Some things in life are just a mystery. What happens when you Xerox a mirror? If you were in a Volkswagen traveling at the speed of light, what would happen when you put the headlights on? Why would anyone buy a government bond with a negative interest rate?
The answer to the latter is particularly intriguing. Just this morning, Germany auctioned a two-year government bond yielding -0.38%. Germany now joins Belgium, France, The Netherlands, Japan and Sweden in offering negative two-year rates. Belgium, Germany and The Netherlands will pay you less than nothing on their five-year bonds. The Swiss 10-year bond yields -0.35%.
Why buy a bond with a negative yield? In the words of Will Rogers, it’s because you’re less concerned with the return on your money than with the return of your money. You figure losing a little money over two or even five years is better than what could happen in other investments. By all measures, this is a dour outlook for Europe by the bond market.
From a government’s point of view, this is one heck of a deal, and raises the intriguing question of whether the government can reduce its debt burden by issuing debt. (Governments usually roll over their debt, rather than pay it off. It’s one of the many ways a government budget differs from a family budget).
On a more practical level, negative interest rates typically guarantee that your currency will fall vs. other, similarly creditworthy countries with higher interest rates. This is certainly the reason for negative rates in Switzerland: The Swiss franc had grown so strong as to be a drag on the economy. For exporters like Germany, a lower currency is a wind at the back of exporters, making German goods cheaper abroad.
And for countries whose economy needs a boost, negative rates gives them the chance to borrow on insanely favorable terms and use the proceeds to rebuild infrastructure — roads, schools, airports and other civic improvements. So far, however, most countries have cut back spending in weak economic times, making the economy weaker. Perhaps the bond market is onto something.