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

Did you know that there's a market worth over $1 trillion that impacts your mortgage, your job, your investments, and even the price of crypto? A lot of people don't know how this market works or even what this market is. And no, it's not the stock market. It's not Bitcoin. It's the bond market. And it's the most important piece of the global financial system. So, what is a bond? Picture this. You're starting a business. You've got a great business idea, a bulletproof business plan. You've got energy and passion, but you don't have the money to start it. What do you do? You borrow from somebody who does have the money, and you make a promise to them that not only will you pay them back, but you'll pay them back with a little extra on top. That extra is called interest. People and businesses often borrow money. But did you know that governments borrow money as well? When a company or a government needs to borrow money, they do it by issuing bonds. That makes them the borrower or the issuer of the bond and the investor is the lender of the bond. Governments are always spending money on all sorts of things from infrastructure to military to healthcare. But government spending money has a secondary benefit. It stimulates the economy by creating jobs and making citizens and businesses more productive because productive citizens and businesses produce tax revenues and most of the government's revenues come from taxes. Look at this graph showing the sources of the UK government's revenue. You'll see that most of it comes from taxes. In fact, only 11% doesn't come from taxes. But here's the thing. Governments tend to spend a lot more than they collect in revenues. And the gap between what they spend and what they collect is called the budget deficit. Every year the governments spend more than they collect, they add to the total national debt, which is the total amount a government owes from all its past borrowing. As of 2025, the total UK national debt is 2.7 trillion. The total US national debt is a whopping $36.7 trillion. So where does this extra money come from? The government borrows that money from the public by issuing bonds. As the government needs money, the Treasury holds auctions, selling bonds to investors from all over the world. These bonds are typically bought by banks, insurance companies, pension funds, even foreign governments and also regular people. Investors buy bonds because US government bonds are considered some of the safest investments in the world. If the UK and particularly the US were ever to default on its debt, meaning they were to go bankrupt and not be able to repay it, well, that could be the end of civilization as we know it. So, if that ever happened, we'd have bigger fish to fry. Let's break down some of the terms you might hear about bonds. The principle means the amount being invested or the amount being borrowed. The coupon is the interest payment or the percent that you're going to receive on that bond annually. The maturity refers to when the loan is due or how long it is until the investor will receive their money back. And the yield is the return the investor gets from the bond. The yield is different from the coupon because the price of the bond can change affecting the actual return. You see the price of the bond can change but the coupon or the percentage of that bond always stays the same. So therefore the yield can fluctuate based upon the price of the bond which is always changing. If the price of the bond falls then the yield rises and if the price of the bond rises then the yield falls. So how are these bond prices decided? The government sells bonds in treasury auctions at a set schedule weekly or monthly depending on the maturity of the bond and the yield at auction will depend on how much demand there is at that auction for these bonds. This is called the primary market. When new treasury bonds are sold in the primary market, the yield at which they're sold becomes a benchmark. Investors in the secondary market will then look to this price to reassess the value of similar bonds that already in circulation. Investors are constantly buying and selling bonds on the secondary market based on what they think is going to happen to rates. They're constantly guessing if the rates are going to go up or down, if the economy is going to speed up or slow down, if inflation is going to go up or down. These questions will determine what yield makes sense for them to loan the money out at. This means that market interest rates are really just the yield that global bond investors are demanding at that current time. It's all based on what they think is going to happen in the future. Now, if market rates go up, that means that the cost for the government to borrow also goes up. And it also means that the interest the government has to pay on its debt goes up. Remember when I told you that the US government debt was currently around $36.7 trillion? Well, not only do they have to pay that back, but they have to pay it back with interest. And the interest payments alone are currently around $3 billion per day. This makes market rates very important because it determines if their interest payments are going up or down. Right now, a lot of government debt is in short-term treasury bills which are constantly resetting because they mature in time frames like 6 months, 12 months or 18 months. The government is constantly using these short-term treasuries to fund the borrowing, a process called rolling over the debt. Therefore, the overall debt burden keeps on going up and so more and more of the GDP of the country has to be spent on paying off the debt burden and paying off the interest as well. So, the government will have less money available for things like healthcare, infrastructure, social services, and military defense. Unless, of course, they keep on borrowing more to cover the debt burden, which unfortunately is what they're doing. in order to pay for public services and pay off their debt and interest at the same time, they're taking on more and more debt, which is compounding the problem for the future. So, how does all this affect the stock market? Well, as I mentioned earlier, bonds are a very safe investment because unless the US government defaults, it has to pay back your bond with agreed interest. Stocks, on the other hand, are riskier. A stock is just a small piece of ownership in a company. So if that company's stock price plummets for any reason, your stock will plummet along with it. So if an investor has the choice between a 5% bond, which is guaranteed to pay them back, or the same value stock, which is a lot riskier, it will be wiser and safer to choose the bond. That interest rate for government bonds is called the risk-free rate. The difference between the expected return from the stock market and the interest rate from government bonds is called the equity risk premium or ERP. When bond yields rise, that premium shrinks and therefore investors start to sell stocks which are now less attractive than bonds. There's a similar concept within the bond market itself. You see, there's a difference between government bonds and corporate bonds. Government bonds are bonds issued by a government. Corporate bonds are bonds issued by a company. Government bonds are a lot safer since it's highly unlikely that the government will default on its debt. Companies are more likely, however, to default on their debt since companies can go bankrupt. When there's more fear in the market, investors want higher interest rates from the corporate bonds since the investment feels riskier. The gap between safe government bonds and risky corporate bonds is called the high yield spread. When that spread widens, it's usually a sign that there's some trouble in the markets. The bond market isn't just a mirror of the economy, it also shapes it because as interest rates go up, it slows down the entire economy. Let me know in the comments below if you found this video useful or if you have any questions about any of this. And make sure that you hit that like and subscribe button for more videos like this one. It would really help the channel out if you did. Thank you.