Negative Interest Rate Government Bonds

Right now there’s a lot of talk about negative interest rate government bonds. Let’s understand what this means for the US and the rest of the world. Are negative interest rate bonds a sign of recession?

Negative interest rate bonds

Most nations and some regions in the world have a central bank. Some central banks are run by the government. Others are privately owned. These central banks try to influence their national economy for the better.

Some of these central banks have tried quantitative easing to stimulate national economic growth. QE means that governments have been paying to buy back their own bonds. This hasn’t worked out well.

Now governments are going the other way. They are selling a new kind of government bond–long term government bonds that pay a negative rate of return upon expiration.

In other words, negative interest bonds are bonds that a government expects to make a profit from at the end of the bond’s lifetime.

Does this sound incredible to you? It is. Who would bet on a horse they knew would lose?

The answer is speculators. They’ll bet that they’ll know when negative bond interest rates will go even lower and some other investor will want to pay a higher price to the speculators than they paid for their bonds.

Michael Mackenzie brands this “the ‘greater fool’ theory of investing”.

Why governments sell these bonds

During the recent Eurozone crisis over a possible Greek default, Germany began to sell negative interest government bonds. Investors seeking a safe haven from falling stock prices began buying these bonds by the boat load.

When the China financial crisis and the oil price declines hit, investors around the globe began panicking.

In late 2015, when the Fed increased its overnight borrowing rate for banks, that boosted the value of the dollar in comparison with other kinds of national currencies. Other global currencies, including China’s, became relatively weakened against the dollar.

Because the US dollar is the most frequently-used method for making payments in most places in the world, it now costs foreigners more of their own country’s money to buy a dollar’s worth of goods anywhere in the world.

That change negatively impacted all kinds of prices around the globe, particularly the stock prices of multinational corporations and the ability of consumers to pay for foreign goods.

The economies of developing nations that rely heavily on imports and exports have been particularly hard hit.

Capital flows into many developing nations in Asia, Africa, Eastern Europe and Latin America are shrinking. Meanwhile, the US economy is threatened by lack of overseas customers for US exports by its multinational corporations.

Central banks issuing negative-rate bonds

Negative-rate interest government bonds could signal recession in Europe and Asia. They indicate investors think inflation is not on the near horizon and that central banks anticipate the possibility of deflation in the near future. The list includes:

Germany
Switzerland
Denmark
Sweden
Bank of Japan
Belgium
France

The question is will the US hop onto that bandwagon too? Gillian Tett reports the Fed now requires US banks’ stress tests include a scenario for anticipating negative effects of negative-rate government bonds. Tett says

…JPMorgan issued a piece of research which suggests that central banks now have the technical tools to cut rates to minus 4.5 per cent in the eurozone, minus 3.45 per cent in Japan, minus 2.7 per cent in the UK and minus 1.3 per cent in the US. But nobody knows any more if even that (unlikely) scenario is the floor.

Tett suggests that what George Soros called ‘reflexivity’, i.e. panic at falling prices that makes people frightened enough to create even more decline in prices, is happening even now.

Negative interest rate government bonds are long-term bonds (10 to 30 year bonds). These bonds would most likely be bought only by very wealthy people, speculators, or large institutions seeking a safe haven from volatility of prices in other financial markets.

For the average American we have already hit bottom. We are coping in a world where even one percent or two percent interest on savings seems like a dream. Five percent interest on short-term Treasury bills feels like a fairy tale. Since the Financial Crisis we’ve seen close to zero rates of interest.

The average American probably aren’t going to buy bonds that pay zero or negative yields. However, consumer sentiment in the US continues to fall. Consumer spending could drop. Soros’ reflexivity theory could prove to be right if we let panic rule our decision-making.

If deflation does hit the US, prices will likely go down until consumers and producers decide to start spending again. That includes foreign consumers of our exports and multinational companies that produce our goods and services. It could be a good time…for those who have the cash to spend. And that’s the rub.

Without a solution to rising global income inequality, the future of the our economy doesn’t look rosy right now.

 

 

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