If You Don't Understand Bonds, You Don't Understand Money — Transcript

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1. 0:00Did you know that there's a market worth
2. 0:02over $1 trillion that impacts your
3. 0:04mortgage, your job, your investments,
4. 0:07and even the price of crypto? A lot of
5. 0:10people don't know how this market works
6. 0:12or even what this market is. And no,
7. 0:15it's not the stock market. It's not
8. 0:17Bitcoin. It's the bond market. And it's
9. 0:20the most important piece of the global
10. 0:22financial system. So, what is a bond?
11. 0:27Picture this. You're starting a
12. 0:29business. You've got a great business
13. 0:31idea, a bulletproof business plan.
14. 0:34You've got energy and passion, but you
15. 0:37don't have the money to start it. What
16. 0:39do you do? You borrow from somebody who
17. 0:42does have the money, and you make a
18. 0:44promise to them that not only will you
19. 0:46pay them back, but you'll pay them back
20. 0:48with a little extra on top. That extra
21. 0:50is called interest.
22. 0:53People and businesses often borrow
23. 0:54money. But did you know that governments
24. 0:57borrow money as well? When a company or
25. 0:59a government needs to borrow money, they
26. 1:01do it by issuing bonds.
27. 1:04That makes them the borrower or the
28. 1:06issuer of the bond and the investor is
29. 1:09the lender of the bond. Governments are
30. 1:11always spending money on all sorts of
31. 1:13things from infrastructure to military
32. 1:16to healthcare. But government spending
33. 1:18money has a secondary benefit. It
34. 1:21stimulates the economy by creating jobs
35. 1:23and making citizens and businesses more
36. 1:26productive because productive citizens
37. 1:28and businesses produce tax revenues and
38. 1:31most of the government's revenues come
39. 1:33from taxes. Look at this graph showing
40. 1:36the sources of the UK government's
41. 1:37revenue. You'll see that most of it
42. 1:39comes from taxes. In fact, only 11%
43. 1:43doesn't come from taxes. But here's the
44. 1:46thing. Governments tend to spend a lot
45. 1:48more than they collect in revenues. And
46. 1:50the gap between what they spend and what
47. 1:52they collect is called the budget
48. 1:53deficit. Every year the governments
49. 1:56spend more than they collect, they add
50. 1:58to the total national debt, which is the
51. 2:01total amount a government owes from all
52. 2:03its past borrowing. As of 2025, the
53. 2:07total UK national debt is 2.7 trillion.
54. 2:11The total US national debt is a whopping
55. 2:14$36.7
56. 2:16trillion.
57. 2:18So where does this extra money come
58. 2:20from? The government borrows that money
59. 2:23from the public by issuing bonds. As the
60. 2:26government needs money, the Treasury
61. 2:28holds auctions, selling bonds to
62. 2:30investors from all over the world. These
63. 2:32bonds are typically bought by banks,
64. 2:35insurance companies, pension funds, even
65. 2:38foreign governments and also regular
66. 2:40people. Investors buy bonds because US
67. 2:44government bonds are considered some of
68. 2:45the safest investments in the world. If
69. 2:48the UK and particularly the US were ever
70. 2:51to default on its debt, meaning they
71. 2:54were to go bankrupt and not be able to
72. 2:56repay it, well, that could be the end of
73. 2:59civilization as we know it. So, if that
74. 3:01ever happened, we'd have bigger fish to
75. 3:04fry. Let's break down some of the terms
76. 3:06you might hear about bonds.
77. 3:09The principle means the amount being
78. 3:12invested or the amount being borrowed.
79. 3:16The coupon is the interest payment or
80. 3:20the percent that you're going to receive
81. 3:21on that bond annually.
82. 3:24The maturity refers to when the loan is
83. 3:27due or how long it is until the investor
84. 3:29will receive their money back. And the
85. 3:32yield is the return the investor gets
86. 3:34from the bond.
87. 3:37The yield is different from the coupon
88. 3:39because the price of the bond can change
89. 3:41affecting the actual return.
90. 3:44You see the price of the bond can change
91. 3:47but the coupon or the percentage of that
92. 3:49bond always stays the same. So therefore
93. 3:53the yield can fluctuate based upon the
94. 3:55price of the bond which is always
95. 3:57changing. If the price of the bond falls
96. 4:00then the yield rises and if the price of
97. 4:03the bond rises then the yield falls.
98. 4:08So how are these bond prices decided?
99. 4:12The government sells bonds in treasury
100. 4:14auctions at a set schedule weekly or
101. 4:16monthly depending on the maturity of the
102. 4:18bond and the yield at auction will
103. 4:20depend on how much demand there is at
104. 4:22that auction for these bonds. This is
105. 4:25called the primary market. When new
106. 4:28treasury bonds are sold in the primary
107. 4:30market, the yield at which they're sold
108. 4:32becomes a benchmark. Investors in the
109. 4:35secondary market will then look to this
110. 4:37price to reassess the value of similar
111. 4:40bonds that already in circulation.
