No, Mr. Bond, I Expect You To Die

Why “full faith and credit” isn’t enough for me

Not quite five years ago, someone thought it would be a smart idea to buy a bond issued by the Republic of Austria that will mature in June of 2120. You’ve got to admire the market timing of the sellers who got away with paying a measly 0.85% on 4.4 billion euros for a century. The owners of this Specknӧdel? Not so much.

Today, for each 100 euros invested, you’ve earned around three euros in interest (before taxes) but lost nearly 60 on the price of the bond. Of course that’s just in nominal terms: The value of your interest payments for the next 95-and-a-half years and the principal of the bond are already a fifth lower adjusted for inflation.

Aside from all of the normal things that dent a bond’s value, a century is just a long time. No adult realistically imagines buying this and then being around to collect their 100 euros to spend it on something–maybe a pack of gum, adjusted for inflation–when it matures. Instead, it is the sort of thing that insurance companies gobble up to better match their assets and liabilities or that a speculator owns briefly in the hope of catching a rise in its price.

Another country that recently issued century bonds was Argentina in 2017, despite having defaulted on its debts eight times by then in its relatively short history as a nation. It did so for the ninth time just a few years later, truly making this bond the fartcoin of fixed income–the triumph of hope over experience. But surely that isn’t a concern with a bastion of Teutonic thrift and solidity?

Well, life comes at you fast–even in Austria. A century before its bond was issued, the country had just lost most of its dominion and abandoned its currency. It already was experiencing a rapid devaluation of the new one, the Austrian crown. A couple of years later it would accept a loan from the League of Nations that helped it launch yet another new currency, the first Austrian schilling, with the promise that it would remain independent for at least 20 years (please google “Anschluss” if you aren’t familiar with how that worked out). The schilling was then replaced with the reichsmark, which did not last a thousand years, despite the promises of a certain charismatic former Austrian corporal. Then came the second schilling after World War II and, since 2002, the euro.

Obviously bonds can survive a currency change or three. There are some very old pieces of paper that still pay interest, including one that just turned 400 issued by Hoogheemraadschap Lekdijk Bovendams yielding 2.5% to repair a dike in what is now The Netherlands. The entire issue of 1,200 guilders would, in addition to covering dike repairs, have then been worth as much as a modest Dutch house or one very expensive tulip bulb. Today it pays about 15 euros a year. I’m not so sure that there will be a euro in 2120, but there probably will be an Austria that will honor its liabilities in some fashion.

The most solid debt in the world at the moment is backed by the full faith and credit of the U.S. government. That’s in no small part because of our huge economy, dominant military, and respect for the rule of law. And, if all else fails, there’s the fact that the U.S. alone owns a printing press that can pay you back in dollars, or their digital equivalent. So it’s more than a fair bet that people who buy $100 of the longest maturity issue available today, a mere 30 year Treasury bond, will get paid $100. Heck, if I bought one then I’d even expect to be alive to spend or reinvest the principal at the ripe old age of 85.

But I won’t. I wouldn’t even venture out as far as 10 years at this point. I’ve owned plenty of Treasury securities in the past, and I still do, but it is now all very short term. I’ll include the caveat here that none of this is investment advice or the shared opinion of sophisticated colleagues at my newspaper who write about this for a living, but I am shocked at how complacent some very smart people are about government borrowings.

This isn't because I expect a world war or some similar calamity–the math is simply daunting and Wall Street is whistling past the graveyard. One respected commentator I know went through the numbers in detail, pulling no punches aside from using some benign official government budget projections. He noted on slide 72 of his presentation that a U.S. government debt downgrade could come without warning. Right below that? “So far, so good.”

Well let’s look at a few numbers and judge for ourselves. The U.S. just passed two ominous milestones: Debt held by the public crossed $30 trillion and the net interest on government borrowings $1 trillion a year or $3 billion a day. This year will see about $10 trillion in U.S. debt roll over.

About 60% of that will be bills–Treasury securities maturing in a year or less–so many of those will reset at lower yields now that the Federal Reserve has been cutting its overnight interest rate. “So far, so good,” as they say. But the other 40% is mostly resetting higher, some from interest rates close to zero, and that could be a problem.

