghouses require participants to post collateral. For example if an insurance company enters into an interest rate swap with a bank, both sides will have to post some percent of the contract's notional value in escrow. This protects both sides from counterparty risk (i.e. what if the insurance company goes out of business and can't pay its side of the swap).
The collateral needs to take the form of low-risk, liquid securities. Usually government bonds. Bringing a big bag full of cash to a derivatives exchange is not accepted. If you're a big financial institution, you have no choice but to buy government bonds. Even if they're negative yielding.
Since 2008, there's been a massive increase in financial regulations. Policy-makers have desperately pushed to make banks and other financial institutions less risky. That mostly means much higher capital requirements and more central clearing. In turn that means the demand for holding high-quality government has exploded.
There's no electronic cash account they can put up? If not, why not, and why can't we enable something like that so people aren't forced to buy bonds in order to hold cash?
It would be counter productive to society. Put money in a bank, the bank lends it out, the money serves society buy financing a new business or perhaps consumption but either way it is doing something. Lend it to the government in the form of bonds and they'll spend it on something.
If it just goes into the cash account you're describing, it does nothing but exist, in the event of recessions this would be severely dangerous to a countries financial system because it would be the safest place to store your money, safer even than bonds, so at the exact time when the economy needs cheap credit, interest rates would rise as money drains into these electronic cash accounts.
That makes sense but I have a follow up question. What forces this? For example, what's to stop a single entity from reaping the rewards of using cash while everyone else buys bonds to keep the economy moving. Is it a government regulation? an agreement between large institutions? or are the gains to each individual entity large enough that the negative yield is worth it?
Cash or a bank demand account is not without their own inherent risks. A fire, robbery, or forced currency exchange could destroy the value of the physical commodity of cash, and the FDIC only insures individual account bank deposits up to a certain limit so a bank institution failure could cause losses to individual accounts.
Ok you're arguing that there is no such thing as a liquid store of value that that offers a better return than a negative yield government bond?
So let's say I'm a bank with a stack of 1B in high denomination central bank notes. I calculate the rate of return as zero minus the annual cost of securing those and the annual risk that they are stolen or destroyed. Inflation isn't a factor because the bond is in the same currency. Based on your explanation that rate of return will be lower than the -0.11% that I would get from a german 30 year bond today. And there's simply nothing I can exchange those central bank notes for that would do any better than the bond.
Like OP I've never understood negative yield debt and I'm trying really hard to.
Not counter productive to the society: as money have nothing behind and central banks can just print it, they can print or electronically grant any amount to anyone needing it. This would not affect the trust in the value of the money because there is no such value. What is $1 or 1 Euro backed by? An ounce of Moon dust?
The fundamental demand for dollars and euros is caused by the fact that every April, you need to have a bunch of them. And if you don't, eventually men with guns will take you to jail.
It is different here, you don't pay the taxes yourself, they are subtracted from your salary by the employer and paid on your behalf. it is not a service you receive, the state does not trust you will pay. When you leave half of the salary on the pay day and then pay another 20% taxes on anything you buy, not many people would pay something in April, even with the men with guns threat.
This is sort of correct, but it also doesn't address the point that this setup can't exist, logically, with fiat currency.
There is no way to hold money that isn't ultimately lent to or borrowed from some other entity. You can store cash under your mattress, but even that's money that you've effectively lent to the government (the seigniorage of storing it under your mattress means that you've now given them the ability to print that same amount of money at zero extra cost).
This is harder to wrap your head around, but once you understand the principle - money is always at work, no matter what form it's in - it's a lot easier to understand the flow of money on a macro or international scale.
> This is sort of correct, but it also doesn't address the point that this setup can't exist, logically, with fiat currency.
Yes, it can. It can't exist with the game playing that exists with most modern fiat currencies to create the illusion that they are something other than fiat of the issuing government, which creates a lot of artificial debt to create the illusion of a government constrained by the same fiscal concerns that apply to a country using commodity or foreign fiat currency rather than its own fiat.
But this is a behavioral hack to reduce the likelihood of a particular undesirable course of monetary policy (unrestrained money printing), not fundamental to the nature of fiat currency.
So people should be forced to invest their money even if they don't think any of the ventures are worthwhile? And physical cash shouldn't exist either?
If you describe negative interest rates as "forcing people to invest their money", how would you describe deflation?
Money is debt. You hold something now and expect somebody else to give you something of value for it in the future. But the future is always uncertain. You may lose out on the deal by holding on to your money. But you seem to be demanding that somebody somehow should guarantee that people never do lose by holding on, no matter what. Who would that somebody be? How could that even work?
Money was debt. It's how it got invented after all.
It's not so clear cut anymore. Most currencies aren't backed by anything anymore nor are they tied to any yearly returns. They've become arbitrary numbers manipulated by central banks to control the economy.
You would have to back the money with something physical such as the Gold Standard. An Oz of gold today will still be an Oz of gold tomorrow. Furthermore, the rarity of gold makes the amount in circulation relatively constant.
The problem is that the purchasing power of gold isn't relatively constant: what you can buy with 1 oz. today and what you can buy with 1 oz. tomorrow are not necessarily the same — so you have much the same problem.
Moreover, the relative constancy of the gold supply is a problem, because as the economy grows that makes each unit of gold more valuable … which leads to deflation, which is far worse than inflation, and can lead to utter economic desolation.
I hate fiat money, I really do: I hate that governments can inflate their way out of debts and inflate away my savings. But gold — appealing as it is — is even worse.
1 oz. of gold doesn't change from day to day, rather, only people's opinion of it changes. In that sense, is there anything you can think of that people would want as much or more in the future than they do today? I can think of maybe 1 thing, sex, but I don't even want to begin to imagine how a system like that would work haha.
Ultimately I agree that fiat currency is a necessary evil because of the ability to expand with the economy.
> So people should be forced to invest their money even if they don't think any of the ventures are worthwhile? And physical cash shouldn't exist either?
Physical cash is also debt (backed by the full faith and credit of the US government, in the case of the US, or the relevant issuer in the case of other fiat currencies).
Non-central fallacy: Yes, it technically meets one definition of "liability", and is therefore debt; it is not "being invested in a venture" in the sense of this discussion.
> Non-central fallacy: Yes, it technically meets one definition of "liability", and is therefore debt; it is not "being invested in a venture" in the sense of this discussion.
Except it is being invested. That's a major part of the role that the government plays when interacting with the macroeconomy.
So people should be forced to invest their money beyond the extent to which holding that money inherently counts as an investment, even if they don't think any of the ventures that they directly invest in are worthwhile?
The fact that government "is debt backed by full faith and credit etc etc etc" does not answer the substance of the question I was actually asking, and which should have been clear from the context I was asking.
