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How safe are government bonds?
I watched The Ascent of Money last night and what I learned from Niall Ferguson (aka British econ-god) about the bond market was pretty scary. Government bonds are supposed to be among the safest investments which was why they skyrocketed in late 2008 when there was panic in the stock market. Niall went back into history when government bonds have gone bust before and explained the reasons why it happened and the consequences. He used Argentina as an example. The Argentinian government had to sell a lot of bonds to raise money to fund 2 wars. The government debt became so large that people lost faith that the government could pay back the debt and nobody wanted to buy the government bonds. The price of the bonds kept dropping causing the bond yield (interest) to be very high. In order to be able to service the interest payment, the government had to keep printing more money and that caused hyper inflation that destroyed the economy of Argentina. I remember hearing about the hyper inflation problem in Argentina years ago when it happened but I never really understood what caused it. We now hear the same thing happening in Zimbawe. This never really bothered me before because I thought these sort of thing only happens in third world countries. I did not realise that Argentina was the world’s sixth richest country where every family could afford steak and a bottle of wine for dinner when this happened to them.
If it can happen to the world’s sixth richest country, would it be unthinkable for it to happen to the world’s richest country? The biggest buyers of US government bonds are the Chinese. The Chinese government have already started showing their concerns about the safety of their US investments. When Timothy Geithner spoke in China recently, he was laughed at by the Chinese students when he declared that US assets are safe. Sovereign wealth funds like Singapore’s Temasek Holdings have recently dumped large holdings of US assets in favour of buying more Asian assets. Bond prices have been dropping like a rock (see chart below) and the US dollar has grown weaker against most of the major currencies in recent weeks.
The US government is planning to borrow another $10 trillion dollars over the next 10 years. Can they afford to do so if the bond yields keep increasing? So will the US government have to go down the same path and print more money which we already know will result in hyper inflation and massive devaluation of the US dollar?
Bond yields have not hit any historical highs yet and many optimists are saying it is quite normal for it to go up when the stock market is rallying as investors are simply moving money from bonds to stocks for better return. However, knowing what I now know about bond markets, I will certainly be keeping a close watch on this.
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[...] some point the money becomes pretty much worthless. I wrote an earlier post on this called “How safe are government bonds?” When I look at the amounts of money that the US government plans to borrow, I worry about [...]