The Congressional Budget Office regularly publishes 10 year forecasts that seem to assume the average interest rate the U.S. will have to pay will be similar to what it is today–a smidge over 3%. But there is no U.S. government security that pays so little. A 10 year note fetches 4.7% as I write this and a 30 year bond yields 4.95%. One large financial firm warned it could soon hit 6%.

Even with its mild assumptions, the national debt is seen by the CBO as hitting $40 trillion in 2030 and $50 trillion in 2034. That is alarming enough, but how good are these forecasters? Well, they don’t assume any recession, pandemics, wars, massive tax cuts, or even a continuation of current tax cuts. A decade ago they foresaw the net national debt being less than $21 trillion today. It’s 43% higher than that despite years of very low interest rates, including a stretch at zero percent.

Will rates get that low again? Maybe. The reason matters, though. It would help the government keep its finances manageable. There is a term for the money-raising and spending side instructing the independent interest rate setting side of the government to help it out: “Fiscal dominance.”

This was the case briefly in the U.S. when there were massive expenditures during World War II and the debt hit a similar level relative to the economy to today, but we didn’t just defeat fascism—we handed out stimmy checks. We’re in an economic boom with a budget deficit last year of $1.8 trillion. And if you think that Elon Musk and D.O.G.E. can or will put any sort of a dent in that, I have a bridge to sell you.

There is not $2 trillion to cut from the deficit, nor is there $1 trillion. Once you get past defense, which is sort of important, less than $900 billion is discretionary. Close every national park, leave every family on food stamps to go begging, tell every farmer that they’re on their own in terms of subsidies, and stop delivering mail, guarding the border, repairing highways and bridges or issuing passports and you’ll save a few hundred billion. Actually you won’t even do that because you’ll cause a recession and tax revenue will decline.

The rest is off-limits, including of course that $1 trillion in interest payments. Entitlements like Social Security and Medicare could eventually go under the scalpel, but they are a political third rail. As it is, the Social Security retirement trust fund (not really a fund, by the way, just an accounting fiction that’s another government IOU) will run dry in less than a decade, necessitating a benefit cut. About four-in-ten retirees get half or more of their income from the program so I would expect the shortfall to be covered with a few hundred billion a year in additional borrowing.

But by borrowing from whom? If you resort to low interest rates despite inflation not being under control then that comes at the expense of eroding savings—the cruelest tax. The alternative is massively raising actual taxes, and I wouldn’t put high odds on it. That’s why I won’t lend Uncle Sam money that isn’t either very short-term or indexed to future inflation.

The last round of fiscal dominance was temporary and came ahead of a long boom in births and economic activity. If we have to resort to it again–and my personal comfort level with owning bonds is shaped by a view that it isn’t unlikely–then it will have been because we lived beyond our means and kept kicking the can down the road. Here’s a Time Magazine cover that’s more than half a century old fretting about the same problem.

Worrying out loud about unsustainable deficits has made you sound like a kook. The numbers are rolling over a lot more rapidly now than in 1973, though, and the consequences of the market being worried about it can more easily become self-fulfilling. I’ve seen it occur with gut-wrenching speed during my time covering emerging markets and there’s no reason the same can’t happen in countries where you can safely drink the water. Remember the freak-out over ill-conceived tax breaks in Britain, once owner of the world’s reserve currency, a couple of years ago? That was deliciously-dubbed the “moron risk premium.”

Like I said, this isn’t investment advice–it’s just an essay on a thing that keeps me up at night. I’m not mollified by people with PhDs in economics who say it isn’t a problem without telling me how, when, and why the trajectory will be changed.

They just assume it will be fine because it always has. The Treasury market is so central to everything financial that goes on in the world that a loss of faith is too painful to imagine. As Upton Sinclair wrote: "It is difficult to get a man to understand something when his salary depends on his not understanding it"

My concerns are probably premature, but I don’t think they’re decades premature. Last year saw the biggest inflows into bond funds in history. I’m missing out on the party and I really hope I’m just being a silly wallflower.