Your job as part of social contract of living in a market-based economy is to allocate capital in the most productive way possible to maximize efficiency of the whole. What this means, is that if you believe no ventures are valuable, you allocate your capital in cash. If you believe ventures will outperform cash, you invest in ventures. So you're "forced" in the same way you're "forced" not to be homeless, have a job, and not hit people. It's a way of life.
But your first question is much more interesting in what it seems to imply.
If i understand it correctly, the converse would be: entities are free to not invest their money when there are no worthwhile ventures.
This sounds all well and good on an individual level.
But by what logic or mechanism can the ~200 countries that exist have the ability to 'hold' money and not 'invest' it?
Actually cash is a form of that: a $100 bill is a bank note that you have $100 in the bank. In theory if you want to deposit $1 million, the bank should just give you a note for a $1 million deposit - that would be a $1 million bank note.
But all this was true when the bank note was for the gold or silver that was deposited in the bank. Now every bank note is just a paper about an amount of nothingness :)
Some people have asked, if US banks pay a minute amount of interest in savings, and the Fed pays like 2% or more on deposits by banks, why can't someone just start a bank that stores deposits at the Fed and passes through the interest?
And the answer appears to be, because the Fed won't let them, because they are afraid it could undermine the regular banks.
Why would a derivatives exchange not accept cash? what are people buying those derivatives with?
Furthermore, how could any bond (or anything at all for that matter) be less risky than cash? the market value of a bond may change over time but $1 will always be worth $1. Inflation may change the purchasing power of that dollar but then the exact same mechanism will effect the bonds as well.
There's some nonzero cost to accept, handle, vet, store, etc for cash. That's not even including if there are extra reporting laws or other for large amounts of cash, which just adds to the overhead.
These are all concerns with paper, not “cash” as it’s commonly considered in finance.
Have $xx,xxx in a checking account at a national bank. It’s a database entry, not a pallet of pennies. Furthermore, with fractional reserve banking, I sincerely doubt if there’s enough coins and bills in the country to account for the total “cash” in all the accounts, let alone all the assets.
Similarly, everyone involved in these transactions have access to the same banking system. There’s no reason you need to fly a C-5 with pallets of Swiss francs around. (Even then, it seemed absurd since both governments could access Swiss banks.)
> Have $xx,xxx in a checking account at a national bank
At the scales of financial infrastructure, bank deposits are not cash. They are debt issued by banks. The point of collateral is to give a bank’s word weight.
Yes, but the FDIC equivalent in Germany is 100k, which doesn't help you if you're in the business of buying 30 year bonds (usually that's institution buying >10MM)
Agreed, but you certainly do it from a bank in Germany that isn't dbag. And if you're not dbag it's not such a sure thing that the government will come and save you.
Or say in the US, you'd buy that from US Bank, which isn't in the big 4 consumer, or top few commercial, and it could be let to fail.
It's still safer than a tiny bank, but it's not as safe as government bonds.
That's all it really boils down to - you pay a bit extra to get more safety.
You may be comfortable depositing $10MM in a US Bank reg D account, but I would not be.
Well actually for US Bank specifically I might because I know their business model is incredibly conservative. But replace that with another large but not big4 bank.
I think the answer to both your questions is because there are costs to securely storing cash. That also makes cash risky compared to bonds, where you are not responsible for the security.
Why is everyone responding to the question under the same misinterpretation, that it means "cash" as in "physical banknotes" rather than "electronic Euros"? I know the principle of charity is hard sometimes, but come on.
A) keep the euro notes in their vault, which only works if you deposit paper bills in the first place
B) keep electronic deposits in the ECB and pay interests to do so
In either case if they give back the money to the clients when they ask for it how do you expect them to cover their operating costs (plus the interest they are charged by the central bank in case b)?
Excellent question. There is a company, The Narrow Bank, that has the same idea, but they didn’t get a banking license from the Fed. Matt Levine, whose newsletter you should clearly start reading, has the details: https://www.bloomberg.com/opinion/articles/2018-09-06/fed-re...
Not only - AFAIR the Colombian Steve Jobs had problems with humidity too - 2.1 billion 80s' USD lost to flooding and rotting is what I would call real liquidity :D
And also rats I think.
In cas that's not obvious I just want to add that the collateral allows you to only keep a fraction of what you're investing in actual collateral. The exact numbers depend on context, but imagine you buy/hold collateral and for that can loan/borrow five or ten or twenty times as much.
This is an example of how to write a good article, I think the first sentence answers your question:
"Germany sold 30-year debt at a negative yield for the first time, as investors desperate for safe assets bet that further falls in yields will boost the value of the bonds in the future."
The investors buying these bonds are simply betting that these bonds will increase in value (which will supposedly happen if central banks cut interest rates more in the future).
These bonds don't pay out for 30 years and I bet few if any of the institutions buy them intend to hold them that long, they plan to sell when the value of the bonds rise.
So why not just park that money in cash? Well let's say you have $1M and you think bond yields will continue to fall. If bond yields fall further, then the value of these bonds increase, then you can sell them and realize a return.
However, you also want to think about any way that your cash holdings could increase. Could a dollar (or euro, or whatever currency) tomorrow be worth more than a dollar today? Yes, if there's deflation then it could make sense to just hoard cash under your mattress and realize that it's purchasing power is growing!
But these investors are assuming deflation is not too much of a risk - they believe central banks will act to quickly slash interest rates - both increasing the value of these bonds and decreasing the risk of deflation.
Markets are pricing in future interest rate cuts, which is probably not a bad bet to make. Markets a probably predicting interest rate cuts because they think various economies are weakening and central banks will cut rates.
The implication then is that we're in a bond bubble. When you're buying something that you know has negative fundamental returns on the assumption that someone will buy it from you at a higher price, that's the definition of a bubble.
And like many bubbles, it's entirely possible they'll be right in the short term, but it's basically guaranteed that they'll be wrong in the long term. You know exactly what a bond will be worth in 30 years, and with negative interest rates, you know it'll be worth less than now.
Expecting the price of something to rise in the future is not the definition of a bubble.
When people were selling houses in Detroit at the bottom of the housing crisis for $1000, the people buying them were expecting the value to rise in the future.
Expecting the price to rise when you know the underlying fundamentals don't support that price is the definition of a bubble.
People buying houses in Detroit have an investment thesis that there will still be people living in Detroit and they will still need houses, and even more broadly, that there will be more people needing more houses than there were at the bottom of the housing crisis. They may be right or wrong, but there's still a thesis based on fundamentals.
People buying unbuilt houses in the middle of the Everglades [1] because they heard of prices doubling or tripling within a year is speculation, and many of those areas still have not regained the value that investors paid for them, almost 100 years later, and probably never will.
The bond market, where trillions are traded by sophisticated investors, is by definition efficient.
If the price of something is higher than the "fundamentals support", that price will adjust because there are literally billions being traded every hour.
You could say that the price of land in the Everglades is set because of unsophisticated investors, with relatively little money at stake. They can't be compared.
