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BROOKE FOX: Why would anyone want to buy an asset that they knew would lose money? Like any fixed interest rate asset, when you buy a bond, if you pay a higher price for it, you get less back in terms of yield.
Now, yield just refers to the interest rate that a lender gets in return for lending money. So just remember, the higher the price, the lower the yield. The two have an inverse relationship.
Now this chart is looking at the yield on the German 10-year government bond, which they call The Bund. Now, as you can see, the yield on the bund has been declining, and declining so much lately, that it's actually gone into negative territory. This happened for the first time back in 2016. But we're actually at a lower rate now than we were back then.
What this means, essentially, is that people are paying such a high price for these German bunds that they know that they're paying for more than they're going to get back. Why would anyone do this? They're paying for the privilege of losing money. Why wouldn't you just hold on to it?
Well, let's start by talking about European banks. The ECB charges European banks 0.4% to hold their money in deposits. Now, -0.4% is actually much worse than -0.2 or -0.3% from the bank's perspective. So they'd much rather put it in these bunds than with the ECB.
And this is actually by design. The ECB wants banks to invest their capital out into the economy, rather than just sitting on the cash.
Now, here's a second reason that some investors might want to buy these bunds. It's because they're safe and they're liquid. So the German government is considered a reliable borrower, making their bonds safe. They also can be traded on the secondary market relatively quickly, which makes them liquid.
If the Euro zone economy goes down, then assets like equity or corporate debt, they're going to perform much worse than these German bunds will. So even though there's negative yield, it's a price investors are willing to pay for that safety and liquidity.
Now here's a third reason why someone might want to buy these negative-yielding bunds. The ECB has recently signalled that it may want to buy more sovereign debt. That would push up the price of these German bunds.
So if you're an investor and you think the price of something is going to go up in the future, you may buy it now so that you can sell it later, making yourself a little profit.
So these are just some of the reasons why people may want to buy German bunds, even though they have a negative yield, but it's not all of the reasons.
In general, it's important to know that even though it's, on its surface, it may seem silly to buy a negative-yielding asset, there are some reasons why it actually makes sense, even though, right now, it essentially looks like a guaranteed loss.