Zero percent yield.

Photographer: Mark Wilson/Getty Images

Maybe Negative Yields Are a Sign of Prosperity

Tyler Cowen is a Bloomberg View columnist. He is a professor of economics at George Mason University and writes for the blog Marginal Revolution. His books include “Average Is Over: Powering America Beyond the Age of the Great Stagnation.”
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Just when it seemed that negative yields could not spread any further, they did. Corporate bonds paying negative interest rates now account for about $512 billion of market value, bringing the world close to a total of nearly $10 trillion in securities with yields below zero. Most are government securities.

QuickTake Negative Interest Rates

There are numerous explanations for this strange and unexpected state of affairs. Some see it as evidence of impending economic doom. Others attribute it to central bank over-reliance on huge bond purchases intended to stimulate economies, and to sluggish growth rates mirrored in bond returns.

I’d like to suggest a more positive alternative perspective. It suggests that negative yields could be around for a long time, but also gives new guidance on what might cause them to disappear.

Start with the long historical view. On average, yields on Treasuries have been falling since 1926 (!), due largely to their safety and liquidity. They've almost become a form of money, offering liquidity and safety comparable to cash. So it shouldn't come as a complete surprise if longer-term U.S. government securities and some corporate bonds recently have followed a similar path because that would just represent an extension of the historical trend. 

Investors Are Paying to Lend in Euros
Average percentage yield on short-dated, high-grade company bonds
 
Source: Bank of America Merrill Lynch Indexes

In this view, very low or negative yields need not reflect major cause for concern. The many years of falling yields include periods of both rising and falling economic growth, so higher global growth in the future may not reverse the trend. In fact, higher growth and greater wealth could raise rather than lower the demand for insurance and liquidity, and thus lower yields.

Perhaps the most overlooked point is that the supply of negative-yielding securities is not so large relative to total global wealth. A recent Credit Suisse estimate suggested that global wealth could reach $369 trillion by 2019, reflecting growth rates of perhaps 7 percent a year. Such numbers are typically inexact, because who can measure the value of all the land in China and the buildings in Uzbekistan? Nonetheless, this number is truly large and it has been growing rapidly. By comparison, the negative-yield securities seem like not such a big deal.  

Maybe it’s time we started thinking of negative securities as the equivalent of fire or earthquake insurance for that wealth. If there is truly $300 trillion in global wealth, is it so crazy to think that investors would pay a premium to buy $10 trillion dollars’ worth of insurance? 

Keep in mind that if you buy securities at a yield of negative 1 percent a year, and equities are yielding 4 percent on average, your insurance cost on the safer securities is roughly 5 percent of the upfront investment.  So on $10 trillion of safe securities, that is an insurance premium of roughly $500 billion -- a relatively small chunk of the $300 or $400 trillion of total global wealth.  In percentage terms it is cheaper than the homeowner’s insurance many of us pay for every day. 

Observers sometimes wonder why there are so many negative yields at a time when volatility indices are not always so high. But the key to the risk-protection insight is not that the world is more volatile, which may or may not be the case at a given point in time, but rather that the quantity of otherwise hard-to-insure global wealth is significantly higher than in times past. It is worth noting that in both China and India, standard insurance remains an underdeveloped sector.

The insurance factor gives us further reason to believe that negative or low yields on safe securities may be with us for a long time. And that's no reason to expect the apocalypse, although the existence of any kind of insurance does imply some chance that negative risks will come to pass.

As to when negative yields might go away or become less significant, there is now a straightforward answer: when Asia and other places become safer places for wealth. That would require less geopolitical risk, greater certainty that economic development will continue, better traditional insurance markets and, especially for China, greater ease of portfolio diversification into foreign equities.

Those developments are hardly around the corner but are plausible in the next few decades. Better insurance markets will eventually come along, the demands for super-safe securities may slack off and yields on the safer securities will rise. Just not yet.

Higher global wealth is a positive development. The world does face some serious risks, but negative yields might just be a sign that you should be less scared rather than more.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

To contact the author of this story:
Tyler Cowen at tcowen2@bloomberg.net

To contact the editor responsible for this story:
Jonathan Landman at jlandman4@bloomberg.net