Perhaps a stupid question

Discussion in 'Economics' started by morganist, Oct 6, 2010.

  1. I was just thinking about the way that bonds are structured (Government Bonds) you buy the bond and receive two interest payments each year, one each six months and at the end of the agreement aka the maturity the initial amount aka principle is paid back. The issue is the payment is large and I don't think Governments have provision accounts so they would have to borrow to pay off the maturity. This is the issue, if the available capital diminishes as a result of a deflationary gap or the output declines will there be sufficient capital available to invest to buy the bond issuance. Surely as soon as you have long term aggregate demand decline or diminishing output this mechanism of borrowing to pay off the maturity value is not viable. In short there simply isn't enough real money to pay off the debt. The only other option is seniorage aka inflation or hyperinflation.

    Any thoughts.
     
  2. Erm, I am not really sure what profound insight you might be seeking here... Governments are able a) to print money; b) impose taxes on their citizens. If the citizens are OK with the taxes (incl the potential inflation tax), repayment of interest, principal, whatever is not a problem. If the citizens are not OK with the taxes, the government will likely change and all old debts will likely be repudiated. Obviously, this will likely have all sorts of implications.

    What exactly is your point?
     
  3. Basically that it is a bit of a ponzi scheme and cannot end without some one losing out. Also the effect on long term aggregate demand on the consequences on the long term economy could imo trigger some sort of default. Which is what is happening. How can they issue more debt if it reaches this point and therefore how could they pay off the maturity if this happens? If they inflate the economy too much no one will buy the bonds because of the real loss, creating the explained. An inability to issue new debt.

    I never said it was a profound insight just a question which I myself was not fully sure of the outcome. Thank you for reminding me that it is principal not principle, I get confused because it is the same as the education term with finance, which seems wrong to me but anyway.
     
  4. Well, here's my view...

    Any investment for which you can't unequivocally establish a fundamental value at all points in the future can be described by someone as a ponzi scheme. I don't really like the whole idea that somehow governments only have liabilities and no assets or cashflows. Moreover, to generalize wildly that there isn't a government that can pay back what it borrowed in the mkt is wrong. To take an extreme example, Norway issues govt bonds and so does Sweden, a slightly less extreme example. And, before people bring it up, Norway's healthy fiscal situation has little to do with its oil reserves.

    At any rate, if you're interested in when/how/if govts get themselves into trouble with debt, let me refer you to Reinhart & Rogoff's "This Time Is Different", which is almost completely dedicated to this fascinating subject.
     
  5. I guess my point is should anyone be buying the debt of the countries in this position. Would you buy British or American bonds? I wouldn't. This poses a problem if people start thinking along that line. I guess my point is perhaps they should be looking at a more attractive repayment scheme to replace the existing one if/when such a scenario takes place.

    I think you are right about Norway, Sweden etc. If they unified it could work well.
     
  6. heech

    heech

    I think what the OP is saying is that the structure of government bonds are poor, because you're not paying any principal until maturity... at which point you pay 100% of that amount. Corporate bonds are structured the same way.

    If you have a government that gets confused budgeting for that payment at maturity (or more likely, rolling over)... you should move to a new country, as soon as possible. The problems the world is facing with sovereign debt today has nothing to do with the "structure" of these payments.
     
  7. Well, to be honest, it's one of those rock/hard place things. If I am going to live in the UK, for example, I am going to be relying on the UK govt for many more important things than cashflows. Moreover, I have to own a diversified bunch of assets, so why not govt bonds? And if it's govt bonds, what is more natural for me to own than my own govt's paper?
    Hmmm, not sure a unification is happening any time soon. There's a VERY long and rather complicated history there.
    Well, yes, that's my point... The point of issuing bonds is to take in some money up front, do something productive with it and then pay it back. That's the way it works for pretty much all borrowing. Obviously, that implies refinancing risk, but that's why you have debt management offices, right? It's their job to smooth the redemption profile to avoid "cliffs".