Reasons why you should never buy a government bond

If there's one financial asset that should really be treated like radioactive ebola virus, it's the government bond. In the past this was not necessarily true, because way back when gold and silver were money and when the government's debts fell due it had to find the money somewhere to repay it. It had to increase taxes. This might not sound like such a fantastic thing, and you right, it's not - really all governments should run balanced budgets no matter what, but at least back then people knew what was going to happen. Of course such tax hikes in the wake of government borrowing were pretty unpopular so all monarchs were always looking for a way around that and the most effective instrument was coin clipping. Governments would reduce the precious metal content of their coins but remint them at the old valuation. When this became really popular after a while you end up with something like the late Roman Denarius with a precious metal content of 0-1%.

All this is to underline why government debt is always a bad investment. In recent times the debt of stable, high performing economies like the US, Switzerland and Germany has come under such high demand that in Switzerland the yield is now negative. In other words, the price of the bonds themselves are now so high that investors are certain to lose money, even after you consider the interest the bonds are going to pay. They are willing to lose the money because they are so afraid of any other inverstment crashing and they want something that is certain to repay their money. All of these investors are going to lose their money, or if not them, then whoever ends up with the equivalent of those bonds down the track. This is certain. Even the ever prudent Swiss or the mighty Germans will eventually end up in the same sort of tight spot Greece, the US and all the rest. Let me explain why.

First we need to examine the purpose of government debts. When a private company goes into debt it usually uses that money to invest in plant, land, resources, anything they need to grow the business and generate the profits that are going to repay the loan plus interest and leave them with plenty of new cash left over. When the government goes into debt it never does it with the intention of spending on things that will eventually repay the debt. This was originally the theory - the government would borrow from its citizens, do some large construction project like a road or a dam or whatever it might be, and as a result of this new infrastructure the economy would be more productive and the tax take would increase and allow the repayment of the original debts. Precious though this theory was to satisfy the general populace that they wouldn't suffer a burden of extra taxes later to make up for it this is not how it has ever, to my knowledge, worked out. The investment was always supposed to pay itself back in taxes and even if it didn't, the bond holders had no fear because if the project turned out to be a dud they would get their money back anyway because the government could always tax the rest of the people more to make up the shortfall. However this lovely theory has never been a reality. The reasons are multiple but the chief reasons are a) if the government's idea for an investment was profitable private investors would be doing it already and b) if - and I stress, if - the government's plan actually did make the economy more productive and did increase the tax take, none of that tax was ever earmarked for the purposes of repaying the debt. It was always more tempting to spend that money straight away and worry about the bondholders when the time came. And what typically happens when it actually does come time to worry about the bondholders? Naturally the government does not actually have the money, so instead of risking the unpopularity of forcing the populace to actually pay for the stuff the goverment had bought on their behalf, it simply sells new bonds to pay off the old bonds.

Are you seeing the problem now? You see now why those bondholders were stupid to buy the bonds at all? The government's incentives always lie towards repaying old debts with new debts. That's why nearly all western governments have had a sustained increase in debt. No one ever stopped to think about the fact that these were loans and that eventually people might ask for their money back and lose faith in the government to such a degree that they would not be willing to give up any more. Everyone knows the US government is never ever going to repay their bonds, and even so investors are still giving it up for new bonds in the certain knowledge that the money ultimately won't be repaid. They simply expect that at some future date they'll be able to find another sucker to sell it to before the bottom falls out, or that the bond will fall due and they won't be trapped into buying back into America's pyramid scheme right before it all goes west. The only reason, in other words, that the bonds have any value at all right now is because the investors expect to be able to sell them or get paid back by the US government before it has to resort to devaluing the Dollar, which, by the way, it has already been doing heavily.

Greece is substantially different from the US. In the US if they really wanted to give those bond holders back their dollars they could always print some up and give everyone their full amount. Of course that would result in instant hyperinflation the minute the investors started to try to buy real stuff with that money, but their bank accounts would at least have the right number in them. In Greece they're on the Euro standard which is one of the reasons for their woes. They can't repay the bonds they've issued because the only place for those euros to come from is taxes and the only way the economy could ever sustain such a tax take is if they were brilliant exporters to the rest of the Eurozone or, failing that, to anywhere else in the world. Needless to say, they are not. As a result of this Greek bond holders (not necessarily Greeks, people holding their bonds) have already had to take a "voluntary haircut" of 74%. That means that every single person who owned a Greek bond just before the bottom fell out has lost 74% of his money and that's despite the bailouts. Spanish, Portuguese, Italian, and other bond holders are on the same road, which is why recently they've started to edge away from those bonds, resulting in a spike in long-term bond yields:
So, to recap: you should never buy a bond because no government will ever pay it back in the long term. Even if you get your money back it's at the expense of some other sucker down the line, and even if he gets his money back in nominal terms its value will be so low he'll wish he hadn't. The eventual crisis is certain to come and when it does the economy of that country is going to tank. Do you want to be partly responsible for making that government's spending possible? Do you want to wear even a millionth part of the blame for lowering the interest rate on those bonds, which kept the state spending and made the eventual collapse worse? State issued bonds are simply a deferred stealth tax - a tax that deludes people into thinking it's an investment and produces a massive crisis when people snap out of it and realise they'll never see their money again. Now that you know, if you have a conscience or any compassion for your fellow man, don't buy a government bond. Not a single one. Not ever.