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Overpaying for bonds? Not as crazy as you’d think

Mitchell Hartman Oct 26, 2010

Overpaying for bonds? Not as crazy as you’d think

Mitchell Hartman Oct 26, 2010


Kai Ryssdal: So here’s an interesting investment idea: Pay the government to hold your money.

For the first time yesterday, the Treasury Department sold inflation-protected bonds at what’s called a “negative yield.” Buyers lined up to lend the government money, and then pay for the privilege. The bond market matters because it can help figure out the future direction of all kinds of things — economic growth, interest rates, consumer prices, the whole shebang. The success of this week’s Treasury auction is a bet that the Federal Reserve’s latest plan to juice the economy and drive up inflation just might work.

Marketplace’s Mitchell Hartman reports.

Mitchell Hartman: Let’s say I invest in a government bond, which is really the same as lending the government money. The bond is worth $100. But instead of getting paid interest by the government, I’m actually going to pay a little extra, 55 cents. Meaning, I start out at a loss.

Rich Gritta: It’s rational, but it appears to be nuts.

University of Portland finance professor Rich Gritta says it’s rational, because this particular bond offers a guaranteed protection against inflation.

Dan Greenhaus at institutional trading firm Miller Tabak explains, if inflation goes up, the value of the bond goes up too.

Dan Greenhaus: Even if you overpaid in the immediate, a sufficient enough rise in prices will compensate you for whatever overpayment you had in the short term.

And Greenhaus says the fact that investors snapped up these inflation-protected bonds means they’re betting prices will rise, eventually. Which in turn means they believe the Federal Reserve will succeed in reversing the stagnation in consumer prices we’ve seen in the recession.

And why would the Fed want higher prices? Well, because low prices are keeping the economy down, says Rich Gritta.

Gritta: Deflation sounds cool, because hey, wide-screen TV sets are real cheap. But the bad news is that producers can’t make money, so they quit producing. And then what you get is a continuing recession.

To make sure that doesn’t happen, the Fed is expected to pump hundreds of billions of dollars into the economy. And bet that prices will rise. Which in turn will give businesses a chance to make more money on what they make and sell, and what they export abroad.

I’m Mitchell Hartman for Marketplace.

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