That's not what's happening with bonds. The underlying fundamentals do support a higher price if interest rates go down. The price would then stay there until interest rates rise. In all of these cases the market price is fully rational and fully supported.
GP didn't say that a bubble is expecting the price of something to rise, they said that a bubble is expecting the price of something with negative fundamental returns to rise.
Individual investors would probably not buy these. It's a lot harder to keep $100m under the proverbial mattress: not FDIC-insurable, literal cash requires guards, etc. And anything else you buy to store the value (gold for instance) has higher volatility and risk than these negative-interest bonds. So the theory would go, anyway.
Individual investors still can buy. For example, if I am sitting on too many dollars and expect that Euro will be significantly stronger than dollar in 30 years, I can diversify a little bit. Same applies to other currencies.
If it's a large amount of money, you might decide to put it in a bank so that you don't have to worry about it being stolen.
Once it is in a bank now you have to play the game of trying to figure out the comparative risk between the bank not being around any more 30 years from now, versus the chance that the German government will have forgotten how to operate the money printing presses.
Of course, since this is the EU, I'd actually be rather worried about the latter. Unlike sovereign currency countries, EU countries do not just get to print Euros. A lot can happen in 30 years, especially to a country with 1.5 births per woman like Germany.
> Of course, that could never ever ever happen in Germany? Not even in 30 years? Let's hear an explanation.
well anything can happen.
I mean I live in germany and I can totally see that happen. our biggest industry needs a lot of breaking changes or else they will fail pretty hard. and they have less than 30 years to do so
Yeah I don't get the impression that you know too well what you are talking about if you don't know the difference between the EU and the Eurozone. Even if the euro were to break up/be abolished and resolve back to smaller currencies there would be a conversion key. The chance that the renmenbi, GBP, yen or even the dollar will have major issues look a lot more likely in the current climate - the renmenbi is still struggling to become a global currency and everyone can see the political struggles on the horizon, the GBP will continue it's free fall after the disastrous Brexit and the following depression, the dollar is widely overdue for a correction and will lose out if eg China starts dumping their reserves, not to speak of the endless debt spiral the us is in - similarly for the yen, with the high debt it looks unlikely to be a stable currency in the long term (even if it's mostly local debt). That doesn't leave too many options - with the euro a fairly stable option as long as people remember the nightmares of Europe pre-euro (and most outside the anglophone bubble do): huge costs and price uncertainty in cross border trade, big financial players gambling and manipulating against smaller currencies (as you still see in Africa today), and overall little trust in the local currencies.
Trust in the euro (not necessarily the EU as a whole, as it is a target for much local political hate & lies when it's easier to blame Brussels than accept responsibility for mistakes) is at an all-time high, with not even Italians wanting to give it up. No one wants the lira or drachma back.
Eurozone is a horrible term to use here, as some nations are pegged to the Euro or have adopted it with no issuing rights or have promised to adopt it. We are talking about specifically about EU governments with partial issuing rights that sell Euro-denominated debt. Like Germany.
One risk (of many different kinds of financial risk) with buying debt denominated in Euros from EU governments is that if such a nation is economically worse off than the others nations that also have Euro issuing rights at the time of bond maturity, then the chance of default goes up substantially. As happened quite recently with Greece.
This is not a type of risk faced with nations with their own sovereign currencies. Default is still possible, but devaluation is a safety valve.
If you take out a bunch of cash you have to store it. If you move it to an international market you suffer currency risk. If you think that the Euro is going to go up like crazy (if you forecast deflation) and you also think that every other European government has a pretty bad default risk, then you'll happily accept negative yields. Don't forget that it costs money to guard a warehouse full of cash.
This means that lending money to the German federal government is considered less risky than just “holding onto your money”. You might think of money as a physical asset (cash), but really it’s far more varied, and for amounts that exceed insured deposit thresholds, you are not protected by the risk of failure (or “bail-in”) of a banking institution. Besides, as others have pointed out, these make little sense from the point of view of an individual investor and are going to be parts of more integrated risk-calibrated portfolios of assets.
I think with quantitive easing this analogy isn’t really true anymore: there is a guaranteed buyer (the ECB) propping up the price of German sovereign debt, so making the yields artificially low.
I’ll definitely grant you that quantitative easing complicates the picture, but i it does so in ways far more complicated than you describe: firstly, the ECB buys at secondary-market prices, so the “flight to quality” effect is still there, albeit perhaps in muted form; furthermore, keep in mind that the ECB can and probably will resell those bonds that it does purchase at a later date when it will want to wind down it’s balance-sheet. Other effects also apply. Negative yields however probably do represent a true aversion to risk on behalf of investors, in some capacity or another.
Your confusion comes from focusing too much on what happens at maturity.
This is the least important thing here.
Bonds have two ways of providing a return. The yield, and the price of the bond itself.
Lower yield means greater price of the bond. They are always inversely correlated.
Even lower yield means even greater price of the bond.
Because of worldwide policies, Its a bond bull market. The greatest bond bull market of all time and there is no exit.
Government creates new bonds at market price. Their independent Central Bank buys those bonds at market price giving newly created money to the government or traders. Market price is always a premium to the prior price. This action devalues the currency, otherwise known as causes inflation, otherwise known as people’s share in the currency stock is diluted.
So nobody needs to care about the yield. Nobody is thinking “well golly I’m going to use a few fractions of a dollar for the next 30 years” theyre thinking bonds to the fckin moon
Buy high sell higher directly to the central bank.
Benign attempts at economic stimulus have turned into a full blown currency war between monetary unions and nation states. The whole point is to get people to think “hm maybe my money isnt doing so well in a bank or in my mattress, maybe I should circulate it in risky investments” , and since people are so willing to pay for the privilege not to do that, the yields will go deeper negative. This prompts other monetary unions to cry foul and consider these actions unfair and uncompetitive, and so they do the same thing to devalue their currency to compete.
Any time you hear someone talk about responding to currency manipulators or reacting to the trade war by lowering rates or devaluing their own currency, just remember:
Currency is mildly decoupled from purchasing power.
Here's how you look at it. You give me $20K today, and I promise to give you $19K back in 30 years. The question is two-fold.
(1) What else would you do with that money, that would offer you a better return, factoring all externalities. Holding cash isn't free once you account for risks like getting robbed holding bills your house burns down, you get fake bills, and potentially-negative interest rates at a bank. If you see the market going down you're not going to put it there either.
(2) How much will $20K today dollars buy you as compared to $19K future dollars? If you're betting on deflation, then that $19K future dollars may buy you a house where $20K today dollars may buy you a car.
(3) what will the best offer to hold $20K be tomorrow? If it's even worse, I can sell my $19K promise and make a profit! (Falling yields means raising prices.)
There are dozens of answers here that explain why institutions buy sovereign debt, in general.
What those comments don't explain is why anyone would buy this particular sovereign debt.
