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Imagine that you loan somebody money. You might not earn interest on the money, but you'd at least you'd get the same amount back, right? Not so for many European government bonds. The current one-year yields in Denmark, for example, would return -0.25% for holders. Why would you pay a government to borrow money from you? Could this happen in the U.S.? What are other options for safety?
Escaping the euro
In case you haven't stumbled into a financial section of a newspaper recently, you may be unaware that Europe is having trouble. There are significant doubts on whether the European Union will survive intact, as a recent Financial Times poll showed that only a quarter of Germans believe Greece should stay in the eurozone. Because of a risk of a breakup, there are fears over what would happen with the euro.
These fears have caused companies to come up with contingency plans, some of which seem right out of an action movie. The New York Times notes that Bank of America (NYSE: BAC ) "has looked into filling trucks with cash and sending them over the Greek border so clients can continue to pay local employees and suppliers in the event money is unavailable." Others have thought of "having someone take a train into Athens with 50,000 euros to pay employees."
There are also less exciting tactics, like chemical maker FMC (NYSE: FMC ) "carefully monitoring the creditworthiness of customers in those countries," and having some Greek customers pay in advance. For others, it means taking cash out from under the mattress and giving it to governments whose currencies might offer better protection. This has caused yields in Denmark, Germany, Switzerland, Belgium, Finland, and the Netherlands to dip below zero at some points.
In essence, negative yield bond buyers are paying for protection, believing that losing fractions of cents on the dollar will be better than any other option in the market.
Could it happen here?
Along with the negative bond yields, central banks have cut interest rates past zero on deposits. For example, a certificate of deposit at Denmark's central bank returns -0.2%. This is to quell demand for its supposedly safer currency by charging holders of that currency. With the U.S. seemingly in a better place than Europe, could negative rates wash up on our shore?
For one, the Treasury is preparing to allow for negative-rate bidding at its bond auctions. Already, the real return from many Treasury bonds (the return minus inflation) is negative.
Also, while the Federal Reserve considers another round of stimulus, it may have to employ completely new tactics. One such policy could be cutting its interest rates below 0%. This would charge banks for keeping cash with the Fed, and push them to lend it out and invest in other areas. It would also do the same for individual investors, as the banks might begin charging for holding cash, too.
A report from the Federal Reserve Bank of New York, however, bemoans the potential outcome of such a policy, which would flip traditional incentives and potentially cause "an epochal outburst of socially unproductive -- even if individually beneficial -- financial innovation."
What options do investors have for safety?
Thankfully, the U.S. doesn't have the immediate currency risks of Europe. However, almost zero interest rates and treasury bonds make it hard for U.S. investors to find returns in traditional safe harbors. High-yield savings accounts at 1% can't keep up with current inflation of 1.4%. Money under a mattress loses even more value with each passing month and is always at risk of bed bugs. Unfortunately, investors will have to swallow more risk for more potential return and to attempt to keep up with inflation, which leaves options like REITs, riskier corporate and municipal bonds, other equities, or your own business.
The best way to hedge against risk for these types of riskier investments is to do proper research. Some past picks researched by the Motley Fool's Income Investor newsletter team include ONEOK (NYSE: OKE ) , Diageo (NYSE: DEO ) , and McCormick (NYSE: MKC ) , all of which offer a 2% or greater dividend yield and have more than doubled in share value since chosen. ONEOK, an Oklahoman natural gas company, has paid a dividend since 1939 and sold off its riskier energy exploration business to shield it from commodity price swings. Diageo, maker of Johnnie Walker, Guinness, and Smirnoff, among others, benefits from the relatively constant demand of alcohol with brand names that help it earn over 20% net profit margin. The spice maker McCormick has paid a dividend since 1925, and what better way to flavor recessionary foods than with its spices.
These stocks are already near fair value, however. But, you can find out more picks, and about the Income Investor newsletter here. For other dividend stalwarts that can help you earn a better return that current interest rates, check out our free report, "The 3 Dow Stocks Dividend Investors Need."