When Yields Go Negative
This week Germany conducted a 2-year government bond auction. While the yield was in line with where secondary bonds had been trading, the result was nevertheless quite remarkable. Te yield was -0.06%. That's right, negative 6 basis points. Buyers of the note literally are paying the Bundesrepublik to take their money.
Macroeconomic theory long held that this was impossible. As soon as bond yields fell to zero, all incentive to hold bonds went away. Even given deflation, where in theory the real yield on bonds might be positive, the fact is that zero-yielding cash becomes the better alternative vs. negative yielding bonds. No reason to hold the bonds. Investors would hoard cash instead. Indeed, this zero bound on interest rates has long vexed economists. If equilibrium interest rates needed to be below zero, which could easily be in a low-growth, low-inflation environment, real life interest rates could never go that low. The money markets would not clear and monetary velocity would plummet, exacerbating the deflationary problem. This is what John Maynard Keynes called the Liquidity Trap....516 more words left in this article. To read them, just click below and try Real Money FREE for 14 days.
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