[apo]

For those wondering why anyone would buy such a thing, consider:

- Many financial institutions are required to hold a certain percent of portfolio in safe assets. German bunds are among the safest in the world.

- A holder of a bond earns a capital gain (bond goes up in price) when interest rates fall. In that sense, zero is no limit at all because there can always be a buyer willing to accept an even lower (more negative) yield.

- Bond investors are well-aware of the two points above. When they sense that interest rates and/or inflation are headed lower, they know they can profit by buying, regardless of yield.

- Anticipated rate of inflation matters a lot because investors seeking return through yield focus on real interest rates (nominal rate - inflation). Inflation can be negative as well (deflation). If inflation is lower (more negative) than the bond's nominal return, that's a real positive yield. And that positive yield is locked in for the term of the bond, which in the case of the story is 30 years.

- The European Central Bank has repeatedly signaled its belief that zero is no barrier and that negative yields will be tolerated indefinitely. The ECB stands ready for quantitative easing (QE), in which the central bank buys bonds with money it creates from thin air. Investors know this and this compounds the incentive to pile on and buy bonds to enjoy the capital gains (and real returns if the investor believes that deflation is inevitable).

It's likely that all these factors combine to create the current environment. How long all of this can continue is anybody's guess because the situation is without precedent.

It's as if the financial crisis of 2008 was never resolved - just papered over through massive central bank purchases of treasuries and stocks (Japan's central bank owns a major fraction of the value of the Japanese stock market at this point).

[solatic]

> - Many financial institutions are required to hold a certain percent of portfolio in safe assets.

In practice this is turning into unnatural demand guaranteed by the law, which goes against free markets and will eventually implode upon itself. If you force the market to buy a certain product regardless of quality, then the underlying quality of that product will erode (as there is no longer an incentive to provide quality and quality implies cost), and the market will evaporate as stakeholders disappear and move to other markets which do assure real quality. That there was natural demand for such products in the past, and indeed that natural demand may coincide with unnatural demand in the present, is not a guarantor for demand levels staying natural in the future.

In context, this creates underlying pressure for investors to divest from Euro holdings. It's likely that investors are currently sticking with the Euro because they have few other avenues for escape, but this is not likely to hold - whether due to Brexit/Euroskepticism or some other external crisis which changes the playing field.

[landivar2]

When you have a central bank that can control rates, no alternative money, and the bank can set rates negative, the equilibrium is for the government to own almost all assets. I'm not kidding. You will end up with communism, only via government regulation of rates, unless something breaks this up.

[kthejoker2]

If our capital markets are so unproductive that having the government own the assets is considered a net economic gain, we'll need all the communism we can get.

The central bank does not "control" rates, they respond to the market signaling where rates should be.

[whatok]

Good post that covers nearly everything. The only thing I would add to this is that the ECB's deposit rate of -0.40% is the only thing that has enabled all of this.

[wcoenen]

This would explain negative bond rates down to -0.40%. Because if you need to park a very large amount of euros safely, banks will start to apply that rate to your deposits so it's better to get any rate that is less negative.

But curiously 10y german bund yields have recently hit -0.70%, and a couple other EU countries (France, Netherlands, Belgium) have also dipped below -0.40%.

So it must be more than the negative deposit rate. It's also the QE program which buys bonds (though it's on hold since the start of the year), and the expectation of lower deposit rates, and the expectation of more QE.

[whatok]

I agree with all of this and probably could have phrased my original post better. My main point is that none of this is really possible without ECB rates being set where they are. Successful monetary policy requires multiple tools to be utilized and the deposit rate is the main tool that anchors everything else. QE in itself does not mean rates are going to be lower. You need central bank rates to also be low in order to have lower government rates. Rates didn't suddenly skyrocket after the ECB announced the end of QE.

[wcoenen]

> Rates didn't suddenly skyrocket after the ECB announced the end of QE.

That's because the QE program only stopped increasing the ECB's assets. When bonds that are held by the ECB mature, the equivalent amount in new bonds is still being re-bought.

I don't think negative deposit rates are really needed to have negative bond yields. You only need a bond buyer (e.g. the QE program) who drives up bond prices beyond the face value + all coupons. Negative interest rates were just a natural step in the progression of lower rates, zero rates, negative rates, and QE. The next thing will be some form of helicopter money.

[whatok]

> That's because the QE program only stopped increasing the ECB's assets. When bonds that are held by the ECB mature, the equivalent amount in new bonds is still being re-bought.