So: why would anyone buy negative-interest-rate German bonds when U.S. Treasury bonds still have positive interest rates, and are available in much higher volumes?
Because those positive yields are only available if you don't hedge your FX risk. Most institutional investors have a mandate to hedge FX risk and this will take UST returns for EUR investors negative.
Because you’re a European and have to pay your taxes (or your investors, or other people) in euros, so don’t want any exposure to the Euro/Dollar exchange rate.
It's quite terrifying to think that pension funds are using forecasts of healthy returns to claim they are well funded, whilst simultaneously making investments with guaranteed negative returns.
If it makes you feel any better, central banks don't either.
Your question is actually fairly straightforward: people own these bonds because they have to. Most countries have regulations that force institutions to own these securities.
The more important question is actually: if you are a bank, what do you do now? You have to pay to lend money to people, it costs you 1%/year to just keep the lights on.
In Japan, most banks are (again) effectively insolvent. Germany is moving that way...and yes, the "point" of this action (according to central bankers) was to support banks...but it will likely end in most banks in affected countries going out of business.
...but don't worry, the central bankers will produce a brand new plan compose of intricate theories that clearly show how intelligent they are and how this totally wasn't their fault.
If you put a lot of money in a bank then there is a counterparty risk the bank defaulting or you getting a haircut. Money in a bank is no longer "yours".
Some hardcore asset management schemes store physical US bills in a high security storage. You will pay % negative yield on yearly storage cost, but cash is truly yours and you can withdraw any day.
Also in the EU, with some fintech startups, you can now open a bank account which comes with a IBAN number from a central bank of Lithuania - essentially your money is stored within European Central Bank system. You will have negative ECB interest and pay some extra, but there is no counterparty risk unless the whole European banking system collapses.
It should be noted that "a lot of money" in this context means more than whatever limit your country has on deposit insurance. In the US, up to $250k is insured by the government against default, and it goes per account type and per bank, so you could easily store, say, $2M fully insured.
But of course, this does not insure you against systemic risks. When the financial system in Iceland broke down, depositor insurance meant nothing.
Another popular way of storing large amounts of money over long time, is to invest in real estate. Buy apartments in central Paris, London, New York. Very small risk that you lose anything, especially in real terms, if you can keep a cool head about when to sell. Downside is that these are not liquid assets.
One way to make money is if you sell the bond at a higher price later to another buyer. From the article:
“Why are people buying at negative yields? It is mainly in expectation that you’re going to be able to sell to someone at a higher price later on,” said Andrea Iannelli, investment director, fixed income at Fidelity International. “Whatever the yield you have to assume you’re going to make more on the capital gain than lose on the yield.”
So Y < X, but if you bet you can sell at price Z to another buyer later, Z > X and you profit.
As an analogy I just thought up: it's kind of like overpaying for a house, thinking that in time the house value will appreciate.
Or just paying for a house, thinking it will appreciate. (The "yield" of a house is negative, because it costs money to keep the thing in the same condition you bought it in, as anyone who owns a house knows.)
Suppose you had half a billion dollars or whatever. You could get it in cash. You can't put that under a pillow. You'd need a really secure vault to guard this cash against theft and accidental destruction (fire, flood). In the best case, nothing happens to the money, so it retains its full numeric value, but that vault costs money to rent and operate, and those costs add up to negative yield. That effective negative yield of the vault could be more negative than the negative bond, making the bond more attractive. The negative bond could be more attractive even if it costs more than the vault, because of lower risk.
A bond is a registered contract that names specific parties, whereas cash is a manifestation of value associated with whoever bears it. (There are bonds like that; bearer bonds.)
Stealing bonds would have to be an information crime; surreptitiously rewriting the identity of the investor on all copies of the contract in existence. Or something like that.
Can't banks just deposit the money as reserves with the ECB and earn zero? I suppose in the 30 year case maybe you're assuming that the ECB won't pay zero on reserves in the future, but how does that explain the short term rates?
The ECB deposit rate has been negative since 2014. The role of central banks during slow growth is to coax banks to lend, not to hoard cash. When growth is high they increase deposit rates to take money out of circulation.
Most 'central banks' dont really offer banking services. Eg: you can't deposit to the federal reserve.
So the question is what to do with your money, that is both (a) easily transferable (b) auditable (c) safe
Government bonds are the traditional answers to these. They offer all of a,b,c. And until now they even offered extra money, aka interest, as bonus.
I think the best way to understand bonds is the old fashioned paper bonds. There was 2 parts: a primary part representing the money down, and a detachable 'coupon', say 5 of them for yearly interest for five years. So every year you'd bring the appropriate coupon in and get your interest. At the end, you'd get your money back which is represented by the main bond. Or more likely trade it for another bond.
All this means is the coupons now represent how much you have to PAY the government for issuing the bond. So it's more like a maintenance fee, rather than 'interest'. Or another analogy, safe deposit box fee. Bank account fees. Etc.
Money in the mattress, in physical vaults, safe deposit boxes all have the following property: (a) difficult to value (gotta count all those bills! who's doing the counting? is it auditable? did any 'shrink' somehow?) (b) costs quite a bit of money to just store ($100m is a lot of bills! it weighs a lot! it can get set on fire!) (c) not so easy to transfer.
As a result of all of the above, it's unlikely to be usable as collateral. Since the primary target is banks, they need 'liquid' assets that they can present to their auditors to prove they have reserves for their deposits.
I wasn't aware that ECB reserves had a negative rate. To your point though, if you're a bank and a member of the Federal Reserve System, you definitely can deposit to the Federal Reserve. Banks have a reserve requirement as you mentioned, and in my understanding, that must either be in cash in the vault or deposits with the Fed. I believe the ECB operates with similar rules.
The ECB’s rates are short-term; who’s to say that they won’t turn acutely negative for at least some proportion of the next three decades? These rates are “locked-in”, provided you hold the bond to maturity (and might have an upside later on).
A majority of institutional investors have investment mandates which limit them in the amount of cash they can hold. Additionally, if you think there's no chance of EU inflation going forward, even if these are negative yielding securities, you will still have a price return on these.
30yr Bunds were yielding 0.875% at the beginning of the year and have recently gone negative. If you were benchmarked against them and at the beginning of the year decided to either move to cash or short them, you more than likely lost your job.
A negative rate bond or CD is not fundamentally different from a normal one, you pay a set amount now and in the future you get a guaranteed payout at a future date. Except that instead of making money on the interest, you pay a little. The banks offer these products because they still make money on the fees, and on the arbitrage from loaning out the invested funds at a higher rate(or by doing nothing with a negative rate), or by bundling and selling the securities. This can still be a good option for buyers compared to investing in junk bonds or CDs that pay higher rates, or in stocks and mutual funds because what is important is the risk adjusted return and not just the yield. There are costs/risks associated with keeping a pile of cash in a vault or stuffed in a mattress, or sitting in another type of account that is not insured. If you expect interest rates to decrease even more buying a bond or CD can make money because you can sell it for more in the future, even with a negative rate. The big one is that in certain cases there are requirements to purchase CDs or treasury bonds by law, or as part of a contract, or by the governing docs of a company instead of just holding "cash".
