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Recently, news of negative interest rates on government bonds from various countries like Germany, Switzerland, Japan, and New Zealand has caused a buzz in the financial press. Even the possibility that U.S. Treasuries could in the near future have a less than zero yield has been raised. How has this seemingly paradoxical phenomenon come to be?

Well, according to conventional financial wisdom, a lender must be compensated for parting with his capital. He is giving up the opportunity to spend his wealth today and should be paid for the inconvenience. On the other hand, the borrower is willing to pay this compensation because he will be able to use the loan for a more profitable purpose. Therefore, we should expect positive interest rates when we loan money to banks through deposits or to governments through the purchase of bonds.

However, many economists have noticed long-term (or secular in economic jargon) factors in the modern global economy that help drive these rates down. The most important is the demographic profile of economically developed nations. With rising life expectancies and the prospect of hopefully decades of retirement, the time-preferences of investors in affluent societies shift from those in earlier, poorer eras. Ensuring future consumption in one’s golden years gains more and more importance over further present consumption. People are willing to give up more compensation for lending their wealth, if they believe the borrower (such as a federal government) can be trusted to return the money at that ever more important future time. Also in modern developed nations, the borrower may see less opportunity to profit from the loan. As the populations of Western countries steadily increased following the start of the Industrial Revolution, there was always growing demand for more trains, more factories, more cars, and more housing from the expanding younger generations. Possible, profitable investment opportunities proliferated under such conditions. However, as family sizes and populations decline in developed countries, the prominent, prudent opportunities for profit diminish. Thus, the fees that borrowers are willing to pay for loans get smaller.

The conditions listed above help depress real interest rates. The nominal interest rates that make news in the press are also influenced by the various central banks. In places like Europe and Japan, where there is significant wealth but seemingly perpetually stagnant economies, the banks have consistently tried to push down borrowing costs to jumpstart growth. This moves their yield curves into the negative range. The U.S. is able to avoid this scenario in part because there remain greater growth opportunities here than in other developed regions. However, an economic slowdown or persistent uncertainty about tariffs could push the higher American rates into the brave, new negative world.



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