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Negative Interest Rates Explained

August 1, 2019 | Commentary

  • Negative yielding bonds invoke the image of creditors paying debtors for the privilege of lending them money.  This does not happen explicitly with negative coupons, but it does occur implicitly as bonds are purchased and held to maturity.
  • In this world the newly issued bonds come to the market above par.  The issuing government or company receives more than 100 today as proceeds with the only obligation being to return par at maturity.  Whether the bonds have a zero or small positive coupon, the current price is high enough that the yield to maturity is negative as the owner of the bonds watches the price erode to par over time.
  • Negative yields are more than an economic curiosity.  They also impose a severe burden on the banking systems in those regions as net interest margins get compressed.  This is an ongoing burden particularly on European banks that have already severely lagged U.S. banks in the post-crisis recovery.
  • If the world of negative interest rates persists or grows, one can expect an acceleration in the push to eliminate physical currencies.  In a world where all transactions were done electronically, accounts could be tightly monitored for both tax and regulatory reasons.  It would also allow banks to actually charge depositors, since there would be no alternatives available to avoid the negative interest rates.

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