For an individual, you would be unlikely to purchase these because the cost/risk of holding cash in a bank account is minimal and some type of insurance likely covers it, and most individuals want higher returns and would rather invest in index or mutual funds than CDs even if they had positive returns. And if you think that interest rates will drop in the future and you can sell the bond for more, you are still more likely to buy higher yield bonds with higher risk.
Safe assets sell a service: they’re a safe place to put your money. For this service, you pay a fee. There are other places to put your money, from cash to money market accounts to listed equities, but they aren’t safe. (They compensate for this unsafeness by promising you a return.)
This will make better sense if you treat money as a trading product with supply and demand.
Negative yield on an investment means the banks and investors believe the amount of money will shrink in 30 years due to less demand in the future or too much supply right now. They further believe that the yield while negative is still better than the amount of money shrinkage down the line. Thus a negative yield investment is still a sound investment.
If you have several million Euros to invest in fixed income securities, that would be a very large mattress. Even if you deposit it in a bank, what do they do with the money if yields are negative? Charge rent for the space, I guess.
> I could just hold on to my money, "keep it under my mattress" and still make a better ROI than bonds with negative yields. Why would anybody buy these bonds?
You think you would do that for millions and billions?
Held individually the negative-yield bonds don't make much sense. However, they can actually improve the risk-adjusted returns of a portfolio that also holds stocks. This is because long-term bonds have, in the past decade, been negatively correlated with stocks [1,2].
Because the interest rate will soon be less than the bonds. Negative interest rates coming down the pipe globally. Only way that I can see it getting justified.
putting cash under your mattress has security costs. For < 1k euro, probably not worth calculating. But for > 1M euro, there is a real security cost to keeping that amount of cash safe for 30 years.
I may be totally wrong, but I think the floor on negative yields is going to be the security costs of keeping cash for that timeframe.
The only reason I can think of is to mitigate the downside risk of financial collapse. These are banks buying these bonds. Banks which might be worried that short term financial pressures might tempt the governments might to reach for their cash positions. I would rather hold some negative-yield bonds instead of cash in that scenario.
From what I understand it’s moreso for institutional investors that have lots of capital they need to park somewhere. Making the bet that the gov will be around longer the bank
But for retail investors who can store their money in a FDIC insured savings account it’s not clear why they would buy negative yield bonds.
Also, look at it this way, if you have, let's say $5b on deposit at a bank, and you need to give it to someone else for some reason. Well transferring that money could destabilize the bank. They might refuse to let you withdraw it quickly. etc.
Bonds are easily and instantly transferable privately without causing major market loss.
This is the thing about huge finance like this, there's a gravity to money, and your intuitions from having bank accounts, money, etc, doesn't apply because entirely new problem appear you will never have. What if every time you paid a major bill at your credit union you threatened the solvency of that institution?
Does that mean a negative yield indicates a loss of trust in banks? That institutional investors are so desperate to avoid relying on banks that they're willing to take a loss on gov't bonds?
No. Bonds are based on their money amount. So as money loses value due to inflation then so does the bond.
If you want to hedge against inflation you would need to invest in something that either yields a positive return or something whose value isn't tied directly into a money amount, like land.
This is the real reason the US yield curve looks the way it does.
All other developed countries are selling negative or near zero government bonds. This has lead to huge international demand for US 30 year treasuries.
US treasuries are giving a greater yield than Italy or Spain for reference. Of course there will be huge demand.
Central banks are no longer islands. They are part of the global economy and a part of a market just like any other. The US acting alone to raise interest rates won't work like it did in previous cycles.
US and EU bonds are denominated in different currencies, and the cost to hedge the currency risk with a forward contract eliminates the difference in interest rates. In other words, the effect of the US raising interest rates isn't just to put pressure on EU interest rates, but also to put pressure on the expected future exchange rate.
I understand that policy makers think that low interest rates will encourage people to put their money into investments like the equities or a business by forcing people out of saving. But, have they ever considered that they may actually be achieving the opposite? Someone who just turned 65 (like aging Europe), really really needs to save in safe assets. Negative yielding bonds don't change that need! So, instead of investing in risky assets, they may simply take the negative yield and save even harder to make up for the negative yield thus reducing spending even further and hurting the economy.
There is also the risk that injecting additional cash into companies that don't need it further disconnects them from the actual economy. Investors can now make money simply through the appreciation of stocks, housing and dividend payments funded by negative interest mortgages. Since companies no longer need to sell more products, services or participate in the economy the end result is that you are not only not stopping deflation, you are actually mildly increasing it.
Their objective is that people won't save the money. They want people to spend the money, the sooner the better, but that goal completely contradicts what a retiree (and aging population) needs/wants to do.
Another thing to consider: the average Joe has little or no cash savings. Rich people already are into stocks, real estate and other asset classes. There might not be much juice left to squeeze.
The extra saving means higher prices for the assets of current retirees, which should end up resulting in them selling assets and spending the extra money.
BER is it's own special case, but the general gist I'm piecing together from media reports is that Germany has a planning problem because there are not enough government workers to plan projects.
For example, there is a budget reserved for infrastructure. The poor regions often fail to produce good enough project plans in time. The richer regions have more planners and present additional projects at the end of the year to get the left over money.
I’m starting to entertain the idea of a massive bubble in bonds. Is inflation really never going to show again? I can’t understand why anyone would want to hold a fiat currency for 30 years for no return.
Is it due to portfolio theory where the assumption is stocks and bonds yields have inverse correlation and the way to manage risk is to have a correct ratio? Due to global QE there is too much money floating without enough to invest.
In developed economies money is being removed nearly as fast as it's being added, in the form of going into the blackhole of low to negative yielding paper. It's removing a present ~$17 trillion of capital that could otherwise be sloshing around pressing inflation higher. That's an extraordinary amount of money that has largely been rendered non-impacting. There are only a few areas where you see any inflationary pressure in the US, such as in assets like equities and real-estate, due to the Fed rates. In that case you've got people with immense collective free capital pressing aggressively upward on prices (willing to pay a high premium to try to get a return beyond what eg treasuries are offering).
It's why Japan can never spark traditional inflation (nor achieve any growth). Their epic pile of low yield debt has sucked a lot of the loose capital out of their economy. It's a giant pile of non-productive, non-active, ineffectual capital. Instead of going toward wage pressure / competition, growth, business formation & loans, VC, productivity investments, R&D, et al.
If you could unleash $20-$30 trillion of increasingly low yielding debt back into the US economy, inflation would skyrocket and it would demand far higher rates to control inflationary pressure.
It takes several things working in tandem to result in this unusual outcome. Countries outside of the developed world - the first tier, affluent economies - have a near impossible time achieving such low or negative yields, and lack of inflationary pressure.