112. 4:43Investors are constantly buying and
113. 4:45selling bonds on the secondary market
114. 4:47based on what they think is going to
115. 4:48happen to rates. They're constantly
116. 4:50guessing if the rates are going to go up
117. 4:52or down, if the economy is going to
118. 4:54speed up or slow down, if inflation is
119. 4:57going to go up or down. These questions
120. 5:00will determine what yield makes sense
121. 5:03for them to loan the money out at. This
122. 5:05means that market interest rates are
123. 5:08really just the yield that global bond
124. 5:10investors are demanding at that current
125. 5:12time. It's all based on what they think
126. 5:15is going to happen in the future. Now,
127. 5:18if market rates go up, that means that
128. 5:20the cost for the government to borrow
129. 5:22also goes up. And it also means that the
130. 5:25interest the government has to pay on
131. 5:26its debt goes up. Remember when I told
132. 5:29you that the US government debt was
133. 5:31currently around $36.7 trillion? Well,
134. 5:36not only do they have to pay that back,
135. 5:38but they have to pay it back with
136. 5:39interest. And the interest payments
137. 5:42alone are currently around $3 billion
138. 5:44per day. This makes market rates very
139. 5:47important because it determines if their
140. 5:50interest payments are going up or down.
141. 5:52Right now, a lot of government debt is
142. 5:54in short-term treasury bills which are
143. 5:57constantly resetting because they mature
144. 5:59in time frames like 6 months, 12 months
145. 6:02or 18 months. The government is
146. 6:05constantly using these short-term
147. 6:06treasuries to fund the borrowing, a
148. 6:09process called rolling over the debt.
149. 6:11Therefore, the overall debt burden keeps
150. 6:14on going up and so more and more of the
151. 6:17GDP of the country has to be spent on
152. 6:19paying off the debt burden and paying
153. 6:21off the interest as well. So, the
154. 6:23government will have less money
155. 6:24available for things like healthcare,
156. 6:27infrastructure, social services, and
157. 6:29military defense. Unless, of course,
158. 6:31they keep on borrowing more to cover the
159. 6:33debt burden, which unfortunately is what
160. 6:36they're doing. in order to pay for
161. 6:38public services and pay off their debt
162. 6:40and interest at the same time, they're
163. 6:42taking on more and more debt, which is
164. 6:44compounding the problem for the future.
165. 6:47So, how does all this affect the stock
166. 6:49market? Well, as I mentioned earlier,
167. 6:53bonds are a very safe investment because
168. 6:55unless the US government defaults, it
169. 6:57has to pay back your bond with agreed
170. 7:00interest. Stocks, on the other hand, are
171. 7:02riskier. A stock is just a small piece
172. 7:05of ownership in a company. So if that
173. 7:07company's stock price plummets for any
174. 7:09reason, your stock will plummet along
175. 7:11with it. So if an investor has the
176. 7:13choice between a 5% bond, which is
177. 7:16guaranteed to pay them back, or the same
178. 7:18value stock, which is a lot riskier, it
179. 7:20will be wiser and safer to choose the
180. 7:23bond. That interest rate for government
181. 7:25bonds is called the risk-free rate. The
182. 7:28difference between the expected return
183. 7:30from the stock market and the interest
184. 7:32rate from government bonds is called the
185. 7:35equity risk premium or ERP.
186. 7:38When bond yields rise, that premium
187. 7:41shrinks and therefore investors start to
188. 7:43sell stocks which are now less
189. 7:45attractive than bonds.
190. 7:47There's a similar concept within the
191. 7:49bond market itself. You see, there's a
192. 7:52difference between government bonds and
193. 7:54corporate bonds. Government bonds are
194. 7:57bonds issued by a government. Corporate
195. 8:00bonds are bonds issued by a company.
196. 8:03Government bonds are a lot safer since
197. 8:05it's highly unlikely that the government
198. 8:06will default on its debt. Companies are
199. 8:09more likely, however, to default on
200. 8:11their debt since companies can go
201. 8:13bankrupt. When there's more fear in the
202. 8:15market, investors want higher interest
203. 8:18rates from the corporate bonds since the
204. 8:20investment feels riskier. The gap
205. 8:23between safe government bonds and risky
206. 8:25corporate bonds is called the high yield
207. 8:27spread. When that spread widens, it's
208. 8:30usually a sign that there's some trouble
209. 8:32in the markets.
210. 8:34The bond market isn't just a mirror of
211. 8:36the economy, it also shapes it because
212. 8:39as interest rates go up, it slows down
213. 8:42the entire economy. Let me know in the
214. 8:44comments below if you found this video
215. 8:46useful or if you have any questions
216. 8:48about any of this. And make sure that
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220. 8:57Thank you.