The Fairytale Connection to Government Bonds

(Originally appearing at LvMIC.)

At the annual World Economic Forum in Davos, Switzerland, economist Nouriel Roubini indicated that “bond vigilantes are asleep at the wheel” insofar as U.S. Treasury debt is concerned.

In other words, he is suggesting that investors who continue to purchase U.S. government bonds at paltry rates are in line for a major haircut when it becomes obvious that the government cannot repay its $222-trillion debt.

Canadian economist Mike Moffatt disagrees. In a recent column, he points out that “bond markets are acting perfectly rationally” because “the alternatives do not look much better.” Translation: in a world full of ugly stepsisters, the U.S. government is the de facto belle of the ball.

The U.S. dollar is a major reserve currency, which reduces currency risk as bond investors will likely want to continue holding on to U.S. dollars after they sell their bonds.

(…) There are two other countries in the world that have reserve currencies, the United Kingdom and Japan.

The debt situation in the U.K. is not much different than the United States, with the latest estimates showing a deficit of nearly 6 per cent of GDP and a debt-to-GDP ratio of over 70 per cent.

Japan, on the other hand, makes both the U.S. and U.K. look like paragons of fiscal virtue, with the world’s largest debt-to-GDP ratio at 240 per cent. While the fiscal situation in the United States is unpleasant, it is strong in comparison to other large countries which control their own currency.

My question for Mr. Roubini is this: “If investors should sell U.S. bonds due to American fiscal problems, then whose bonds should they buy instead?”

I know, I know. He didn’t ask me. Nonetheless, I’ll venture a response.

The question, as posed by Moffatt, presents us with a false dichotomy. If we confine our analysis to the purchase of government debt, he may well be correct in asserting that U.S. bonds are a better investment than the bonds of other nations. But who says an investor must only buy bonds? If profligate government spending, debt, and currency debasement is the problem, why not sell bonds and buy gold coins instead? Bottom line: viable alternatives exist to handing your money over to deadbeat governments. When viewed this way, Roubini’s comments resonate.

Let’s revisit our ugly stepsister analogy. In the Disney adaptation of the story of Cinderella, the handsome Prince hosts an extravagant ball. He extends an invitation to all of the young ladies in his kingdom, one of whom he will ask to be his wife. Naturally, he is entranced by Cinderella, who has gained admission with some assistance from her fairy godmother.

After the clock strikes midnight, Cinderella is forced to depart in haste, leaving only a single glass slipper behind. In an effort to locate her, the Prince embarks on a plan to try the slipper on every woman in the kingdom. When he finally arrives at Cinderella’s home, the ugly stepsisters taunt her mercilessly for requesting to participate.

We all know how the story unfolds: the Prince grants her request and the slipper fits perfectly. Later, the two are married and live happily ever after. The Prince, you see, is clever. He refuses to confine his options to the two ugly stepsisters, Anastasia and Drizella.

When it comes to investing, I humbly intend to do the same.



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  • About Gregory Cummings

    Gregory Cummings writes about Canadian monetary and economic policy. His writing has been featured at the Ludwig von Mises Institute of Canada and the Ludwig von Mises Institute's Mises Daily publication. Read more.

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