Should You Fear U.S. Treasury Bonds?
I have received a number of emails from people, asking what I think of the United States reaching its debt ceiling —and the probability of the U.S. defaulting on its debt obligations on August 2nd.
The U.S. won’t default. Your U.S. bonds are safe.
You’re probably aware of the issue with Greece: Big debts and an uncertain ability to pay them.
With the United States it’s different: Big debts, but a certain ability to pay them—if they choose to.
It’s all political posturing, of course. Obama needs to raise the debt ceiling. If he can’t, then the U.S. risks defaulting.
The Republicans are using this opportunity to draw attention to (what they hope to portray) as an inept party in power.
Of course they’ll eventually raise the debt ceiling. To think otherwise is silly.
For some historical perspective, the United States raised its debt ceiling 17 times during Ronald Reagan’s presidency…8 times during the presidency of George w. Bush.
And the political posturing has occurred before. But our memories are short.
In 1987, Ronald Reagan said this:
“The choice is for the United States to default on its debts for the first time in our 200 year history, or to accept a bill that has been cluttered up. This is yet another example of Congress trying to force my hand…Unfortunately, [it] consistently brings the government to the edge of default before facing its responsibility.”
One person, via email, asked me whether she should momentarily pull her money out of the stock market to “see what happens.” Another person asked me about the safety o f buying Vanguard U.S. government bond indexes.
Most foreign governments see the U.S. silliness for what it is: political posturing with an agenda to make the current government look bad.
“The market is assigning a near-zero probability of an actual default happening,” said Thomas Simons, a money market economist at Jefferies & Co. “Until there is a significant event that makes Treasurys[sic] much more dangerous, foreign governments are going to continue to invest in the U.S.”
I don’t need to listen to Thomas Simons, the market economist at Jefferies & Co. to know that foreigners aren’t taking the debt default threat seriously. And I’ll show you how I know.
The chart above indicates how popular U.S. government bonds are. Bonds, like anything, are based on supply and demand. When demand increases, the prices rise. You can see that demand for U.S. government bonds is higher than it has been for many years.
If foreign markets were selling U.S. government bonds (and you can see that they were in 2006 and 2007) then the price of the bonds declines.
During the recent debt woes, the world’s largest holder of United States government bonds—China—has increased its holding of U.S. bonds by $7.3 billion since last May, to $1.16 trillion.
If you’re a bond holder looking at that chart and seeing some kind of bond bubble, with the increased popularity of U.S. bonds, let me show you the same plotted course from a different perspective:
The chart below is from exactly the same time period, but this time I compared Barclay’s 1-3 year Treasury bond index with the S&P 500 stock index:
The green line above is the movement of the S&P 500 stock index since 2003 and the blue line below it (the one that barely shows any movement at all) is the same 1-3 year Barclay’s global bond market index that I showed you on the first chart. The movement of the bond index on the first chart is simply exaggerated for a clearer sense of where the bond prices have gone. But when comparing the volatility of that bond index to the stock index above, you can see how stable the bond index really is.
Please note that the charts above do not include reinvested interest from the bond index, nor do they include reinvested dividends for the stock index.
The U.S. is certainly an interesting place when viewed from foreign eyes. Perhaps, from a global perspective, the U.S. could fix its debt issues far more easily than most Americans realize. The United States will raise its debt ceiling, and then it has to get busy reducing its debt.
Without the political posturing, it wouldn’t be that hard.
First, there’s the outrageous spending on wars that don’t appear to have any tangible benefit for anyone involved. By cutting back on war spending efforts, the U.S. can easily seal up a couple of the gaping holes in its fiscal bucket.
Second, there are the incredibly low taxes that Americans pay. And they’ll need to increase them.
Let’s start with gasoline prices. Countries, for instance, reap plenty of revenue from the taxes built into the prices of gas. An Australian friend of mine just came back from a trip to the U.S. last week, disgusted at the grumblings of folks he met at American gas pumps who complained about the “sky high” prices of gasoline. Most Americans don’t know what expensive gasoline prices are because they haven’t paid them….unless they’ve rented a car abroad.
Most countries, when they sell fuel at the gas pumps, tax that fuel considerably. But that doesn’t happen to the same degree in the United States. And it should—especially with the government’s current thirst for revenue required to ease the debt burden.
Keep in mind that the U.S. national pump price average, as of July 18, 2011, is a paltry $3.67 per gallon. You can see U.S. state and national averages GasBuddy.com.
According to CNN, here’s a sampling of world-wide pump prices.
By no means is the comparable CNN list above complete. It just gives a sample. After traveling to more than 27 countries myself, I have never found any first world country (not Canada, not New Zealand, not Australia, not Singapore) to have fuel prices anywhere near as cheap as they are in the United States.
When looking to fix financial problems, we have to fill the holes in our buckets (decreasing war spending efforts would work nicely for the U.S.) while slightly increasing the flow of water from the tap. With the U.S., some of this revenue could come from raising taxes on fuel prices.
And if Americans get upset at a further 20 percent or 30 percent future fuel hike, they can take a drive to the Canadian/U.S. border to see how many giddy Canadians are gleefully filling their summer motor homes at U.S. pumps—to pay some of the lowest fuel prices in the first world.
Then there are the low income taxes that Americans pay. It’s well known that average U.S. income taxes are far lower than they are for most of the developed world. International comparisons generally reveal that U.S. tax rates are kind to the rich, but not particularly lenient for the poor.
When George W Bush reduced the dividend tax rate, he granted a further benefit to America’s rich. But it’s worth noting that the middle class (as a group) spend much more money than the wealthy do. Increasing taxes for the rich (which I believe Obama wants to do) while lowering income tax levels for the poor and middle class, would keep money flowing into the economy, as the poor and middle class would have the ability to spend more.
In 2006, Warren Buffett stated (and has repeated it several time since) that he paid 15.5% tax on his income of $46 million while his secretary paid 30% tax on her $60,000 income. With a salary of just $100,000 U.S. a year, most of Buffett’s income came from dividends he reaps from the holdings in his private stock account. He also mentioned that a few of his friends calculated and compared their percentage of taxes with those of their lower level employees and the same conclusion was reached: the US tax system allows the rich to pay less than the poor.
In a June 2011 article for Personal Finance magazine, Asian tax expert Yong Siew Chuen notes that even the wealthy Chinese pay nearly double the income tax rates that wealthy Americans do.
This brings me back to the question that recently popped up on my blog, about the fear of investing in U.S. bonds. I think the U.S., despite reaching their debt ceiling, has plenty of wiggle room to play with. Like anyone suffering from debt, they need to reduce their expenditures that don’t make sense (wars) and selectively increase the flow of revenue (taxes) that can pay down the debt.
And for someone who’s still afraid of U.S. government bonds, there are U.S. corporate bond indexes that they could choose instead, such as the Vanguard intermediate corporate bond index:
Having said that, if the U.S. ever defaulted on its debt obligations, we would all be passengers on the Titanic anyway and the first to sink would be the country with the most skin in the game: China.
But the U.S. won’t default on its debt obligations, so don’t fear what the media or the political posturing drum up.
I have a healthy six figure sum in U.S. bonds. And I’m upset that the recent silliness hasn’t dropped their price.
If Fox News can do a better job of whipping up hysteria, I just might get what I want. Then I’ll buy U.S. government bonds with both hands.