Concepts on bonds investment and bonds yield isolate you from the herdBonds investment should be part of a diversified investment that provides a source of predictable income under considerable risks. However people are often misguided on bond investment. This article focuses on clarifying some important fallacies with emphasis on evaluating China impact. In fact, it is underlying demand and supply that determines bonds yield not Federal Reserve Chairman. For simplicity sake, we will just look at treasury debts issued by US Government only. The principles can be applied equally to different types of debt instruments. Are US bonds investment truely risk-free?US treasuries are risk free... Is it because "in God, we trust"?No, it is because US Government can at any time print you US dollars notes to settle the debt. Therefore the money you lend to US Government can always get repaid. However, is the money repaid to you, say 10 years later, have the same purchasing power? This depends on whether the dollars falling trend will continue...
In an extreme case (although very unlikely) if most people lose confidence on US dollars, there can be a risk of losing purchasing power by holding US denominated bonds. We can think of situations when US reserve currency status is challenged. One situation is that OPEC, Russia and even Canada accept Euro dollars and RMB as well as US dollars on oil purchase and global trading. The falling US dollar trend can be resumed and intensified... With the 2008 financial turmoil and the huge bailout money that most nations proposed, we believe that the disastrous situation that people losing confidence will not happen... Except for the above situation, US treasury can be a very low risk investment. US government bonds are still the safest investment. It is doubtful if you should purchase municipal bonds and corporate bonds given the financial risks. If capital preservation or never losing any money is your primary goal, then bonds investment from a stable government is a good choice, at least in monetary terms. But keep in mind that although bonds are safer as a general rule, all monetary assets denominated in US dollars can suffer from lost in purchasing power. You may not know that US CPI index raised 74% from August 1987 (Alan Greenspan on board as Fed Chairman) to November 2005. This means that US dollars suffer a 74% reduction in purchasing power or on average 3.1% compounded every year! This is the reason why China government is so concern buying additional bonds from US. This is particularly true with the huge US bailout money that will, for sure, affect the future purchasing power of US dollars. In the longer run, this may drive other nations to store China currency as its reserve currency.
Learn more about different types of treasury debts
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