Treasury Bonds might be the riskiest investment to own
Treasury Bonds are how the US borrows so much money. We’ve been discussing asset management in a crazy economy. In the last post in this series, we’ve shown how inflation and rising interest rates affect Treasury Bonds. Today, we’ll get into an example and see how it affects you.
After reading the last post, do you see how and why rising interest rates destroy the value of your Treasuries (or any other bond?)
The Treasury bond was guaranteed. It will pay the 4% it originally promised for the full duration of years promised and then give back the $100,000 in principal. (This is a big reason there are so many Treasury Auctions, they have to constantly refinance all this debt already outstanding.) Of course, the US Government could default on their promises. But this is really not very likely because the own the printing press which makes US Dollars. And actually we do see that it’s quite customary these days for the Federal Reserve (which prints the currency) to be one of the largest buyers of Treasuries at the auctions (don’t’ you wish you could do that!)
The government is not totally and completely stupid. They can look at the numbers and realize that it is a mathematical impossibility that they will ever be able to pay all the promises that they’ve made (this doesn’t even include the future promises that will be coming soon). The only way it’s feasible to pay all these promises is to devalue the US Dollar. If they print a lot more of them and therefore the value of each is less then they can pay back the trillions and trillions of dollars with these newly printed dollars which have far less value. If each American is used to paying a Million Dollars in taxes each year because the poorest among us is a millionaire, then trillions of dollars of debt are not that hard to repay.
Of course, this means that all the money you currently have will be worthless. This is what inflation does. The government won’t admit it, but this has to be their plan to pay off their debts because it’s the only possible way to do so. What’s sad about this is that their biggest debts are Social Security and Medicare payments (far bigger than the US Debt). People depending on these promises are going to find out that the checks they receive don’t cover much more than a cup of coffee.
If you believe this economic turn of events will happen, it is a horrible mistake to hold long term bonds thinking that they are safe. Short term bills aren’t nearly as affected as longer term bonds because the principle is returned so quickly. Because inflation can so drastically reduce the value of a future stream of payments (and particularly the return of principle) of a long term bond the value of this bond can god down quite quickly when inflation strikes.
However, there are ways to deal in Treasuries that can do much better than the typical way. Before we get into those, let’s be clear about one thing…
Treasury bonds will probably be one of the best and safest investments out there….right up until they’re not. The million dollar question is when this change will happen. Keep this in mind as you are watching them. They will safely and securely make a small amount of income very consistently. And then one day it will be over quite quickly.
In the next post, we’ll examine Treasury Inflation-Protected Securities (or TIPS) and look at the advantages and disadvantages. If you have any thoughts or questions on this or other topics, please let us know.