Why U.S. Treasuries Aren't as Good as Gold
Greece's debt is - to put it crudely - crap. The Greek government issued bonds, i.e., borrowed money for years and they have virtually nothing to show for it.
If a corporation issues bonds, they typically do so after telling their borrowers what they're going to use the money for. Unless the creditors (the people buying the bonds) understand the purpose of the company's borrowing, they won't buy the bonds. (At least that's the "rational" way things should work.)
It's different with governments. They just issue bonds, and no one really pays attention to what they're going to use the money for. People just buy the bonds.
(When I say "people," that includes institutional buyers. In the case of institutions, there are people employed by the institutions who make decisions.)
Buying corporate bonds makes sense. Buying government bonds clearly doesn't. So why do people (including me) buy government bonds? People buy government bonds because they are somehow "guaranteed." What's guaranteed? Both the payment of interest and principal. Who makes the guarantee? The government who issues the bonds.
Being an American, I grew up in a country where if the U.S. government guaranteed something, it was - to use an old expression - good as gold. A U.S. government guarantee of their bonds was unquestionably safe and secure.
And being an American, I look at Greek bonds and shake my head. I think that somehow buying Greek bonds isn't as safe as buying U.S. bonds. The guarantee that comes with Greek bonds comes from the Greek government. Their guarantee isn't as good as the guarantee that comes from the U.S. government. At least that's how things worked for as long as I remember - until now.
Now we hear that the U.S. government's guarantee - while not as questionable as the Greek government's guarantee - isn't as safe and secure as everyone once understood it to be. It's not "good as gold" anymore. How did that happen?
There are lots of explanations that have to do with things like thefederal debt to GDP ratio, the federal deficit, the possibility that the interest due on outstanding federal debt will rise if interest rates rise, while the revenue to pay that interest remains flat, and on and on. When you look at these and other explanations, you find that the U.S. government's finances are pretty much a mess. So that certainly helps to explain why people are starting to questions whether U.S. government bonds are as safe and secure as they once were. It helps to explain why some people wonder whether they will get back their interest and principal if they loan money to the government by buying its bonds.
But here's a simpler explanation, and it has to do with the expression I used above: good as gold.
At one time, U.S. money - the dollar - was exchangeable for gold. If you had a dollar, or a thousand dollars, or a million dollars, you could demand an equivalent amount of gold for that dollar at any time. And the U.S. government held enough gold to back up its guarantee (at least they said they did).
So if you bought a government bond that paid you in dollars (and they all did), then you could take your interest payments to the bank and demand gold for those dollars, if you wanted to. In fact, there was a time when the government issued "gold-backed" bonds. The principal of the bond was explicitly backed by gold.
And if the government bond wasn't specifically gold-backed, then you could just look at the finances of the government and see that it typically didn't run a deficit every year (where it spent more money than it took in). And even if the government ran up debts, the interest payments could easily be paid because the revenue coming in to the government was far more than needed to pay the interest.
Then the fun began in 1933. That's when the federal government decided that you couldn't exchange U.S. dollars for gold anymore. But they always paid the interest on their bonds, so - for the most part - no one paid much attention. That is, no one paid much attention until now.
But maybe if people realized that the government bonds weren't "as good as gold" back then, because the dollar was no longer "as good as gold," things would be different. Maybe people would have demanded that the government keep its finances in order before they bought their bonds.
But they didn't. They just kept trusting our politicians, without really holding their feet to the fire.
Big mistake. Look where it's gotten us.
If a corporation issues bonds, they typically do so after telling their borrowers what they're going to use the money for. Unless the creditors (the people buying the bonds) understand the purpose of the company's borrowing, they won't buy the bonds. (At least that's the "rational" way things should work.)
It's different with governments. They just issue bonds, and no one really pays attention to what they're going to use the money for. People just buy the bonds.
(When I say "people," that includes institutional buyers. In the case of institutions, there are people employed by the institutions who make decisions.)
Buying corporate bonds makes sense. Buying government bonds clearly doesn't. So why do people (including me) buy government bonds? People buy government bonds because they are somehow "guaranteed." What's guaranteed? Both the payment of interest and principal. Who makes the guarantee? The government who issues the bonds.
Being an American, I grew up in a country where if the U.S. government guaranteed something, it was - to use an old expression - good as gold. A U.S. government guarantee of their bonds was unquestionably safe and secure.
And being an American, I look at Greek bonds and shake my head. I think that somehow buying Greek bonds isn't as safe as buying U.S. bonds. The guarantee that comes with Greek bonds comes from the Greek government. Their guarantee isn't as good as the guarantee that comes from the U.S. government. At least that's how things worked for as long as I remember - until now.
Now we hear that the U.S. government's guarantee - while not as questionable as the Greek government's guarantee - isn't as safe and secure as everyone once understood it to be. It's not "good as gold" anymore. How did that happen?
There are lots of explanations that have to do with things like thefederal debt to GDP ratio, the federal deficit, the possibility that the interest due on outstanding federal debt will rise if interest rates rise, while the revenue to pay that interest remains flat, and on and on. When you look at these and other explanations, you find that the U.S. government's finances are pretty much a mess. So that certainly helps to explain why people are starting to questions whether U.S. government bonds are as safe and secure as they once were. It helps to explain why some people wonder whether they will get back their interest and principal if they loan money to the government by buying its bonds.
But here's a simpler explanation, and it has to do with the expression I used above: good as gold.
At one time, U.S. money - the dollar - was exchangeable for gold. If you had a dollar, or a thousand dollars, or a million dollars, you could demand an equivalent amount of gold for that dollar at any time. And the U.S. government held enough gold to back up its guarantee (at least they said they did).
So if you bought a government bond that paid you in dollars (and they all did), then you could take your interest payments to the bank and demand gold for those dollars, if you wanted to. In fact, there was a time when the government issued "gold-backed" bonds. The principal of the bond was explicitly backed by gold.
And if the government bond wasn't specifically gold-backed, then you could just look at the finances of the government and see that it typically didn't run a deficit every year (where it spent more money than it took in). And even if the government ran up debts, the interest payments could easily be paid because the revenue coming in to the government was far more than needed to pay the interest.
Then the fun began in 1933. That's when the federal government decided that you couldn't exchange U.S. dollars for gold anymore. But they always paid the interest on their bonds, so - for the most part - no one paid much attention. That is, no one paid much attention until now.
But maybe if people realized that the government bonds weren't "as good as gold" back then, because the dollar was no longer "as good as gold," things would be different. Maybe people would have demanded that the government keep its finances in order before they bought their bonds.
But they didn't. They just kept trusting our politicians, without really holding their feet to the fire.
Big mistake. Look where it's gotten us.
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