Being Paid to Borrow Money Isn’t So Bad

(Bloomberg Opinion) -- A Danish bank is now offering mortgage bonds with a negative interest rate. So if you’re willing to buy a house on borrowed money, Danish banks will pay you for your trouble..Reaction to this state of affairs — which, after all, is beneficial to borrowers, which almost all of us are at some point — has been fierce. Negative interest rates have been called idiotic, unnatural and a tax on virtue — and that’s by economists. For most other people, including many in finance and investment, they’re just bewildering..But zero is just a number, and a drop in rates from 5% to 2% is not so different from a drop of 2% to -1%. In reality, this is all just old-fashioned supply and demand at work..Worldwide, there is now some $14 trillion in debt with a negative yield. In Germany the yield curve is negative, which implies that the German government can borrow money for any length of time, from 30 days to 30 years, and actually be paid to do so. So why would anyone buy German bonds? And why doesn’t the German government go on a spending spree?.The second question is easy to answer: The German government is fiscally responsible to a fault and cannot even be bribed into increasing its deficit. The first question has a straightforward answer, but it is not intuitive: Savers are willing to accept negative interest rates because the German government is providing them with a valuable service that they can’t find elsewhere at a better price..Think of savers as people looking for a way to decrease their spending today so that they can increase their spending tomorrow. Those with only modest savings could simply withdraw their cash and keep it under the proverbial (or literal) mattress. This not without risk, however. They could be robbed, or their house could burn down. They could install a safe to protect them from that risk, but that would cost money.For people with more money to save, of course, keeping it in a home safe is impractical. A hundred thousand dollars in a home safe is risky. A million is courting disaster. Safely keeping $10 million in bills is just about impossible. Pablo Escobar’s accountants reportedly assumed a 10% annual loss rate on his stores of physical cash..Yet there are businesses, non-profit organizations, governments and even high-net worth individuals who need or want $10 million — or much more — in liquid assets. Some kind of financial product is their only real option..They could turn to traditional money-market funds, but as my colleague Brian Chappatta points out, that’s no guarantee either. Money-market funds reinvest their holdings in assets like government bonds, and as bond yields go down around the world, they will find it increasingly difficult to pay out their yield. To make matters worse, as yields collapse, money-market funds can (and do) go bankrupt..The German government’s fiscal stability means that you can be sure it will at least pay you what it promised. That sort of guarantee is not a deal investors can get anywhere else. U.S. government bonds still offer a positive rate of return, but if you live or do business outside of America, buying U.S. bonds exposes you to exchange-rate risk..Underlying all of this is demographics. For decades there have been warnings about how declining fertility rates threaten the solvency of programs like Social Security: There won’t be enough taxpayers, the theory goes, to fund the payments going out..What’s less well understood is that this same phenomenon applies to private capital. Savers require borrowers with sufficient stability and earning capacity to pay them back. In Japan, Europe and increasingly the U.S., there just aren’t enough low-risk borrowers to go around..This turns expectations on their head. From the dawn of the Industrial Revolution until recently, the population of Western countries had been steadily increasing. So there was always demand for more trains, more factories, more cars, more housing, more retail to serve the expanding population. By investing prudently across a diverse set of assets, financial institutions could all but guarantee savers a net positive return..That’s no longer true. Even housing has proved riskier than anyone imagined. That leaves well-established Western governments as some of the world’s only remaining risk-free borrowers. Yet the ranks of savers only continue to grow..Which brings us back to Denmark. The population of Danes aged 40 to 59 is projected to decline over the next decade. Someone who purchases a house now may have real difficulty finding a qualified buyer 10 years from now. Danish mortgage laws are notoriously stringent and designed to ensure that the borrower, not the bank, bears the risk..So in a very real sense the borrower is doing the lender a favor. She is guaranteeing the savers who fund the loan that they will get paid, in exchange for an asset whose value is not at all guaranteed. There are higher return investments available, but they don’t come with steadfastness of the Danish homeowner..Negative interest rates can be unsettling, and not just for savers. But they’re merely reflective of the world around us. The developed world is aging, and uncertainty — whether political, economic or technological — is rising everywhere. The supply of risk-free investments is scarce, and savers will have to be willing pay for them..To contact the editor responsible for this story: Michael Newman at mnewman43@bloomberg.net.This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners..Karl W. Smith is a former assistant professor of economics at the University of North Carolina's school of government and founder of the blog Modeled Behavior..©2019 Bloomberg L.P.

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Being Paid to Borrow Money Isn’t So Bad

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