I still don't understand this at all. Is all this money that's being parked in almost no-yielding bonds just going to stay there forever, never to be used?
What does this say about the state of the economy or the expectations/psychology of whomever buys them?
There's either something very hard to understand that's happening to the world economy, or it's just a strange phenomenon that people pretend to understand but don't.
>Is all this money that's being parked in almost no-yielding bonds just going to stay there forever, never to be used?
The money can come back out, however it seems very difficult to see when that'll happen. That being said, if it does happen, I think we'll see a lot of inflation due to the sheer amount of money that would be pouring into the system.
I think ECB is doing a terrible job in reaching their stated goal of 2% inflation.
I think actual helicopter money distributed equally to each EU citizen (a few hundred EUR) would have been much better than buying state bonds. Most people would have spent the money immediately and thus caused the desired inflation. As it is now the states benefit from QE in the first step, used in questionable projects in the second step and then it doesn’t tickle down but just inflates various financial asset bubbles. It’s neither fair nor effective.
Of course you need some thought, how to actually distribute the money without losing to much on bureaucracy, but it is possible.
No. The deal with bonds is that they have just been a way better risk-adjusted investment than stocks. An optimal portfolio still owns stocks but the point of all these approaches (risk-parity, much of the hedge fund industry pre-2008) was just owning levered govt bonds...that was it. Correlation is a minor part of that story (although it is very important).
And this effect isn't driving the price (imo). What is driving this is risk aversion, central banks, and regulatory requirements to hold risk-free securities (most investors aren't sophisticated enough to be doing portfolio math). Also, it is no coincidence that the worst affected countries (Germany/Japan) are those with risk-averse populations, crazy central bankers, and completely dysfunctional banking sectors.
The alternative is: property, commodities, private business, etc. But remember, the financial world has gone crazy...but the rest of the world is just going on as normal. This is part of the problem: central bankers believed they were geniuses and could control the real economy by fiat...well, they can't. Their world will go down in flames but everything else will likely continue as normal. Investing is not about risk-free rates or volatility/beta-adjusted portfolios, it is about providing capital to business for growth. These opportunities still exist, the financial world of central banks is (these days) unrelated to this.
> Their world will go down in flames but everything else will likely continue as normal.
> These opportunities still exist, the financial world of central banks is (these days) unrelated to this.
It's not unrelated at all. It's the central banks policies that are pushing the economy out of balance. These policies obfuscate the real risks that come with investing, like defaults and money-losing investments. Greece, a country close to default a few years ago and with a debt-to-GDP ratio of 180% in a currency it cannot print manages to have a 10Y yield of ~2%.
Not predicting any doomsday but I believe in the upcoming years EU banks will slowly push the negative interest rates down to consumers, as they have no alternative. Their business model of borrowing-short and lending-long is no longer sustainable.
Also, on the long run, these policies have the effect of shrinking the middle-class, increasing inequality and polarising societies.
Turkey and other economically weak countries have high pop growth and high inflation and high bond yields, so that is not the answer. it has more to do with flight to safety. Countries that are perceived as economically strong and geopolitically stable have low yields, countries that are weak have high yields ,regardless of pop growth.
Thanks for the link! My take from that is the bubble is even worse than I thought. I didn’t realize the capital appreciation part and how sensitive long term notes are to rate changes. It seems to more or less work on the greater fool theory between central banks and investors. The intrinsic value held within the bonds is not there and where is the stopping point on the negative side? There’s a discrepancy between Central banks lower rates and bid up bonds through QE so bonds rates are continually on the decline and investors use that rate lowering for returns when bonds appreciating in value.
The amount of compounding leverage here between all parties would mean the system would implode if bonds went the other way for a longer duration. Maybe this threat of implosion only further accelerates lowering of rates as there is no alternative and even systemic deflation risk.
Gold miners. With physical gold you have to worry about storage, but gold miners solve this problem. The gold miners have run pretty hard already, but the developers (those building a new gold mine) have not yet moved that much.
If there is a collapse of civillzation the last thing anyone is going to be worried about is their investment returns.
Gold as an asset class does well in periods of low real interest rates. All signs suggest we are going to be in a low real interest rate environment for sometime.
One of the nice things about investing in gold miners over just gold is in trying to find the best ones. There is real alpha in this as not all gold mines and gold miners are equal.
So it is a zero coupon bond sold above par, but this doesn't mean the bank isn't making money off of it. There are a lot of technical reasons that these can be purchased (such as a tax advantaged stutus or a requirement to hold certain duration on a portfolio). I'm an expert on German bond market, but I expect the actual yield to be positive after taking into account other factors (or there being some regulatory reason). Last time I saw an article on a negative yield mortgage, there were tax resons it was actually coming out positive.
I'm looking at the bond on Bloomberg right now and it's showing a yield of -0.14% with a price of EUR104.54. All things equal, if you buy this bond right now and hold it to maturity, that will be your yield. This is an after-tax yield.
I'm not sure what bank you are referring to in the first sentence. These are bonds issued by the country.
Any after tax yield is going to be an estimate. i no longer have access to a bloomberg login, but does it give its methodology? @ 104.54, YTM would be -0.44 not taking other factors into account. There could also be technical reasons such as collateral requirements or other banking/trading requirements.
> I'm not sure what bank you are referring to in the first sentence. These are bonds issued by the country.
The purchasing institutions, not the issuing. These mostly banks aren't just giving money away, and they don't really have costs associated with carrying base money since they can just ship cash back to the central bank for reserve credit, i assume under most conditions.
And the can always go elsewhere in the eurozone for yield, but they seem to need bunds for particular reason. not sure, i just pretty sure they aren't giving money away for no reason. they could even lay off currency risk and go for US Tsy.
If you have to ask, the answer is almost certainly "no."
There are reasons to hold commodities and precious metals like gold/silver, but they are pretty specific and for retail investors usually circle the idea of hedging against your first-party currency.
The stereotypical HN reader (age 20-40 tech professional) should have three to six months of salary in cash (interest-bearing savings/checking/money market account), rest in low-cost equity index funds (I use 60% VTI / 40% VXUS).
Gold is, IMO, a disaster preparedness thing you buy after purchasing a shotgun, ammunition, and a month's worth of canned food. The main use case for gold is as highly portable physical wealth - in highly messed-up situations, you retain at lease some ability to engage in limited amounts of commerce to get yourself to a more stable situation.
That's an interesting implied point. Does it make sense to hold gold on paper, if it's mostly useful in highly messed up situations where paper gold would become worthless?
Yeah, I wouldn't do that. Security costs for physical gold are already low if you have a way to securely store a shotgun, most of what you're dealing with is a wider buy/sell spread, which is pretty small overall.
The problem with "paper gold" of various sorts is that it usually winds up being a promise to give you a certain number of dollars based on the spot price of gold. This is a problem if dollars stop being of practical use.
