The other cause was fear that China's shift from an economy based on
exports and infrastructure to one grounded in domestic consumer activity
would result in much weaker activity for the near future. That,
combined with interpretations of Fed policy, led investors to sell so
much emerging market debt that some prices dropped close to 10 percent
in a matter of weeks.
Ever since the 2008-2009 financial crisis, the financial world has
been driven primarily by fear and risk-aversion. Wealth managers will
tell you that clients who wanted double digit returns in the 1990s and
2000s have gone from obsessing about "return on capital" to "return of
capital." Pension funds, which account for trillions of dollars of
investing activity, are caught in a multi-year bind between their
obligations and over-optimistic return assumptions. Their boards have
been focused on at least retaining the assets they have. The net result
is that bonds, and especially U.S. Treasuries, have been seen as the
What the June upheaval in the bond market shows, however, is what
people should have known all along: there is no such thing as safety.
Bonds, however, are routinely touted for just that. Go to
Investopedia, one of the more popular online resources for investing,
and you will see an entire article under the heading "Why Bonds Are Ideal for Safety and Income."
Investors of all stripes will routinely assail the stock market as a
casino, view real estate skeptically, and then state a preference for
municipal bonds or U.S. government debt.
What June showed is that bonds represent a safety bubble. Yes, the
word "bubble" is bandied about these days to an absurd degree. But in
terms of bond sentiment, it is merited. The only other asset that
approaches the safety mania is gold, and we have seen gold in the past
months plunge more than 30 percent. The bond market is many times larger
than the gold market, with global bond holdings in excess of $60
trillion, and while vast swaths of it represent legitimate, measured
government financing and corporate financing, far too many pension
funds, individuals and sovereign wealth funds treat bonds as a slightly
juiced proxy for safe money with a little bit of yield.
They aren't. And they never really have been. Bonds are simply
another financial instrument entirely dependent on the integrity of the
financial system. As James Carville famously remarked in the 1990s, "I
used to think if there was reincarnation, I wanted to come back as the
president or the pope or a .400 baseball hitter. But now I want to come
back as the bond market. You can intimidate everybody." Bonds may be
contracts between lenders and borrowers, but they also function as any
other financial instrument in that they are sold, priced and traded like
stocks and derivatives, and the community doing the selling, pricing
and trading is small, insular and not always rational or functional.