Treasury Bonds

They’re not a bubble — they’re just “frothy:”

How much foam is there on top of this fiscal frappe? Treasury bond yields are down about 40 percent in the past six months, as Gross also notes — a frothy market indeed. But I do not think Gross is showing much guts in his proposed wager: True, the U.S. government probably is not going to default on its debt in the near future. (Probably.) And, sure, he’s right that the values of the bonds will fluctuate but “won’t double, and they won’t go to zero.” But here’s the thing: They don’t have to. The government doesn’t have to default, and the value of the bonds doesn’t have to double or go to zero to cause all sorts of havoc in U.S. finances. Interest rates are very, very low — but even as low as they are, we’re still piling on debt so quickly that any serious uptick in the government’s cost of borrowing — and no, it does not have to double — could send us into a Greek-style fiscal crisis, especially if it should coincide with, say, the second and even more painful decline in a double-dip recession. Or a financial shock caused by an international crisis in, oh, Iran. Those are the kinds of risks that the Leviathan-on-a-leash guys never really account for: “Oh, everything will be fine, so long as everything is fine.”

Goody.

14 thoughts on “Treasury Bonds”

  1. I know the following comments are gonna cause a $h#tstorm from the ignorant but I work in the brokerage business and I know a little about bonds.

    Bond yields are a function of bond prices not the other way around. The only way for treasury yields to rise is for treasury prices to fall. Treasury prices fall when there are fewer buyers for treasuries than sellers. In times of crisis, treasuries rise in price because buyers, globally, fly to quality and safety.

    Suppose, for funsies, that treasury holders worldwide start dumping treasuries. Where are they gonna go with their cash? Greece? Indonesia? These articles fail to suggest where treasury sellers would put their cash if they sell their treasuries.

  2. These articles fail to suggest where treasury sellers would put their cash if they sell their treasuries.

    They shouldn’t have to, especially to someone like yourself if you understand the mind of the investor. Do you imagine they see nothing safer than bonds? How about tangible assets like precious metals? What happens when nobody will buy dollars and their value heads toward zero? They will get spent before becoming toilet paper, but very little on bonds which pay in dollars.

    You don’t think investor took note of how GM bond holders were treated by our government.

  3. Ken,

    Let’s suppose you are the Bank of China and you want to sell some US Treasuries. When you sell a treasury it is redeemed in US dollars not chinese currency. Say they fetch a million in cash. Then you have a million US dollars on your hands and you are still in China. Where will you spend those dollars?

    You can sell them for renimbi, strengthening the renimbi and weakening your trading position or you buy US goods and weaken your trading position. You lose either way.

    Or you say buy metal. Great, metals are even priced in dollars. Then the price of metals goes up. What good does that do for the Bank of China. You can’t spend or loan metal to customers and they don’t even draw interest like the treasuries did. At some point you have to swap the metals for cash. What happens when everyone decides to unload the metals. They crater in price. You lose again.

    What you have to realize is that treasuries are only a problem for large foreign holders of treasuries not the US Government. Overseas holders can only unload at their own peril as illustrated above. But suppose everyone actually does unload treasuries and the price drops by say, half. This would imply a doubling of yields. Ten year yields are around three percent. Cutting treasuries in half would imply a yield of six percent. Disaster! Not.

    This is not a catastrophre for the US government. In fact, this is what the US government is counting on. The US Government can buy back the same treasuries it sold for half off. What a deal for the government. The government buys back its debt at a discount and large foreign holders get screwed.

  4. Jardinero, the problem with your assertion is that you assume these strategies are worse than holding on to US bonds. If you think the US bonds are going to become a lot less valuable, then these other strategies can make a lot of sense even though they have significant costs. An expensive Renimbli is less harmful than losing what you invested in US Treasuries, especially since China can print more Renimbli (a have cake and eat it scenario if there ever was one for a government that’s driven by self interest). Buying commodities such as gold means that you have something of concrete value which in some situations, such as a US default, will be far better than US treasuries.