Reinvesting maturing proceeds does not produce the same effect as net purchases. One, maturities are lumpy vs regularly scheduled net purchases. There have been rate shocks where idiosyncratic country events happened outside of maturities. Two, while the ECB can basically do whatever it wants, no new net purchases restricts its ability to act in an emergency. Three, size is much smaller.

>I don't think negative deposit rates are really needed to have negative bond yields. You only need a bond buyer (e.g. the QE program) who drives up bond prices beyond the face value + all coupons. Negative interest rates were just a natural step in the progression of lower rates, zero rates, negative rates, and QE. The next thing will be some form of helicopter money.

Note how I didn't mention anything about negative rates in particular; just low rates and that the deposit rate anchors things. Whether rates are negative or not really doesn't matter in isolation. What matters is the spread vs other less risky assets for the goals of the central bank. If a central bank indiscriminately purchases bonds without regard for existing yields or the deposit rate, they will quickly lose control over the market.

[AdrianB1]

Actually the ability of the ECB to print money out of nothing is the main enabler.

[whatok]

The ECB printing money is a factor in stabilizing rates but it in itself does not create conditions where governments are able to borrow for 30 years at negative rates. For example, if the deposit rate was at 3.00% instead of -0.40%, governments would not be able to issue at negative yields; QE or no QE. Additionally, the ECB stopped net QE purchases at the beginning of the year and negative rates are still a thing.

[arez]

isn't that the it's job? It hands out loans for money it doesn't have but can steer the market with the interest rates

[logicallee]

>- Many financial institutions are required to hold a certain percent of portfolio in safe assets. German bunds are among the safest in the world.

Can you explain how this can possibly beat cash? If I say to you "I'll let you pay me ten cents to hold onto your $100 bill for a while, and give you a paper showing the obligation to repay your $100" (the meaning of a negative yield bond), how can the offer to let you pay ten cents to let me hold your $100 possibly be less risky than just holding the $100?

Why would a bond with a negative yield ever be a safer asset than just holding the cash?

[toast0]

Holding cash usually means putting it in a bank account. The banks are going to put a significant portion in their country's central bank; the European central bank and member central banks are currently charging banks to store money; at large balances, those banks will charge customers.

Now, you could put cash into a USD account at a US bank, where interest is still currently positive, but if you were storing Euros, you now have currency risk and jurisdiction risk. Negative rate German bonds have less risk than that.

[tempestn]

Of course you could take physical cash and put it in a safe or something, but that doesn't scale well. Although maybe it does suggest a lower limit on negative interest rates, where it would actually be cheaper to store large amounts of physical cash...

[umeshunni]

You have to buy a safe, you have to have a location to store it, you need to secure the location. You need to ensure that the safe is temperature and humidity controlled, so that the currency doesn't mold, rot etc.

These costs add up. Once you've done all of those things, you're essentially a bank.

[dgacmu]

+this. As a thought experiment, assume you need three full-time guards to store 100M €. Two physical and one watching the video. (why two? Less likely your guard steals all the money).

Salaries of 30k €/year. 8760 hours/year, one FTE works 2080 hours/year, so that's 4.x times 3x redundant guards, or about 500k €/year with overhead.

That's half a percent negative return.

Presumably, the physical storage cost creates a lower bound on how negative the inflation rates can go, but I'm sure I left off a bunch of other things that would add to the bottom line costs of this proposal, such as insurance.

[javert]

Instead of having a vault with just 100M euros, it probably makes more sense economically to build a huge vault that can store billions of euros, and then charge people to use the vault.

[repsilat]

It seems absurd that the cost of storing physical notes should have an impact on workable interest rates. Surely if the government wanted to allow you to sock away vast sums of money, they should provide a secure electronic sock and avoid the destruction of wealth that is your security costs.

And conversely, if they didn't want to provide the bed for you to keep your money under because it would defeat their interest rate policies, they should (and might) make putting money under beds illegal.

It just doesn't make sense for the sizes of socks and beds and cash denominations, and the security of locks, and the wages of security guards to determine macroeconomic policy.

[nabla9]

Cash is universally considered the most liquid asset because it can most quickly and easily be converted into other assets.

If the amount of physical cash is huge however, say 1 billion euros, it can be less liquid than German government bonds. There is cost of moving, counting, securing it and significant delay for buying and selling. If you try to buy something for 1 billion EUR in cash, it might cost 100k EUR to do so and few days until you can buy anything.

But you are correct, there is probably a limit after wich banks start to convert some part of their assets to cash.

