Why would anyone in their right mind purchase a government bond with a negative yield when doing so means that at the bond’s maturation date, the investor will receive less money than was originally invested? Well, believe it or not, today investors are making the decision to purchase negatively yielding bonds in many of the world’s bond markets. Some estimates indicate that almost $10 trillion dollars worth of negative yield securities are currently being held by investors. This figure represents over 40% of the total volume of outstanding government-issued securities.

Recently, demand for the 10-year German Bond (Bund) has become so high that the price investors have to pay to acquire the bond is at a level that the yield-to-maturity of the bond is in the negative range. Currently, the 10-year Japanese bond also “offers” a negative return. Germany and Japan can now borrow money for 10 years without paying any interest at all. From the investor’s viewpoint, these governments now get paid for the privilege of holding investors money.

Let’s return to our original question: Why would anyone purchase a bond with a negative yield? The answer depends on the size of the investor’s portfolio. For the small, typical consumer investor, it is unlikely that this investor would purchase such a security. The small investor could easily turn any asset into cash and hold the cash in the form of currency, money market account, or bank saving instrument in the form of an FDIC-insured deposit. Even if the yield on these accounts is zero or near zero, that rate is higher than the negative yield of the bond. The problem with this strategy is that FDIC insurance limits are very low, and large volume investors must look elsewhere for depositing cash.

Imagine you are responsible for managing a portfolio with billions of dollars of assets. Bank deposits are out of the question. One option would be to purchase a large vault and simply hold the cash. Of course, one would need to purchase the vault and place it in a secure location. The investor would most likely wish to insure the vault and its contents, and purchase security to protect the vault. Obviously, this method of holding cash is not without costs. It turns out that for many institutions, the preferred method of holding large volumes of cash safely and relatively inexpensively is to give those funds to large stable governments, even if the amount received at the end of the holding period is less than the original investment.

Many of the world’s major investors now believe that the expected return of traditional markets (i.e., equities, derivatives, commodities) may be less than the guaranteed return of safe, government bonds, even if that yield is negative. Plus, in many economies, actual deflation or the possibility of deflation exists. In that case, the negative yield of a government bond might result in a positive “real interest rate” after the yield is adjusted for price changes.

Dr. Ed Seifried is Chief Economist and Strategic Advisor at BNK Advisory Group. He is also professor of economics and business at Lafayette College in Easton, PA, and a faculty member of numerous graduate banking schools, including Stonier Graduate School of Banking and the Graduate School of Retail Bank Management. He also serves as dean of The West Virginia and Virginia Banking Management Schools. Dr. Seifried is a nationally recognized speaker and is the author of both academic and popular articles and books. He is the co-author of BNK's Art of Strategic Planning in Community Banks and The Art of Risk in Community Banks, a series for the committed bank director. He holds his doctorate in economics and business from West Virginia University.

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