September 06, 2019 Friday
Bedtime Story
How Sovereign Bonds Work
The promise made in issuing bonds by the sovereign
governments is similar to the promise made by President Ulysses Grant to the
holders of the “green backs” during the Reconstruction Era and the Gilded Age.
Government rolls out these paper coupons
for anyone with excess prevailing money to buy with promise of healthy returns
or interest rates that are seductive for the wealthy as the rates promised in
return are superior to the prevailing inflationary rates.
Yet another way to seduce people to buy
these paper promises is to make the income made on them free of all taxes –
both local and central/federal.
For instance, the government can say that
they are selling a 10-year bond with a 10% annual interest.
So an investor who has excess of “real
money” (and not bonds) in his hands might use 10,000 units of it to buy such
bonds and this invested amount would be called the face value (technical terms
that are not only irrelevant in grasping the subterfuge behind the whole plan
but sometimes I feel intentionally introduced to confound any lay person trying
to decode the entire economic intrigue – yes, intrigue I think would be the
appropriate word for it).
In that case every year the government will
pay to this investor 10% of 10,000 units which is 1000 units at the end of
every year.
After a period of 10 years (since it was a
10-year bond) which is the maturity period the government would return the principal
amount or the face value invested which was 10,000 units of the currency.
Thus the government using absolute paper
and its sovereign promise has managed to borrow from this investor 10,000
unites of real money for a period of 10 years at 10% percent annual expense.
Eventually over the 10-year period through
this bond mechanism the government has managed to raise 10,000 units of currency
at the price of 20,000 units.
So do you think such a government will ever
be able to come out of its debt and get rid of its excess spending habit?
I would think that the answer to that
question would be a universal negative.
To investors on the other hand investment
in sovereign or government bonds is virtually a risk-free investment.
Can you guess why it is so? Can you?
How can investing on an entity that
overspends recklessly and whose debts keep mounting can still offer you
risk-free investments on its papers and promises?
There is one and only one way for it to
happen.
The government (that is “we the people” –
the opening phrase of the Preamble to the United States Constitution) has the
Mint which produces coins and Currency and Banknote Press which prints out the
paper currencies and notes!
So all it (“we the people”) has to do is to
order the chief of its central or reserve bank to print more
papers/notes/currency and voila – the magic perpetuates!
Stay tuned to the voice of an
average story storytelling chimpanzee or login at http://panarrans.blogspot.com
Good night Mon Ami and my fellow cousin ape.
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Another great educator and a teacher that I am aware of is
Professor Subhashish Chattopadhyay in Bangalore, India.
While I narrate stories, Professor Subhashish an electronic
engineer and a former professor at BARC, does and teaches real mathematics and
physics.
He started the participation of Indian students at the
International Physics Olympiad.
Do visit him here:
All his books can be downloaded for free through this link:
For edutainment and English education of your children, I
recommend this large collection of Halloween Songs for Kids:
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