Who would ever buy a bond?

That was my daughter’s question when my wife and I had lunch with her the other day (she paid!).

She certainly wouldn’t.  Even after this year’s rise in yields, a 10-year Treasury still only provides income of 2.7%, or not much more than the dividend on the S&P.  And, although, unlike most bonds, Treasuries are liquid, there’s a good chance that if you buy a 10-year today you’ll lose money if you have to cash in early.  Not an attractive proposition for a twenty-something.

Her question, though, brought home to me how long it has been since we’ve had a normal bond market in the US.  You have to go back to the second half of the 1990s to see a 10-year bond yielding 6% (a real yield of 3%).

It shows what a peculiar world we live in today–and how thoroughly unappealing bonds are at present.

Why doesn’t everyone see this?  We all tend to extrapolate from past experience, and for almost three decades bonds have been a one-way street going up.  In addition, bond management firms are spending tons of money–much of it customers’ money–on advertising and public relations saying their superior investing skills will let them weather the coming rise in interest rates without a hitch.  To my mind, the best you can say is that this is a classic case of confusing brains and a bull market.

bond buyers

To answer my daughter’s question, there are normal buyers of bonds, though.  They include:

1.  senior citizens and the wealthy.

As people get older or become rich, they also become more risk averse.  They shift from wanting to make a fortune to preserving what they have and providing steady income for their retirement.  During economic emergencies–the current one having lasted five years(!) and slated to last another two–the government disadvantages these two groups for the good of everyone else by lowering interest rates sharply.

2.  financial institutions, especially life insurance companies and pension funds.

The former are legally required to invest conservatively so they’ll always have enough to pay off claims.  The latter deal with the same kind of issue, but aren’t as heavily regulated.

3.  governments of countries where there’s more foreign demand for local goods and services than there is local demand for foreign equivalents (think:  China).

The result of this imbalance is that in the foreign exchange market every day there’s more demand for local currency than there is for foreign.  To keep the local currency from rising sharply, the local government prints more currency and exchanges it.  In doing so, the local government accumulates piles of foreign currency (Beijing, for example, has $3 trillion, more or less, in US$).  Rather than let the funds lie idle, the treasury buys foreign government bonds.

 

 

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