Losing money, U.S. bond investors are shying away

A typical bond index fund now invests 71.5 % of its assets in U. S. government and agency obligations and mortgage-backed securities issued by Fannie Mae, Ginnie Mae, and Freddie Mac. A portfolio weighting of 13.5% would seem, in essence, a vote of "no confidence" in anticipated future return of government bonds. It is the closest one can get to a completely objective report on the sustainability of the government's current fiscal policies.

Nearly all serious economists point out that it is not just the current annual deficit of $1.4 trillion that is unsustainable; it is also the compounding of the national debt that puts our future at risk. As Federal Reserve Chair Ben Bernanke told the Dallas Chamber of Commerce on April 7, future deficits of as "little" as 4% of GDP are unworkable. Government must reduce spending or increase revenues. Yet when is the last time government reduced spending?

Investment advisors who manage large income funds and annuity plans are not particularly interested in issuing political opinions, but in choosing to invest so little in U.S. government debt, the managers to whom I refer are nonetheless making a powerful political statement. What these investors are saying is that the debt of the United States is not very appealing at this time. Their avoidance of U.S. government debt speaks volumes about current fiscal mismanagement in Washington.

Over the past year, an investment in a long-term U.S. Treasury mutual fund would have lost 7% of its value. If intermediate-term interest rates were to increase by only two percentage points, the additional losses would amount to 20%. Just about the only ones overweighting such debt are Asian governments who view it in their best interests to subsidize the excessive spending of their largest trading partner. Yet even those investors are growing restive -- so much so that Treasury Secretary Geithner is now spending a good deal of his time shopping America's debt in foreign capitals.

The spectacle of a U. S. Treasury Secretary going begging in Asia is unprecedented in American history, and it is not a reassuring sign. Even at current levels of nearly $12 trillion, the national debt is frightening investors, and frightened investors demand higher rates of return. As expected, interest rates on ten-year Treasuries are beginning to move up, from 3.25% four months ago to just under 4% at present, thus reducing the appeal of U.S. debt and increasing the burden of servicing that debt.

Yet conservative budget projections by the CBO now suggest a national debt of $20 trillion by 2020.