There's still a hell of a lot of things that are better to do before buying physical gold here, of course. Bigger risk-mitigation moves are like, minor emergency preparedness, own-occupation disability insurance, term life insurance, and dumping a ton of money into the stock market for getting enough long-term price appreciation.
I used to be against having any significant amount of gold in a portfolio because it's not a "productive" asset. Companies earn profit, bonds pay interest, and real estate gets rent checks, but gold costs money to store. "Productive" assets get you price appreciation + income. Even companies that don't pay a dividend are investing trying to grow, hence your profit comes partly from economic activity, not just a bet that people will pay more money for the exact same thing tomorrow.
Now that many bonds aren't necessarily meeting my definition of a productive asset (small or negative yields for the safest bonds in Europe), I'm backtracking on my stance. The zero-interest rate world is weird.
As with any investment, don't put in more than you feel you can afford to lose.
While gold and precious metals assets can appreciate in these times, at some point paper gains need to be converted into cash, so make sure you can liquidate your holdings if you need to. Many crypto investors for example have been burned by being unable to convert their gains into cash due to exchange related shenanigans.
I'd guess the gold market is more mature in that regard, but I've never invested so I don't know what it's like for consumer-level investors.
Slightly OT but I’ve been trying to google this for a while and there are people reading this who will know where I can look:
If a government (pretend US if it helps) stopped collecting taxes, and instead funded the budget by printing money every year, who would be the winners and losers compared to the current system? Where can I go to learn more?
I suppose it would lead to inflation and as long as the inflation is controlled, that's doable.
Effectively, the government is being funded by all dollar holders at that point. It's a wealth tax of sorts imposed on those who hold their wealth in dollars.
The idea would be that the government is being funded by the fact that $100 today, is worth only about $90 last year, and that loss in value is what's funding the government.
This might explain why the idea is more popular on one side of the political spectrum. What's interesting though is that thus far it doesn't seem like the expected inflation has been happening in the US, despite significant deficit spending. Any idea why that might be? What I've heard is a lot of, "Current levels of deficit spending are sustainable because we're not yet seeing a resulting increase in inflation." Which makes sense. But.. what's the mechanism for that? Like, taken to an extreme, if a government did indeed stop taxing and pay for everything with deficit spending, but there wasn't inflation as a result, how would that be?
The only explanations I can think of are that 1) many other countries are also doing significant deficit spending, so all major currencies are being devalued together, and so they're not actually being devalued at all, and 2) in as much as (ie) the US currency is being devalued faster than others, there are other, strengthening factors that are counteracting this. (Such as higher interest rates.)
I'm not an expert and expect this to have flaws but here goes:
Fiat currency is backed by value (not gold, but also not nothing like some people say). It's worth what we all collectively think it's worth and that's going to depend on the underlying assets of a nation.
Lets say there are $1T dollars floating around the economy and this year the Fed wants to print another 100bn. That's totally ok (and necessary) so long as there was that much value created this year. New factories have been built, businesses created, etc. This has created more underlying value in America and so it's ok that we print some more money. Your $1 bill still holds the same amount.
If central banks weren't setting the price of credit by fiat, what would a "market" risk free rate be? Have any economists tried to answer this question?
Edit: not sure why I'm being downvoted for this...?
A fair question, and there's an argument that's been made (though I'm unable to recall precisely where I ran across it, possibly in a New Books in Economics podcast) that while interest rates might once have been considered exogenous (market-determined) they are now endogenous (central-bank determined).
Which would mean that interest rates are (more or less) what CBs want them to be, at least within the bounds defined by inflation. Which presumably they want to be kept low presently.
Are you maybe thinking of what MMTers e.g. Warren Mosler assert? (E.g., Mosler calling for 0% interest rates, always.)
If you can think of source, please let me know. Sounds interesting.
Edit: It also sounds fallacious to me. Interest rates are central-bank determined because the central bank chooses to determine them. In the absence of a central bank controlling rates, there undoubtedly would still be interest rates. There ostensibly also still would be risk free rates. In some hypothetical parallel Earth, the Fed might instead choose to control the price of some other commodity, like oil. That doesn't mean that the price of oil would be "endogenous" and therefore that there's no market price. Just that the Fed had chosen to suppress that market price. Thus, as far as I can tell, it still makes sense to ask the question "what would be the market risk free rate?"
NB: Definitely not in the John Quiggan interview (though I did enjoy listening to it again).
The upshot was that interest rates and/or bond markets might once have been nominally open/free markets, but with the actions of central banks, that's far less the case, and reading activities as market actions is now far harder to judge.
I think issuing fiat money and setting price of credit by fiat are two faces of the same coin. I think the way real interest rates behaved under the "Gold Standard" would be close to an answer to your question.
Not sure, but to your point even during the gold standard there was an element of fiat because the government mandated a convertibility with respect to gold.
Another reason, I've not seen mentioned, is that you think bonds will go even more negative, so you buy now, to avoid having to buy a much more negative rate later.
Those of you (US) with large stock/cash positions: what are you doing to weather the (inevitable) storm? Feels like we’re in the doom and gloom media phase. I suspect lots of people will start forgetting within the next 6 months in which the stock market will go sideways, until the next catalyst which is the US election cycle.
Yeah I get that. What about for people like me who are trying to enter the market? I'm wondering if it's worth it to wait and see, or if I should just not worry too much and invest now anyway.
True, but time in market with educated and not naive timing beats "time in market". Edit: "naive", and that I simply mean to time ETF payments with awareness and possibly technical indicators.
No, its absolutely not "worth" it to "wait and see" unless you have proven clairvoyance. Just invest for the future when you have the money to invest - stock market should be for the long term.
Minimum 3 months of savings, pay off high interest debt, and max out 401k or at very least max out your employer match. Max out employee stock purchase programs and sell quickly.
>what are you doing to weather the (inevitable) storm?
Stay invested in equities. Keep some cash on hand as an emergency fund in case you lose your job, but just don't sell your stocks when the market is down. Stay diversified and stay in the market.
Agree 100%. Always worth noting that you should have an asset allocation based on your risk profile. If you need the money to pay for your kids college and it is less than 5 years away, don't have it in stocks!
Beyond that, equity allocation makes sense. You want to walk the line between not being able to sleep at night because the market is cratering and not being able to sleep at night in 30 years because you don't have enough money saved to retire the way you want to.
Disclaimer: I like this stuff, but I am not a financial advisor.
Stay the course. Don't try to time the market. You just need to avoid the irrational decision to pull your money out of the market because you'll most likely get it wrong and be worse off.
We've had 10 years of prosperity which should have been ample time to secure an emergency fund to weather the storm.
If you have stock gains that you need, and can't live without - consider your exit price, and perform proper portfolio maintenance.
