This afternoon, I purchased some additional shares of Berkshire Hathaway for the KRIP plan as I did general maintenance work on the portfolio holdings, examining dividend yields, look-through earnings, global distribution of assets, et cetera. I noticed that the 30-year Treasury bond yield is now 2.8%.
Imagine you wanted to lend the United States Government $100,000. They promise to give you the entire $100,000 back on May 15th, 2042. In the meantime, you will get checks amounting to roughly $2,800 direct deposited into your bank account each year. That figure will never grow. Plus, you have to pay taxes on the interest income you generate because interest income from Treasury bonds is exempt from state and local taxes only, not Federal.
Using a quick back-of-the-envelope analysis (ignoring things such as semi-annual nature of the coupon payments), what would the economic outcome be for an investor who bought a 30-Year Treasury bond today, was in the 25% income tax bracket, and held until maturity in 2042? How much purchasing power should he or she receive in exchange for giving up three decades of enjoyment on the money that had been saved?
Over 30 years, the interest income would amount to $84,000. You’d pay a total of $21,000 in income taxes if you were in the 25% tax bracket, leaving you with net interest income of $63,000. Plus, you’d get your $100,000 back at maturity for a total of $163,000.
However, if inflation ran the same 4% that it has for the past century, the after-tax economic purchasing power equivalent of your interest income would be $36,313. At the same time, when you got your $100,000 back at maturity, it would only have the purchasing power of $30,832 today. Thus, for waiting 30 years, you were rewarded by watching your $100,000 in savings drop to $67,145 in purchasing power, for a real, net loss of $32,855.
If this were the only available investment opportunity present in the world, I wouldn’t even bother saving my money. I’d spend every penny on diamond-tipped David Oscarson fountain pens, vacations to Bora Bora, a couple of Bentley’s in the driveway, and dinner out every night at $300+ steakhouses. Presented with these terms, saving and investing money would be irrational. Money is about utility. Investing only makes sense if you are adequately compensated for delayed gratification and risk of loss with increased purchasing power on an after-tax, inflation-adjusted basis.
The only possible justification for long-duration Treasury bond ownership at these levels is if someone believes that we are going to enter a deflationary spiral on par with the Great Depression or the disaster that was the 1870′s. I’m in the opposite boat, personally. I think the central bank will monetize the debt and we’ll see signifiant inflation at some point in the future.
Tell you what. To prove my point, any of you wanting to buy Treasury bonds, how about you call me, instead? If you have at least few million dollars to make it worth the time, I’ll gladly bring in the lawyers to structure some sort of private deal. Heck, I’ll even throw in an extra percentage point or two as long as I get to keep the 30-year maturity. Anyone would be insane not to take those terms. Economically speaking, it’s free money.