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Wait, Investors Paid Germany To Hold Their Cash?
Originally published on Thu July 19, 2012 4:00 pm
On Wednesday, investors paid Germany to hold on to their money for a couple years.
That's right: Germany got to borrow more than 4 billion euros (about $5 billion), and instead of Germany paying interest to its lenders, the lenders are paying Germany. This a lot like Citibank paying you a smidgen to carry a balance on your credit card or to take out a loan (without also charging you interest).
Germany is just the latest country to get what's called a "negative yield" on its debt. The phenomenon is still rare, but France, Belgium, Denmark and Finland are among countries that have been paid recently to borrow for shorter terms, six months, for example.
Still, selling two-year bonds at a negative yield is remarkable.
As so often happens with unusual economic developments, there are a few possible explanations, ranging from optimistic to pessimistic to scary.
First, the mechanics. National governments hold auctions periodically to borrow money from investors by selling bonds. Those bonds pay investors a given interest rate, or yield.
The precise process differs a little, but the gist is that the investors bid by saying what interest rate they're willing to receive as compensation for parking their money with the government.
In this case, as with the previous examples, investors told Germany they'd be willing to pay it a little bit to hold their money. They won't pay much: The yield is negative 0.06 percent, which means they're paying Germany a little less than many U.S. banks pay customers on savings accounts. But it's still a distinct difference from the normal scenario, where the government pays bond investors.
So what's happening? Three possible scenarios stand out. First, this could be what economists call a "flight to quality." With other European countries looking shakier — think not just Greece, but Spain, Portugal, Italy and more — investors are willing to take a lower return now for a greater likelihood that they'll be paid back in full later.
They could invest in U.S. Treasury bonds, and many people are doing so (pushing Treasury yields to historic lows). But if you make your money in euros, investing in dollars means taking on another kind of risk: The relationship between the euro and the dollar could change while you're holding the bonds, reducing your return.
To avoid that, invest your euros in the safest euro-denominated bonds you can find — like Germany's, perhaps, even if it costs a bit.
The flip side is that this could reflect what's called a "macro" bet on the European economy relative to the world's. If an investor feels that fears about the euro's undoing have become overblown, it might make sense to take U.S. dollars (or Japanese yen or funds in some other currency), and invest them in euro-denominated bonds.
Even if they pay a little bit for the privilege, they could win when they convert their euros back into dollars (or whatever) down the road, assuming the euro has strengthened again relative to the original currency.
In other words, under these two scenarios, Germany's negative yield could reflect growing fears about other European economies — better to pay Germany a little now than lose more later — or confidence in the euro and European economy generally, relative to countries outside the eurozone.
Investors act independently, of course, so Germany's lower yield could reflect a combination of these two strategies, by different investors.
But there's a third and potentially unsettling possibility: deflation. In a way, this is a bleaker version of the first, pessimistic scenario.
Deflation, of course, is the opposite of inflation: a destabilizing spiral of falling prices. Very roughly, everyone waits to buy things (cellphones, cars, houses) because they expect prices to fall. That can become a self-fulfilling prophecy if enough people do it. It sounds great, but it also means companies earn less and start to shed jobs, leaving consumers with less money and a renewed incentive to postpone purchases.
If investors think this is going to happen, the euro could start to get more valuable over time — falling prices mean each euro could buy more. Then, paying a little now to hold German bonds might not be so bad, because it's a way of holding euros safely while they rise in value because of deflation. The rise in the value of the currency could offset whatever interest the bondholders must pay in the meantime.
In other words, the "real" interest rate — the rate after inflation or deflation — is still positive, and investors still make money.
And sure enough, an International Monetary Fund report on Wednesday called the risk of deflation "significant" in the "periphery" of Europe (think: Italy).
The European Central Bank still has tools in its arsenal to fight deflation, chief among them printing money. And the IMF is encouraging the bank to buy huge amounts of government bonds, flooding the economy with euros in the process, which would tend to favor inflation (and thus counteract deflation).
It remains to be seen which of these scenarios is borne out.