Recession indicators have been in play for about 2 years. If nothing else, be much more aware of your high downside risk - and at least scenario model if we go down to multi-decade lows. Specifically in any items with negative EPShare, or not necessities. We're in the cycle now that hits equities -> mid-consumer spending -> business spending -> consumer spending -> real estate. Don't consider the specifics of this message, but the generalities and apply to life
Prepare for years of lower rates of return; If you own property, you will be able to re-fi in a few years to some very low rates. Cash is king for fire sales - lots of people will be going super broke the next 5 years. House prices will de-value enough, so don't buy property for the next 1-3 years. Stock market can revert to 50% of current values.
Edit: used this technique to purchase my first house, firesale. Will do it again this round, along with other lessons learned ;)
Edit 2: Listen to your own companies investor calls (if large enough) - you can predict upcoming layoffs. If you need a new job, do it now before wages stagnate or deflate some. Place yourself in a line of business that is close to a revenue stream of the business, they're rarely cut.
Each house market would act differently, some with a depressed recovery, some a whipsaw recovery. Watch your own market as the rule applies "last to go up, first to go down". Coastal markets will drop enough, interior less. Here is a good Case Shiller analysis of prices over time for markets.
Buy when it gets near last periods low prices (do own analysis, don't rely on my flippant date mention though...).
Continue investing passively through your 401k, Roth, and HSA. But start spending less, and sock away that extra cash into high yield bank accounts. That way you're investing for your future, while covering any emergency needs in case of job loss. I've been working my way up to a 6-9 month buffer for the last year.
This seems like overly simple advice but it's the best advice you can listen to if you think there is a storm coming. Cutting spending and allocating that money to cash reserves while keeping your usual investment strategy (401k / Roth IRA / etc) is the most effective thing you can do.
If the capital flight away from the rest of the world is bad enough, US markets could even go up during a global recession. That's the thing about the stock market, it goes up and down and you can never guess which.
A cash emergency fund is there to help you weather financial storms, that's its sole purpose.
I have a six figure US stock position and I'm not going to change anything I do as long as I remain employed. Save for retirement/long term in the stock market, save for big ticket items in cash (I have a new car fund, for example). If I lose my job I'll have to stop contributions until I get another job. If I remain unemployed longer term I'd have to tighten my belt on frivolous purchases.
>> what are you doing to weather the (inevitable) storm
Investing every two weeks into my standard allocation that I've decided on, rebalancing when necessary. Anything beyond that is speculation. Especially the concept of an inevitable storm coming. When, how, and where that happens is not something too many people know.
Look at the S&P 500 index from early 2008 to say 2012. Governments will enact policies to prop up the stock and bond markets, as they always have.
Our entire civilization is held up on the promise that financial market indices go up over time, except for temporary recessionary periods. We just accept that retirees cashing out at the wrong time will be victims of 'collateral damage' during these 'market corrections'.
Everything from job growth, to the pension funds that you contribute to, to the municipal bonds governments issue to fund projects, rests on this one core assumption.
After dividends, you broke even after inflation (-0.096% return) if you dumped your life savings into the Nikkei in Jan 1990 and never invested another dime.
But if you kept investing incrementally over the years, like most people do, then annual returns went to 2.5% after inflation in 1995-2000, to 6.5% in 2005 and 9.4% in 2010.
Good point. The Japan case is a weird one. There's a Paul Krugman essay from the '90s that argues it's partially due to a historically high savings rate among Japanese consumers[0]. A good chunk of their boom was export-driven after all.
Loosening monetary policy to fight deflationary pressure in the '90s also didn't seem to work because interest rates were already near zero. I think the US is different because the benchmark Fed rate is 2.25% now after many years of near-zero rates. So there's room to cut rates if needed.
Interestingly, it could also be argued that the breakneck economic growth that some Asian countries went through (in the case of Japan, at least until the 1990s) can be partially attributed to their high savings rate. [0]
I've been trimming positions to increase cash on hand, as much as possible these past three months. I'll likely put it in some of the more stable industry ETFs moving forward, and won't bother with shorting index funds since we don't know exactly when/where the major hits will come.
My take is that this trade war is irrationally based on animosity (even if the sentiment behind it is rational) so my hypothesis is when the tariffs are finally enacted you'll start to see a bigger shift as fund managers figure out that yes, the trade war is here.
Same as always: improve skill-set to 1) live more cost-efficiently 2) provide more value at work. 1) definitely leads to better savings rate over time, 2) probably does.
Not in the US nor have a large $$$ position, but as someone who dabbles a bit in options trading on the side, I've got to say: this volatility is great.
I'm using Questrade, and because I have a self-directed account, I need to put in a buy order manually 1x/month. Is that the way it's normally done?
I used to have a mutual fund through my bank, where I'd set a monthly amount and they'd automatically deposit that into the fund from my chequing account. I decided to try something different since the reporting tools available through the online banking system were very basic.
Cheap Vanguard funds like VFIAX (S&P500) or VTSAX(Total US stock market). No need for managed funds that charge over 5 basis points, you're just wasting money. Then sock away cash in a no fee online high yield banking account like Ally or Marcus.
I'm reducing margin (borrowed money for investing) to zero or near-zero. I'm also building up a savings account. Some of the Democrats could very well push for a pre-election recession in order to make Trump look less re-electable.
Like most economic and finance topics on this site, there seems to be a lot of people posting opinions/"facts" without really understanding the subject matter.
The reason why bonds are trading at negative rates in the EU are the following:
* The ECB deposit rate is -0.40%. Everything else is benchmarked against that
* The majority of the EU is either currently in a recession or rapidly heading there
- Many financial institutions are required to hold a certain percent of portfolio in safe assets. German bunds are among the safest in the world.
- A holder of a bond earns a capital gain (bond goes up in price) when interest rates fall. In that sense, zero is no limit at all because there can always be a buyer willing to accept an even lower (more negative) yield.
- Bond investors are well-aware of the two points above. When they sense that interest rates and/or inflation are headed lower, they know they can profit by buying, regardless of yield.
- Anticipated rate of inflation matters a lot because investors seeking return through yield focus on real interest rates (nominal rate - inflation). Inflation can be negative as well (deflation). If inflation is lower (more negative) than the bond's nominal return, that's a real positive yield. And that positive yield is locked in for the term of the bond, which in the case of the story is 30 years.
- The European Central Bank has repeatedly signaled its belief that zero is no barrier and that negative yields will be tolerated indefinitely. The ECB stands ready for quantitative easing (QE), in which the central bank buys bonds with money it creates from thin air. Investors know this and this compounds the incentive to pile on and buy bonds to enjoy the capital gains (and real returns if the investor believes that deflation is inevitable).
It's likely that all these factors combine to create the current environment. How long all of this can continue is anybody's guess because the situation is without precedent.
It's as if the financial crisis of 2008 was never resolved - just papered over through massive central bank purchases of treasuries and stocks (Japan's central bank owns a major fraction of the value of the Japanese stock market at this point).