Bonds Are Currencies – A Derivative Of Currencies

I saw a thought-provoking retweet on Mark Yusko’s twitter feed and I wanted to clarify the idea conveyed:  “When bonds yields nothing, they aren’t much different than currencies.”

This comment is somewhat misleading because bonds are indeed a derivative of currencies. It’s basic financial economics that Mark Yusko learned in the same Robert Leftwich finance course at U of Chicago that I took.

The tweet references sovereign-issued bonds. Sovereign bonds are simply a sovereign’s currency issued to investors who are willing to bear the “time value” risk connected to the sovereign, where “time value risk” is the sum of “credit risk” – the risk of getting repaid – and “opportunity cost” – the foregone cost of spending that capital now or investing it in an alternative asset that might yield more.

Together, in a free market, those two costs equal the interest rate of a sovereign bond. From there, all bonds that are priced off the sovereign bond curve are 2nd order derivatives of a sovereign currency. In that sense all bonds are a derivative of currencies.

Quantitative easing – when a Central Bank prints money and uses that money to buy sovereign bonds for the purpose of controlling interest rates – removes the market’s ability to price “time value risk.” Western sovereign bonds have been driven down to zero – below zero on a real interest rate basis. Western sovereign bonds arethereby simply interchangeable with a country’s currency. There’s almost no difference between holding cash or holding a 30-day T-bill , or even a 2-yr Note, other than the inconvenience and transaction cost of buying and selling the bond.

The point of this is to reflect on the fact that bonds are indeed currencies – currencies with the added feature of time value risk. An investor buying the bond is willing to exchange current spending/consumption in order to lend money to the sovereign issuer.  The interest rate is the amount paid to bear the time value risk. The interest earned is paid in more of the sovereign currency.

QE has destroyed the market’s natural function of pricing time value risk into the capital markets which in turn has reduced most bond investments to the equivalent of holding currency in the pocket sans the benefit of compensation for bearing time value risk. This has in turn forced a flood of money of Biblical proportions into the the non-currency assets that are moving higher at the greatest velocity – primarily stocks. Right now primarily tech stocks.

Eventually the QE intervention will fail – it always fails and history has confirmed this fact ad nauseum. When that failure occurs, and I believe that point of failure is closer than most are willing to accept, there will be an asset crash of Biblical proportions.

Is more difficult to see the truth or accept the truth?…

11 thoughts on “Bonds Are Currencies – A Derivative Of Currencies

  1. Food for thought article.

    I know a tiny fraction of most who post here, but other than being in mainstream consensus, why would an individual [not a fund or portfolio manager] buy & hold a bond that bears so little interest that, as an asset, the principle is losing purchasing power over time?

    1. A sovereign bears the least amount of risk of repayment because of the ability to print money to pay it. It’s the corporate bonds that confound me. There will be a major pension blood bath in those. But your point is the reason why there’s a gigantic stock bubble – TINA – There Is No Alternative.

      1. Correction – the masses can’t spell “gold” – Gold is the best alternative – but you can’t invest in something that you can’t find because you can’t spell the word…

    2. For people with too much money, bonds are used as a bank account substitute. You may be able to put a few hundred thousand in a bank, but you don’t put a billion in a bank.

  2. The ZIRP/NIRP yields force people into stocks and that yield has been around 200% since the 2009 crash.
    Those that missed that surge, such as public pension funds, can’t spell even spell yield, much less spell GOLD
    The surge of cash into crypto currencies is also reflective part of the misapplication of capital into any asset that has a pulse.
    When the surge comings into gold and silver we long suffering stackers will be vindicated. I hope it’s soon

  3. Since truth is truth, seeing and accepting go hand in hand…
    Cognitive dissonance comes into play when money is made by
    ignoring the truth. It’s all about money.

  4. I enjoy reading your succinct and no nonsense articles.

    However, there are some articles that are grammatically incomplete.
    Would you consider having a proof reader reviewing your grammar?

    1. I was an English major in one of the top college English departments at the time. I know there are occasional grammatical errors in my writing. I write these posts for FREE and thus spend a commensurate amount of time editing. Substance takes precedence over form. Therefore, I don’t care it if I miss some things. Before you harangue me, spend time going after the major news and journalistic publications. People and advertisers PAY for that content and those publications tend to butcher the language…

      1. One more thing, just like everything else in this country, neither do most people know formal grammatical rules nor do they care. I hate when I go to the symphony or theatre and patrons are wearing jeans and shabby shirts. But it is what it is.

      2. Many of us appreciate that you provide these type of insights at no cost, and while I tend to be pedantic, I couldn’t care less about the occasional error.

        Thanks Dave.

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