Economic Recovery

Hey... Govt borrowing costs just went negative

Government borrowing costs just went negative, yet politicians fear debt and are bringing back austerity just as our worst recession in a century takes hold. Bernard Hickey looks at the disconnect.

It happened just after 2pm on Thursday, September 10, via the results of bond tender 738.

This is what that announcement looked like, which may explain why this article is the first you've probably heard of it, even though it is one of the most significant events in our economy's history, and for our Government.

The clue is the tiny minus sign on the yellow highlighted line.

Blink and you'd miss it.

Fair enough.

History-making events in New Zealand bond market tend not to lead the six o'clock news, especially in the middle of a pandemic where more New Zealanders get their (mis)information from Facebook and Youtube than TVNZ's OneNews or TV3's Newshub. Understandably, Health Minister Chris Hipkins' warning to Kiwis not to be believe or spread conspiracy theories about the pandemic led the bulletins in the wake of bunch of Covid-19 denying parishioners extending Auckland's lockdown for a few weeks - at a cost of $500m per week, Treasury reckons.

The public's ignorance of the bond markets is fair enough, but it's also a pity for a bunch of reasons.

Firstly, these historic events are the canary in the mine of a major shift in the way our governments view spending, taxing and borrowing.

Secondly, they are a direct reflection of epic events happening in the real world and can tell us when something major is happening under the surface and away from the public's gaze. The pandemic, the misinformation, the fear of investors and the Government's response are all directly connected and mixed up and expressed into one variable -- the Government's borrowing costs.

This week the Government was able to borrow at a negative interest rate for the first time.


The Treasury's Debt Management Office (DMO) announced on Thursday it sold $50 million worth of inflation indexed bonds maturing in 2040 at an average yield of minus 0.1032 percent. The DMO reported there were 22 successful bids for the bonds from fund managers where they paid the Government money to lend their money to the Government.

There was even one fund manager who bid a negative rate of minus 0.165 percent to park their money with the Government. There were actually 27 bids worth $72m to pay the Government money to look after the $50m of their money. That means there are fund managers out there this week with so few places to put their money and so afraid of the future that they are willing to pay more than $1m for a piece of paper that guarantees they will get $1m back in 20 years time.

The way these bonds work is they pay a regular interest rate or 'coupon' of 2.5 percent per annum, on top of an inflation payment equal to the Consumer Price Index. But these bonds are sold as fixed interest securities, which mean that each $1m bond is priced including the coupons. Therefore, as the price of the bond goes up, the market 'yield' or interest rate goes down. As investors worry more about low inflation and have nowhere else to put their money, they effectively bid up the price of the bond and push down the yield.

Here's the formula. You're welcome.

But the price they paid this week was so high that the effective yield was negative.

Become a security guard

On the face of it, that seems ludicrous. Why would anyone give $1m to a Government for 20 years knowing they would get back less than $1m? Surely they could just take the money out in bundles of physical cash Breaking Bad-style and put that under the fund manager's desk or in a safe out the back?

The trouble for the fund manager is the costs of holding money in a cash form like that are higher than just paying the Government to look after it. Demand for safes and security guards and locks and rubber bands has exploded in recent years. Along with demand for diamonds, art works and vintage sports cars, which allow large sums of money to be stored more cheaply.

This is a global phenomenon and we're one of a several countries now with some or all of their Government bonds trading at negative yields. About a third or over US$16 trillion worth of bonds now trade with negative yields.

Fund managers are sending two major signals.

Firstly, they are saying they don't want to take the risk of investing in businesses and new job creation because they are worried the economy won't grow fast enough to ensure they get their money back. They are saying to the Government: 'we're too scared, but we know you have a bigger balance sheet, you have the power to tax and you have a longer time horizon for investing so you invest it'.

Secondly, they are saying to central banks that they don't believe that inflation will stay around two percent over the long run. Their inflation expectations have dropped into disinflationary or even deflationary territory. They are saying central banks are not stimulating enough.

So why are voters and politicians so afraid of debt?

Yet despite the Government being able to borrow for 20 years with a real interest rate of less than zero, New Zealand's politicians, at both central and local Government level, are competing to see who is the most hairy chested about getting debt down, or not adding to it. The last weighted average government bond yield they remember was the record high of 22.215 percent set on September 19, 1985 -- almost 35 years ago to the day. It is the number that has driven Treasury's obsession with debt reduction ever since, along with a generation of politicians who came of age in the late 1980s and early 1990s.

National Finance Spokesman Paul Goldsmith, who was 14 in 1985, has signaled $21b of spending cuts over coming years to aim to get net Government debt down to 30 percent of GDP by 2030 from a currently-forecast 50 percent by 2023. Yet that would still be significantly lower than our peers and ratings agencies have not blinked an eyelid.

Prime Minister Jacinda Ardern has also taken in recent weeks to saying that every dollar of borrowing is a dollar that has to be repaid in future. Finance Minister Grant Robertson cited the rising debt in proposing a tax rise for the top two percent of income earners.

Hipkins just told District Health Board chairs to get their deficits under control. Canterbury DHB is sacking workers.

Councils, including the largest in Auckland Council, are actively cutting costs because they worry about increasing their debts. Ratepayers who vote don't want the debt to rise. So Councils are also now skimping on maintenance, laying off staff and cutting back on investment plans.

The worst time for austerity

This is exactly at the wrong time, just as the Reserve Bank needs more stimulus to avoid having to print more than the $100b it already plans to. It is also at the time when much of the emergency wage subsidies and spending are ending and the effects of border closures and the global economic slump hit business owners.

It's like refusing to have a life saving operation after a car crash because you're worried about getting cancer from the x-ray you need just before surgery.

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Roger Dennis
11 September 2020
Great summary of a very complicated situation. It will be fascinating to see which dominant economic theory emerges from this chaos, because it will shape the world for the next forty years.


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