Beware the Bond Bubble

It’s no surprise to most investors that bonds, like stocks, have been in a massive boom market over the past decade. In fact, experienced investors refer to the past decade as a continuation of a major bond bull market that has been ongoing since the 1980s. Bond yields have been steadily falling since that time and, as everyone knows, falling yields mean rising prices. But now that the practical lower bound has been reached, what will happen when yields start rising and prices begin to fall?

Just like stocks, bonds have benefited from loose Federal Reserve monetary policy. Quantitative easing programs that the Fed and other central banks around the world undertook purchased trillions of dollars worth of bonds. Those programs were so large that central banks now own nearly 20% of their governments’ debt.

The first obvious consequence of that is that government spending has received a massive subsidy. It has enabled governments to spend more money, borrowing at historically low-interest rates. That’s why the US government’s debt is now over $20 trillion. But that loose monetary policy has also dangerously skewed investment markets.

Government debt instruments are a historically popular investment option, as they are considered the safest from default. Risk-averse investors will accept the lower interest payments from government bonds in exchange for their relative security. When central banks purchase trillions of dollars of government debt, that debt is removed from markets, yet the demand from investors to purchase debt remains.

That demand for debt then drives up the price of existing debt still on the market, driving other bond yields down. Corporations and local governments see yields falling and try to get in on the action, issuing more debt to take advantage of those low interest rates. The result is a growing level of indebtedness throughout society. In the United States, total debt outstanding is now nearing $48 trillion, over 60% higher than it was just ten years ago.

That debt must either be paid back at some point in the future, or it will be defaulted on. The odds are increasingly likely that the government will default on its debt, and the ability of households and corporations to avoid default decreases as they take on ever more debt. In the event of a widespread debt default, the economic effects will be tremendously harmful.

But that is the natural result of decades of loose monetary policy. By forcing interest rates lower artificially, debt is mispriced. Resources that could be used for productive purposes end up getting funneled to indebted companies and individuals. Indebtedness grows but real productivity does not.

That’s why I have always trusted in gold and silver as investments. When companies go bankrupt and the bonds they issued are no longer worth the money they’re printed on, gold and silver will continue to maintain their value. Their value isn’t dependent on continual money printing; in fact, they protect investors against the worst effects of inflation. Investors who hold gold and silver won’t have to worry when the bond bubble bursts, as their precious metals will protect their wealth just as they have for thousands of years.