There is now more than $17 trillion worth of outstanding negative-yielding debt in the world. Negative interest rates in places like Japan and the eurozone have created the conditions for the birth of something that many people thought was a logical impossibility - a situation where lenders are paid to take out loans, and where savers are charged negative interest for the privilege of parking their cash in government bonds. In a recentĂ Ă interviewĂ with Bloomberg, investing legendĂ Howard Marks (Trades, Portfolio) discussedĂ what the implications of negative rates are.
When rates are negative, is debt a virtue?
Negative interest rates bring with them a lot of weirdness, as Marks pointed out:
âIf a company has a lot of cash, and they put in the bank, and you have to pay money to keep it in the bank - is that a negative? If a company is highly levered - which historically has been a negative, that means they owe a lot of money - but if theyâre getting paid on their borrowings, does that make them a better credit?â
In other words, a lot of the usual rules and conventions start to break down in a negative interest rate environment. It doesnât seem to make sense to treat a company with high levels of debt as a better prospect than an equivalent business with lower debt - but if debt becomes an interest-earning asset, does that change? I donât know, and I honestly donât think anyone else does either.
You may think nobody would want to buy a negative-yield bond. However, as an asset class, they have made some sense for investors. For instance, in a risk-off environment, Marks argued that it might make sense to pay a premium for the safety of government bonds:
âYouâre [the hypothetical investor] afraid and what youâre actually doing is youâre paying the government to store your money. Itâs part of the flight for safety.â
Another reason it might make sense for investors to load up on negative-yield bonds is that they are bet that rates will continue to go lower. It was once thought that negative interest rates were impossible - this is clearly not the case. Whoâs to say that they canât go even lower?
âIf interest rates go down, bond prices will go up. An interest rate can go down in the sense of going from -0.5% to -0.75% - that would make you money, if you own that [negative-yield] bondâ.
The reason why rates have been so low in the U.S., as well as in Europe and Japan, though rates are not (yet) negative in the U.S. - is that they incentivize banks to lend out cash, rather than hoarding it on their balance sheets. The problem is they are not working so well. Marks said they may be having a counterproductive effect on economic activity:
âThey seem to connote an economy where the future is negative. And so they send that signal and the savings rate has gone up in Europe - people are hoarding. There is a concept in economics called âpushing on a stringâ - if you put a string on a table and you push the back, the front doesnât move. Sometimes you canât get people to spend money.â
Economic activity in Europe has been slowing down over the last several years, and never really recovered from the 2008 crisis. Trying the same thing over and over is not going to solve the problem.
Read more here:
- Is the Boeing Narrative Finally Shifting?
- The US Economy Needs the Trade War to End
- 'The Big Short's' Steve Eisman: Quantitative Easing Is Monetary Policy for the Rich
Not a Premium Member of GuruFocus? Sign up for aĂ free 7-day trial here.