    Finally, they have other options. They can buy bonds in other currencies, particularly the Euro. Maybe buying corporate bonds will become a safer option than buying US treasuries. There’s still a lot of choices out there.

  5. If you sell goods to the USA like China and Japan and Germany do then you accept dollars for those goods. There is no way around it.

    The US does not have to default and won’t default because the interest being paid is close to nil. Net interest on treasuries relative to expenditure and GDP is at an historic low for the last forty years. In absoute terms, net interest on the debt is at its lowest level since 1986, an annual rateof 135 billion.

    http://www.gpoaccess.gov/usbudget/fy10/pdf/hist.pdf

  6. The US does not have to default and won’t default because the interest being paid is close to nil.

    “I don’t have to worry about whether he can pay my loan back, because he can always borrow the money to do so from someone else” is not a safe investment strategy, it’s just another version of the Bigger Sucker theory. It turns out that eventually you do want to look at how profitable that company you’re buying stock in is, how intrinsically demanded those tulips are, or how short the supply of houses is, even if right this moment it looks like there’ll always be someone else just as willing to buy as you were. Otherwise there’s a risk that when the Biggest Sucker is eventually reached it will turn out to be you.

  7. People selling treasuries are going into gold, silver, and platinum. Then there is also China and Indonesia who are diversifying their reserve portfolios a lot more. China dumped a lot of treasuries and dollars recently. Furthermore, China is on a big push to encourage international banks and other businesses doing business in China to denominate their contracts in Renmimbi rather than dollars, an effort to establish their currency as a world currency. This will have a positive effect for the US in the long run. This will boost the value of the renmimbi on world markets as the Chinese let the currency float freely. This will raise prices for Chinese goods and lower prices for US goods, thus helping to improve the trade balance between the two countries.

  8. It makes no difference how you denominate the price for purchase. If you sell your wares in the US, you are still going to get dollars. If you sell in Europe, you are still going to get Euros. If you won’t accept the local currency then you are not going to sell your wares. You are always left with the problem of what to do with the foreign currency you just obtained after the sale. You can either keep it, exchange it, or buy something in the local currency.

  9. Where will you spend those dollars?

    Anyplace you see a better value. If you’re driving the value of dollars to zero, that would be anyplace not valued in dollars.

  10. To clarify ‘not valued in dollars,’ that would include any asset even if you normally think of it as ‘valued in dollars’ other than legal instruments that pay in dollars. So you might buy stocks in blue chips, real estate, etc. You would not buy CD’s (which always pay less than what they are worth… banks are in business to make money… even 11% in the Carter years was a losing proposition… well, perhaps a five year just before Reagan.)

  11. What you have to realize is that treasuries are only a problem for large foreign holders of treasuries not the US Government.

    No, they are the US govt’s (and hence our) problem too, because if rates rise future borrowing becomes more expensive. Rates are now so low that it wouldn’t take much to double or even treble them. That’s Williamson’s point. Bond yields decline gradually but increase rapidly. The risk is all on a sharp increase in rates brought on by an economic or geopolitical surprise. We are insane to borrow so much that we are in effect betting the ranch on the indefinite continuation of low interest rates. That’s not the way to bet.

  12. I’m not following you Jonathan, are you saying it’s bad if rates go up because they’re short term and the borrowing would have to be replaced at a higher rate?

  13. You don’t get how interest rates are set. Interest rates are a function of the price of bonds in the bond market. If bond prices fall then the implicit yield, not stated yield, rises. What the US government is counting on, is for bond prices to fall(ergo for rates to rise); then they can buy the debt back at a discount.

  14. Yes, I understand basically how bonds work.

    What the US government is counting on, is for bond prices to fall(ergo for rates to rise); then they can buy the debt back at a discount.

    That makes no sense. Every bond represents added debt at whatever terms. All the government can rationally do is offer new bonds. The government can’t ‘buy at a discount’ because they have to sell it back to themselves. This is Enron accounting.

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