Very Basic Finance

There are some excellent references available on-line concerning what financial institutions trade.  And, once more I apologize for the redundancy in the basic message BUT it is important:

One mans debtIn the simplest of all realms, if I owe you $25.00 then I’m in debt and you hold something receivable; the $25.00 plus any interest we’ve agreed upon. The “bond” is a more sophisticated IOU.  The safest of these are Treasuries which come in three basic flavors — Treasury bills (13 weeks to 1 yr. investments), notes (2 to 10 yrs.), and bonds (10 yrs).  Because these are backed by the full faith and credit of the United States of America the Treasuries are the safest IOU in which a person can invest.

There’s also a gadget called a “Zero Coupon” Treasury” best explained by the CNN Money description:

“Zero-coupon bonds, also known as “strips” or “zeros,” are Treasury-based securities that are sold by brokers at a deep discount and redeemed at full face value when they mature in six months to 30 years. Although you don’t actually receive your interest until the bond matures, you must pay taxes each year on the “phantom interest” that you earn (it’s based on the bond’s market value, which usually rises steadily during the time you hold it). For that reason, they are best held in tax-deferred accounts. Because they pay no coupon, zeros can be highly volatile in price.” [CNNMoney]

And, there’s one more Treasury on the ladder, the inflation indexed Treasuries — also explained by CNN Money as follows:

“Inflation-indexed Treasuries. These pay a real rate of interest on a principal amount that rises or falls with the consumer price index. You don’t collect the inflation adjustment to your principal until the bond matures or you sell it, but you owe federal income tax on that phantom amount each year – in addition to tax on the interest you receive currently. Like zeros, inflation bonds are best held in tax-deferred accounts.”  [CNNMoney]

Notice these last two are better placed in someone’s “tax deferred” account.  In the case of all these forms of bonds, if you have them in your portfolio then you are holding government IOU’s + the interest the government promises to pay.   Want to find out those interest rates? The Department of the Treasury has a whole page for that.   Want Bells and Whistles? The Treasury site has a page for that too, with charts, historical data, and graphs.

How I Calmed Down And Learned Not To Be Scared Of The National Debt.

First, breathe deeply.  Simply because some commentator, pundit, or investor is making hissing sounds whenever the topic moves to the National Debt, doesn’t mean we have to panic.

Remember all five of the forms of Treasuries are secured by the federal government.  But, but, but… The Chinese are about to “own” us?  Yes, China tops the list of foreign investors in U.S. Treasuries, with about $1316.7 billion in their accounts.  Does that mean the Chinese “own” us? No.  Like every other domestic investor they want to (1) hold the bond to maturity and collect the interest; or (2) sell bonds in the bond market at a profit.   But, but, but… what if they cashed in all at once?  Stop.  Think.

They bought the bonds for the same reason we’d buy E Series savings bonds — because they’re an ASSET.  Government debt being our asset.  Now, what possible reason could the government of China have for dumping all its ASSETS on the market at once? Most folks cash out in circumstances which are usually on the negative side. We cash out when we need to raise funds or when we think the value of our ASSETS may decline.  So, do, governments.

As long as other countries view the United States as an economic power — which we are, with the largest economy on this planet — then investing in US is a good idea.   It’s in our own best interest to keep it that way.   As of 2014, the U.S. economy is valued at approximately $17 trillion; China at $10 trillion; Japan $5.3 trillion; Germany $3.7 trillion; France $2.8 trillion; Brazil $2.6 trillion; U.K. $2.5 trillion. [CNN

There are two reasons foreign investors like purchasing U.S. Treasuries.  The first is obvious from the list of values in the last paragraph. We’re the biggest, safest, investment they can make.  The fancy term is that we have “premium risk free assets” on the market.  Secondly,  these Treasuries are liquid.  Liquid + Safe = a very desirable investment.  There’s also a third reason, we’re the world’s reserve currency, with some 87% of all financial transactions in global foreign exchange markets taking place in U.S. dollars. [GAO]   Because we are the largest Gorilla in the Financial World, we can borrow surplus savings from other countries beyond what we could invest all by ourselves.  The GAO report phrases this more elegantly:

“…an economy open to international trade and investment, such as the United States, essentially can borrow the surplus of savings of other countries to finance more investment than U.S. national saving would permit. The flow of capital into the United States has gone into a variety of assets, including Treasury securities, corporate securities, and direct investment. [GAO]

That’s the preferred direction for investments — INTO the United States.   The bigger and safer we appear, the more surplus savings from abroad we can take in, or conversely when the economies of other countries aren’t looking too attractive the capital flows into our “safe harbor.”

There are limits, as there are to all human endeavors.  We don’t want to rack up “too much” indebtedness” such that investors start to look elsewhere and we have to raise the rates (yield) on our bonds, bills, and notes.   The trick is to determine what’s “too much.”

National debt clocks are useless.  The only thing those graphics are good for is to scare people into believing we already have too much indebtedness.   Those inclined to panic should step back from the abyss and remember that our debt is someone else’s asset.  Assets they are holding because they believe we are the best, safest, investment they can make.   How do we know that the world is still happy with us?  We look at the Yield Curve.

Where do we find that Yield Curve?  On the front page of the U.S. Treasury Department’s web site.   The U.S. Treasury is currently paying 0.04% to attract investors in one month bills; a two year note currently pays 0.30% interest; and, a 30 year bond pays 3.55%.    It’s fairly apparent when the “too much” level has been hit — the yield on a 10 yr. bond from Greece is a whopping 8.18% (compare to U.S. 2.59%.) [Bloomberg]

Thus, when the Advocates of Austerity cry, “Look at the Clock!” The correct response is “Look at the Yield Curve.”  In other words — what we really ought to be wary of is the day that the Yields soar upwards.  That “debt clock” is a gratuitous graphic, which obfuscates the real issue: If we are going into debt are we getting a return on it?

Debt incurred for war/military operations is essentially a loss on the books.  We borrow money and then blow things up.  Debt incurred for the improvement of infrastructure projects means that we may just be using other people’s surplus savings to build our own highways, air transport facilities, and communications systems, all items which become assets on our own books.   The essential question concerns the purpose to which we put those borrowed funds.  

Now, breathe more easily and decide HOW we should be spending the surplus savings we are siphoning off from foreign investors.

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