Are Your U.S. Treasury Bonds Safe?
On its face, the probability of the U.S. defaulting on its spiraling debts seems highly unlikely. But that’s not what the markets think. The price of insurance against such a default—using derivatives known as credit default swaps—has jumped by more than 50% in the private market in recent months. According to CMA DataVision in London, a specialist in these contracts, it will now cost you 0.34% of the principal per year to buy default insurance on U.S. government bonds. If you held $1 million in Treasurys, insuring against default would cost you $3,400 for the year. A few months back, insuring those bonds would’ve cost less than $2,000.
The cost of insuring government bonds has risen world-wide in the last couple of months, partly over worries about deteriorating government finances, and partly in response to the Dubai debt crisis. Insuring British government bonds will cost you 0.77% for the year, while Dubai bondholders will pay more than 5%.
Yet CMA DataVision calculates that professional investors with real money in the game still think there is a 3% or so chance that the U.S. might default within five years. And that 0.34% annual insurance cost is pretty hefty compared to the gross yield on five-year Treasury bonds, right now just 2.1% a year.
For investors, the greatest danger is not that America could formally default on its debts, it’s that the government may informally default by unleashing inflation.