22 April 2019
Pay rises in the United States have largely stalled in recent years, and US consumers are trimming expenses although the economy appears to have bottomed out. Photo: AP
Pay rises in the United States have largely stalled in recent years, and US consumers are trimming expenses although the economy appears to have bottomed out. Photo: AP

Why investors pile into govt bonds despite negative yields

Western economies, as a whole, are on the verge of deflation.

Advances in artificial intelligence, information technology and 3D printing have been remarkable, but investors are largely overwhelmed by the uncertainties, fearing that technological breakthroughs could mean fewer jobs, eventually doing the economy more harm than good.

Many thus opt for the most conservative strategy with their investments, buying government bonds even when their yields are negative.

Earlier this month, the yields of various government bonds, including those of the Netherlands, Sweden, Austria, Germany, Denmark, Switzerland, France and Slovakia, turned negative – creditors are effectively paying these governments for the right to hold their debt.

Of course, if bonds are in short supply, prices climb, dragging down the yield.

Debt-ridden European governments have been pressed to tighten their belts with fiscal streamlining initiatives, and many central banks have been ordered to cut back on issuing bonds.

At the same time, market demand has soared in the face of the European version of quantitative easing, pushing up the price of already scarce government bonds to higher levels.

Germany’s prudent stance of keeping a lid on government borrowing has further complicated the situation.

With all of these factors, the yields of European government bonds have been falling and even touched or dipped below the “zero lower bound” this month.

Last year, I said in my column that bond yields were unlikely to plunge below zero, as no one would be interested in negative returns.

So why are people scrambling for money-losing bonds?

The answer lies in the “super safe” nature of government borrowers.

At a time when the economic outlook is extremely uncertain, even the survival of individual banks is being doubted (government deposit protection schemes are capped at a certain maximum – usually 100,000 euros (US$114,145)).

The only way to make sure one can get one’s money back is by lending to these governments, which for certain won’t go bankrupt.

Buyers of these money-losing bonds consider the minor losses a sort of insurance fee.

Some may also look forward to currency gains, which can offset the negative yield, as they pile into Danish and Swiss bonds.

Then of course, some funds have to invest a minimum share of their portfolio in bonds, no matter how unattractive the return is.

Negative yields also reflect the deflationary threat as technological achievements cap the demand for labor and therefore wages.

Research by the PEW Charitable Trusts found that the average wage of an American employee rose 22 percent cumulatively between 1979 and 1999.

But the gain in the next decade, to 2009, plunged to a paltry two percent.

With slow growth in income, consumers in the United States have to pinch and scrape as a precaution, although the consensus is that the economy is halfway out of the tunnel.

When more people abandon the American tradition of consumption, prospects for an economic boom look dim.

This article appeared in the Hong Kong Economic Journal on Feb. 10.

Translation by Frank Chen

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A famous Hong Kong writer; founder of the Hong Kong Economic Journal

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