The Bubble That Isn’t

Don’t worry about a bubble in U.S. government bonds.

Now you see a bubble, now you don’t …

Everyone is fretting about the possibility of a bubble in U.S. government bonds. Bloomberg BusinessWeek worried here. Personal finance columnist Andrew Leckey warned against one here. Evan Newmark in the Wall Street Journal does too.

There’s no question the massive market for U.S. government debt is frothy. As this six-month chart of the 10-year government bonds shows, the yield has plummeted from about 4 percent in April to about 2.6 percent today—a decline of 40 percent. The market is displaying some of the signs of bubbles—the momentum and the continuing defiance of expectations and recent history. With rates so low—interest rates on short-term government bonds are close to zero already—they literally don’t have much more room to run up.

But I’ve lived and reported through a couple of bubbles, and have written a book about some, and the recent boomlet in U.S. government bonds doesn’t strike me as particularly bubblicious.

First, one of the features about bubbles is that, toward the end of them, the people selling assets—shares in telegraph companies in the 1840s, railroad bonds in the 1880s, dotcom stocks in the 1990s, Miami condos in 2006—are hawking pipedreams and fantasies. They’re making financial promises that can’t be fulfilled, or that simply don’t add up. When reality finally catches up with the hype, the crash can wipe out some investments entirely and the bubble-prone sector can slump 70 percent or more. But that’s not what is happening in the government bond market. The people selling Treasury bonds—that is, the U.S. government—are making extremely modest promises and have a long record of living up to much more extravagant promises. On Monday, Aug. 30, according to the Wall Street Journal, Treasury will sell $30 billion in 13-week bills and $30 billion in 26-week bills. I’d be willing to wager my next paycheck that those bonds will perform exactly as advertised: Buy those bonds and hold onto them, and you’ll get your principal back plus a bit of interest in a few months. In the interim, the market value of those bonds may rise and fall. But they won’t double, and they won’t go to zero.

Second, bubbles are generally driven by greed and fearlessness. Investors jump in thinking they have nothing to lose and are certain they can get a massive return—buy a house for no money down and flip it next month; buy Global Crossing at $50 with the expectation of selling it at $100 in a couple of weeks. But today’s bond buyers are driven more by fear than by greed. They’re not buying government bonds because they think they can double their money by December, or get a 50 percent return in a year by finding a series of greater fools. In fact, it’s the opposite. U.S. government bonds are the ultimate safe haven, the least bad place to invest. People are buying government bonds with paltry yields because they can’t think of anything better to do with their cash.

Third, look at the behavior of the peddlers of the allegedly bubbly securities. During bubbles, when foolish investors are willing to place high valuations on companies in a hot sector, entrepreneurs and managers rush to give the public what they want. With Wall Street’s assistance, they funnel new paper into the markets—mortgage-backed securities in the ‘00s, dotcom stocks in the ‘90s—at a furious pace. In a bond bubble, when borrowing costs are exceptionally low, you’d expect the government to increase its borrowing significantly, taking advantage of the idiots by issuing new bonds like crazy. But that’s not happening. The federal government has actually borrowed less as bond yields have fallen—much to the chagrin of liberal economists and progressives, who think the Obama administration is foolish not to borrow money at these insanely low rates and invest in high-speed rail, job creation, and infrastructure.

The July monthly Treasury statement shows that for the past several months, tax receipts have been rising compared with the previous fiscal year, while outlays have been falling. In the first seven months of calendar 2010, the deficit was $782 billion, down from $935 billion in the first seven months of 2009. Translation: The government is selling less new debt this year than last. And the trend is expected to continue. The Office of Management and Budget’s mid-session review calls for the budget deficit to fall from $1.47 trillion this fiscal year to $1.416 trillion in fiscal 2011 (which starts in October 2010) and to $911 billion in fiscal 2012. Meanwhile, the Obama administration is highlighting the need for short-term fiscal restraint while impaneling a commission to deal with long-term fiscal challenges. In other words, in the midst of this bubble, the government is taking politically painful steps to borrow less.

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