Is the “Risk-Free” Rate Really Risk-Free?


Although the yields on government Treasury bills or long-term Treasury bonds are often referred to as “risk-free” rates, this may be a bit of a misnomer.

The questions that have been frequently singled-out by a growing number of individuals concerned by the size of U.S. debt and U.S. attempts to depreciate the dollar are:  Is U.S. debt credible?…  Is U.S. currency reliable?… For this group, which is growing in popularity, gold and precious metals are often their preferred investment — they may even refer to themselves as “gold-bugs” (see The Fractional-Reserve Banking System and Currency Creation / Why Some People Like Gold).

And although the concern about U.S. debt is a valid one — addressed frequently here (see Debt LevelsThe Orchestration of Debt-Based Expansions, & Economic Constraints and Policy Options) — placing this concern in the context of history is important.

Total Public & Private U.S. Debt to GDP

As discussed in Debt Levels the total U.S. public and private debt as a percent of GDP is approximately 375% (the highest level that the U.S. has ever seen) but not so vastly different than the ~300% level seen in the 1930s; at that time, the U.S. was able to work off the debt burden during the great depression — and over the next 20-years the level fell below the “caution-level” of 250-275%, eventually reaching ~140% in the early ’50s.

Comparing the total-U.S.-public-and-private-debt-as-a-percent-to-GDP to other economies one can see that Japan, the U.K., and the Eurozone are all higher than the U.S. — and based on the velocity of money, China may have the highest level.

Currency Devaluation

It’s important to note that during the debt-dilemma of the 1930s, the debt that was affected first was private debt — i.e. credit-sensitive debt (today this would include bank loans, corporate debt, high yield bonds, mortgage/auto/student/personal loans).  The great depression was the result of the buildup of years of unproductive debt (debt that does not create an income stream to repay the principal amount borrowed and interest on the debt); the “roaring 20s” were “roaring” due to over-spending.

Government-debt issues of major world economies/empires have typically grown over a much longer timeframe, as those governments have usually resorted to currency depreciation to fund their debt.  As discussed in The Fractional-Reserve Banking System and Currency Creation / Why Some People Like Gold, a government can create new currency and pay their debts with that currency (which makes the currency that you’re holding worth less).

High levels of inflation and hyper-inflation are signals that a country’s credibility is being called into question; currently (except for the asset-price inflation discussed in The Orchestration of Debt-Based Expansions & Financialization & the Erosion of Growth) inflation is relatively muted — for further discussion see Economic Cycle Research Institute(ECRI): Disentangling Cyclical from Structural.

The important idea to note is that the process of currency devaluation in a major world economy/empire can go on for a very long, long time — sometimes a lifetime or more; this is why the government debt of a major world economy/empire has more reliability than credit-sensitive debt.

To add to this, it’s also worth noting that throughout history, if the debt of a major economy/empire is called into question there are usually much more significant/dangerous issues to be concerned about that investments — i.e. war, poverty, social disruption, food & supply shortages, unemployment, economic panics.

Highlighted again, the U.S. debt-dilemma is a significant problem that may or may not be solved — it was solved in the ’30s, with much difficulty — but it’s also worth noting the extent to which nations/empires will go to protect their credibility/debt.

See this infographic regarding currency devaluations in the Roman Empire: Currency and the Collapse of the Roman Empire