Bonds: Are They Safe?

With this morning's jobs report broadly in line with expectations, stocks have not done much this morning, with the Dow Jones Industrial Average (DJINDICES: ^DJI  ) and the broader S&P 500 (SNPINDEX: ^GSPC  ) up about two points each as of 10:05 a.m. EST.

Is it safe?
In the aftermath of the credit crisis, the whole notion of the risk-free asset has been called into question as government debt loads have increased substantially and economic stagnation does nothing to flatter government debt-to-GDP ratios. Nevertheless, major economies with some of the worst state finances -- the U.S., the U.K., and especially Japan -- continue to enjoy record-low borrowing rates, which suggests a shortage of safe assets.

In a recent paper from the Bank of International Settlements (link opens PDF), the so-called "central bank of central banks," the authors suggest that the problem is not so much a shortage of such assets, "but rather that the definition of safe assets has been elusive and shifting." Recently, for example, the scrips of several European governments have lost that status.

This is not simply a matter of academic debate. Banking regulators decide what constitutes a safe asset for the purpose of calculating the minimum risk-weighted capital ratios banks must comply with. As a result, the stricter Basel III guidelines reinforce the link between banks and sovereigns. As the BIS papers note:

The supply of safe assets has a key impact on the financial sector and the real economy and so the definition of the safe asset universe should not be left entirely to the private sector. The authorities should commit themselves to a clear definition of safe assets and back it with a policy regime that makes those assets credibly safe.

Of course, defining what a safe asset is on a statutory basis is easily done. It's the second part that's hard: backing them with policy that makes them "credibly safe." Unlike banks, individual investors are unconstrained in the way they construct their portfolios and can decide for themselves what constitutes a safe asset. Obsession with the safety of one's nominal principal to the exclusion of all other considerations looks like a short-sighted approach to managing one's assets. Just ask the investors who bought long-term U.S. government bonds in April 1946 (the last time yields were at record lows) -- and suffered a one-fourth loss in real terms over the next decade.

The markets have made huge gains to start 2013, but you could be up much more over the long term. In fact, The Motley Fool wants to give you a 98.79% chance at beating the market. If you're interested in the best odds in the universe -- including more than a 70% chance at doubling the market's return over the long haul -- here's some very good news for you: Motley Fool Supernova is reopening to new members for the first time ever on Jan. 15! Get instant and free access to learn how you can get these kinds of market-beating odds by clicking here now.


Read/Post Comments (2) | Recommend This Article (5)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On January 04, 2013, at 6:29 PM, xetn wrote:

    The Basil III also recommends adding gold to the reserves of banks.

  • Report this Comment On January 04, 2013, at 6:59 PM, TMFAleph1 wrote:

    There's nowhere near enough gold for that purpose.

Add your comment.

Sponsored Links

Leaked: Apple's Next Smart Device
(Warning, it may shock you)
The secret is out... experts are predicting 458 million of these types of devices will be sold per year. 1 hyper-growth company stands to rake in maximum profit - and it's NOT Apple. Show me Apple's new smart gizmo!

DocumentId: 2179203, ~/Articles/ArticleHandler.aspx, 9/19/2014 7:54:53 PM

Report This Comment

Use this area to report a comment that you believe is in violation of the community guidelines. Our team will review the entry and take any appropriate action.

Sending report...


Advertisement