<p>The economist Simon Kuznets once remarked that there are four kinds of countries in the world, developed countries, developing countries, Japan and Argentina. Japan, for decades, appeared to defy every rule of conventional economics and still prosper. Argentina defied the same rules with less happy results. The line still works, although the joke has changed. Japan, which spent years worrying about deflation and practically giving money away, now has inflation and a ten year government bond yield heading towards 3%. Argentina, meanwhile, has managed to bring monthly inflation down sharply. Its bonds still offer the sort of yields that cause sensible people to read the small print, but the direction of travel has changed. </p><p>This is worth keeping in mind when looking at what is happening in the bond markets, particularly in America. For most of the past fifteen years, money was cheap and governments borrowed merrily and private equity discovered that anything could be made to work if one borrowed enough money at 2%. Whenever something went wrong, the Federal Reserve would cut rates. It was an extraordinarily comfortable arrangement while it lasted. The trouble is that the bond market is beginning to suggest that it may not last. Thirty year US Treasury yields have been trading above 5%. The actual numbers matter less than what they are telling us. Money is expensive and may remain so even if central banks reduce short term interest rates. Long term investors worry about things beyond the Fed’s next meeting. They worry about inflation, government deficits, the sheer amount of borrowing taking place and whether they are being paid enough to lend governments money for twenty or thirty years. On all of these counts, there is quite a lot to worry about. </p><p>America is borrowing on an epic scale. Its debt has crossed USD 40 trillion and deficits remain colossal. Other governments are hardly models of restraint. At precisely the same time, companies are looking for vast amounts of capital to build data centres and the infrastructure required for AI. There is, consequently, a large amount of paper looking for buyers. Japan makes this more interesting. For years, Japanese investors sent money overseas because returns at home were almost non-existent. If Japanese government bonds now offer something approaching 3%, some of that money need not leave Japan at all. </p><p>Then there is the question that equity investors would probably be discussing. If I can earn about 5% lending money to the US government, how much am I prepared to pay for a share whose profits lie several years in the future? This is particularly relevant to technology companies, where valuations depend heavily upon earnings that may years later. Raise the discount rate and those future profits become worth less today. At some point, a perfectly respectable return on a government bond begins to compete rather effectively with the excitement of owning an expensive share. Companies also face the same problem from the other side of the balance sheet. A great deal of debt raised during the era of ridiculously cheap money has to be refinanced. If a business borrowed at 2% and now refinances at 6%, this is not a rounding error. </p><p>None of this means markets are about to collapse. Inflation could fall further, energy prices could soften, growth could weaken and governments might even rediscover fiscal discipline. The point is simply that the underlying financial environment has changed. The years after 2008 taught an entire generation of investors and managers that cheap money was normal. It is not. Business managers need to keep an eye on this underlying risk, as it affects both cost and liquidity. </p><p>The bond market is rarely the most entertaining guest at dinner. But it has an irritating habit of noticing the bill before everybody else does. </p>
<p>The economist Simon Kuznets once remarked that there are four kinds of countries in the world, developed countries, developing countries, Japan and Argentina. Japan, for decades, appeared to defy every rule of conventional economics and still prosper. Argentina defied the same rules with less happy results. The line still works, although the joke has changed. Japan, which spent years worrying about deflation and practically giving money away, now has inflation and a ten year government bond yield heading towards 3%. Argentina, meanwhile, has managed to bring monthly inflation down sharply. Its bonds still offer the sort of yields that cause sensible people to read the small print, but the direction of travel has changed. </p><p>This is worth keeping in mind when looking at what is happening in the bond markets, particularly in America. For most of the past fifteen years, money was cheap and governments borrowed merrily and private equity discovered that anything could be made to work if one borrowed enough money at 2%. Whenever something went wrong, the Federal Reserve would cut rates. It was an extraordinarily comfortable arrangement while it lasted. The trouble is that the bond market is beginning to suggest that it may not last. Thirty year US Treasury yields have been trading above 5%. The actual numbers matter less than what they are telling us. Money is expensive and may remain so even if central banks reduce short term interest rates. Long term investors worry about things beyond the Fed’s next meeting. They worry about inflation, government deficits, the sheer amount of borrowing taking place and whether they are being paid enough to lend governments money for twenty or thirty years. On all of these counts, there is quite a lot to worry about. </p><p>America is borrowing on an epic scale. Its debt has crossed USD 40 trillion and deficits remain colossal. Other governments are hardly models of restraint. At precisely the same time, companies are looking for vast amounts of capital to build data centres and the infrastructure required for AI. There is, consequently, a large amount of paper looking for buyers. Japan makes this more interesting. For years, Japanese investors sent money overseas because returns at home were almost non-existent. If Japanese government bonds now offer something approaching 3%, some of that money need not leave Japan at all. </p><p>Then there is the question that equity investors would probably be discussing. If I can earn about 5% lending money to the US government, how much am I prepared to pay for a share whose profits lie several years in the future? This is particularly relevant to technology companies, where valuations depend heavily upon earnings that may years later. Raise the discount rate and those future profits become worth less today. At some point, a perfectly respectable return on a government bond begins to compete rather effectively with the excitement of owning an expensive share. Companies also face the same problem from the other side of the balance sheet. A great deal of debt raised during the era of ridiculously cheap money has to be refinanced. If a business borrowed at 2% and now refinances at 6%, this is not a rounding error. </p><p>None of this means markets are about to collapse. Inflation could fall further, energy prices could soften, growth could weaken and governments might even rediscover fiscal discipline. The point is simply that the underlying financial environment has changed. The years after 2008 taught an entire generation of investors and managers that cheap money was normal. It is not. Business managers need to keep an eye on this underlying risk, as it affects both cost and liquidity. </p><p>The bond market is rarely the most entertaining guest at dinner. But it has an irritating habit of noticing the bill before everybody else does. </p>
