In recent days we have seen how the 10-year bond has started to pay negative interest rates, but the question is… how did we reach this situation?
When economic agents have income, this income can be transformed into savings, and these savings can be used to acquire consumer goods, capital goods or financial assets.
Many of these agents decide not to invest in consumer goods or capital goods due to the risk they could entail, and decide to opt for financial assets, since they have a wider range of options to mitigate this risk.
Among this range of assets is the public debt of solvent governments. It is considered a very attractive financial asset, as it diversifies its risk among all taxpayers, making it a very safe asset.
If the demand for government bonds is very high and the supply very low, the price of government bonds rises (as with any other asset), so if government bonds rise, the yield on the bond will fall, as it will not need to provide such a large return to the investor, and may even go into negative territory (which is what has happened).
But then… what does offering negative interest rates mean? Well, it means that the saver who lends his capital to this state will obtain as final capital a lower amount than the one he initially granted.
We could then ask ourselves what an investor who decides to invest in public debt gains, if by depositing the capital in a simple bank deposit he would obtain the same capital, without incurring losses.
The answer is simple. For individual savers, with small amounts of capital, it is true that it benefits them to have a bank deposit, since such deposits are guaranteed up to 100,000 euros by the state, and therefore would not harm them at all.
However, those who have a larger amount of capital cannot afford to deposit their money in a bank deposit, since, in case of bankruptcy of the entity, they would lose a large part of their savings.
Let’s say an investor deposits 5 million euros in a current account with a bank. After two years the entity goes bankrupt, so our saver will lose all his capital, except for the 100,000 euros guaranteed by the state.
This is why large holders of liquidity prefer to invest in a government bond, which guarantees the viability of their capital and gives them a small percentage return, even if they have to pay a small amount of interest to maintain their capital (in the event that interest rates become negative).
In short, if a government bond has a low interest rate, it means that the country is solvent, offers security, and therefore offers a lower return.
If, on the other hand, a country offers a higher interest rate, it means that the country offers less solvency, and applies a higher yield in order to attract more financing from investors.
A very simple practical example. Germany is much more solvent than Venezuela, Germany offers an interest rate at 0, because as it is in a good economic situation, it is not necessary to offer higher profitability to investors because even being at 0, they will want to invest in Germany.
Venezuela, on the other hand, is a risk to invest in, since at one moment or another you can see how your investment becomes 0 due to the bad situation in which they find themselves. That is why they have to offer a higher profitability to attract external capital.
It is here where investors who want to keep their capital choose countries with a good economic situation, even if they do not grant high returns, having the peace of mind that their money is safe without any risk.
