☆ ☆ ☆ Why shouldn’t the French government take advantage of negative interest rates to issue a mega-loan and earn money through interest?

The question was raised by Stéphane Soumier on the BFM Business program, who believed that this issue would « come up in public debate » (video below). The idea is indeed very appealing. Since the rates at which the French government borrows are negative (up to a maturity of 5 years to date), this means that investors who buy French government bonds pay to hold these bonds. A loan with a positive rate costs money, while a loan with a negative rate earns money, with the cost or gain in both cases being equal to the interest rate. So why not take advantage of the opportunity to issue a mega-loan of 1 trillion, for example, earn interest, and repay the entire debt with it?

Jean-Marc Daniel: Adopting interest rates… by BFMBUSINESS

The reason is simple and perhaps counterintuitive at first glance: such a huge loan at a negative rate would ultimately provide no financial gain for the French government.

Let’s suppose that the government issues 5-year bonds, for example, for an extraordinary amount of €1 trillion with a negative rate of -0.02% (the rate in effect in mid-April [0]), with the aim of recovering €1 trillion * 0.02% = €20 billion in 5 years. In the end, the government issues €1 trillion today and recovers €1.02 trillion in five years, but what happens to the money collected in the meantime? There are several possibilities, and each of them inevitably leads to the final gain being wiped out.

1) The government could, one might say, choose to buy back its debt with the money raised. However, past debt, which was issued at a higher nominal rate than today, necessarily has the same effective interest rate as current debt on the bond market. When we say that today’s 5-year bonds have an interest rate of -0.02%, this means that all bonds with a 5-year maturity (those issued today with a 5-year maturity and those issued 5 years ago with a 10-year maturity, for example) have the same effective interest rate (known as the « yield »)[1]. Issuing at -0.02% to buy back its own debt with a similar maturity at -0.02% is therefore a neutral operation in practice, and is therefore irrelevant. The government could, of course, choose to buy back debt with a different maturity, but this amounts to betting on interest rates[2], which has nothing to do with the fact that the rate is negative. This possibility is therefore meaningless.

2) The government can choose to leave its money in the bank. And the government’s bank is the central bank. The relevant question would then be: at what rate does the central bank pay interest on government deposits? In reality, the rate at which the Banque de France pays interest on government deposits is irrelevant[3]. The money that the central bank loses by paying interest on the government’s account is money that it will not pay back to the government at the end of the year (the Bank of France pays its profits to the government at the end of each year). Conversely, the money that the central bank earns by paying interest on the government’s account at a very low rate is money that it will return to the government at the end of the year due to higher profits. Ultimately, therefore, the interest rate on the government’s account is irrelevant. What matters is the rate at which the Banque de France can in turn « invest » these deposits. In other words, what is the return on the assets in exchange for these new deposits?

Let’s imagine for a moment that the Banque de France has a choice in its investment program. If the Banque de France does not want to take any risks at the national level, it will invest in Treasury bonds. And Treasury bills, assuming (for simplicity’s sake) the same maturity as before, yield -0.02%. The central bank will therefore lose -0.02%, and the loss will in turn be transferred to the government. Ultimately, the government will lose -0.02% over the five years with its investment in the Bank of France, and will then regain this 0.02% with the repayment of its loan. Net gain: $0. Of course, the Banque de France could choose to invest its money in riskier and therefore more profitable assets. But this ultimately amounts to making a profit not through negative interest rates but through a risky investment strategy, which contradicts Stéphane Soumier’s initial intuition.

3) The government can choose to invest its money in the market. And, as we explained earlier, making money necessarily means investing in products that are riskier than OATs. The fact that the rate is negative does not change anything.

Ultimately, while it is true that « going into debt makes money » with negative rates, leaving your money idle also costs money. For this reason, asking a government to borrow at negative rates to make money, although highly intuitive, does not make sense.