[arez]

the ECB also removed the 500€ bill, so the cost of storing cash went up, because you need greater storage, at least that was a theory that I heard

[nabla9]

Indeed. 500€ bill was known as "Bin Laden" because it was so hard to find one. It was estimated that 90% of the bills were held by drug dealers, money launderers and other criminals.

[princekolt]

They're gorgeous though. Because they're so low circulation, when you do get to see one they look brand-new. My father got one from a currency exchange this year and when he mentioned that I had to take a picture of it: https://imgur.com/a/aiaZmP2

Edit: I suppose since it was an exchange outside of Europe, they probably wanna put them in circulation before they lose legal tender status.

[nabla9]

They will maintain their legal tender status. ECB just stopped printing more and existing notes will be removed from circulation when they enter the banking system.

[auntienomen]

The world is different when you're dealing with really large amounts of cash. You can't just store it yourself; your mattress isn't big enough. And if you ask a bank to store it for you, the bank will charge you for the service. (Banks that work in this line of business are known as 'custodian banks'.) Consequently, the effective interest rate on cash for large amounts of cash can be negative.

[whatok]

You can argue safety (bonds you have sovereign default risk vs cash will have bank credit risk) but your math is not incorporating how a transaction in this case would actually take place. It's not as simple as just holding onto $100. You have a deposit rate of -0.40% at the ECB. So instead of -0.40%, you settle for -0.14% which is what these newly issued Bunds are yielding.

[DennisP]

Not a safer asset, but possibly a more profitable one, since if interest rates go down even further, you can sell your bond for a capital gain. To see how the numbers look out, go to https://portfoliocharts.com/2019/05/27/high-profits-at-low-r...

Of course if interest rates go up, you have to keep the bond until it matures (earning less interest than you would with a new bond), or sell it for a capital loss. But this is always a risk with long-term bonds, and institutions still hold them.

[FPGAhacker]

That's a great link, thanks!

[blawson]

Maybe at certain sums much larger than individual depositors concern themselves with, you can't just "hold the cash".

Like banks might say there is no way we want your $10 billion in cash to look after. Either invest it yourself or pay us to invest it for you.

[josefx]

You really don't want $10 billion in a bank. Laws mostly guarantee a few hundred thousand per account holder if the bank itself has financial issues. You would have to spread that amount over quite a few banks if you wanted it secured.

[noah_greeen]

As some people already mentioned, the problem is the amount of cash you would have to keep safe somewhere. As far as I know, there are companies that use tunnels in mountains to act as huge cash depots. But such a storage also comes at a price. Also to prevent this kind of business, the European Central Bank already considered dismissing the 500 Euro bill. With that the physical amount to store would be even bigger. (The german economics professor Hans-Werner Sinn mentioned this once in a talk)

[arez]

the 500€ bill is already not produced anymore

[kovek]

A lot of commentators are discussing the drawdowns of storing cash bills. However, who buys bonds by paying with physical cash bills? Most of us have a number in our bank account that reflects some sort of wealth? (Ownership of a security elsewhere or an I Owe You?) People with a salary directly deposited and big companies do not need a bank to store their physical cash bills.

I’m still trying to understand how this all happened.

[whatok]

The ECB charges banks -0.40% to deposit money with them. These bonds are currently yielding -0.14%. Rates are not low enough to the point where physical cash is a thought. Rough estimates are a deposit rate of -0.75% where you would make more by holding physical cash.

[peteretep]

OK, so you have a bank balance of $1m, rather than paper bills. Your bank can go bust -- it does happen -- and you'll probably find that the Government only insures/guarantees something like the first $100,000 of that. However, the government here are selling you 30 year storage and guarantee of your balance at a small cost (the negative interest).

[shpongled]

Also, you can sell or buy bonds at any time - you're not locked in for 30 years. I think this is a crucial point many don't understand

[simonebrunozzi]

Great comment, however:

> the central bank buys bonds with money it creates from thin air

QE generates inflation in the long run, which would by definition make these bonds less valuable over time.

[dvfjsdhgfv]

> - Anticipated rate of inflation matters a lot because investors seeking return through yield focus on real interest rates (nominal rate - inflation). Inflation can be negative as well (deflation). If inflation is lower (more negative) than the bond's nominal return, that's a real positive yield. And that positive yield is locked in for the term of the bond, which in the case of the story is 30 years.

But for this and the other reasons you mention, wouldn't cash be in any case better than the bonds?