Tag: James Grant

Solved Problem: A Half-Price Sale on U.S. Treasury Bonds?

Supports: Money, Banking, and the Financial System, Chapter 3.

Image generated by ChatGPT of the U.S. Treasury building in Washington, DC

In a recent book review in the Wall Street Journal, financial analyst James Grant wrote: “The Treasury may indeed pay off every claim in freshly printed dollars. But 30-year Treasurys issued at the sub-2% yields prevailing in 2020 change hands today for less than 45 cents on the dollar.”

To illustrate Grant’s point: On May 15, 2020, the U. S. Treasury issued a 30-year bond with a $12.50 coupon and a face value, or par value, of $1,000. On October 6, the market price of the bond was $424.25. If you buy this bond today, you will receive a payment of $1,000 from the U.S. Treasury on May 15, 2050. The U.S. Treasury most recently issued 30-year bonds on August 17, 2026. Those 30-year bonds have a coupon of $51.25.

a. What does Grant mean by writing that 30-year Treasury bonds issued in 2020 “change hands today for less than 45 cents on the dollar”?

b. Why would anyone would be willing to sell you a bond for less than 50 percent of the amount the seller would receive by holding the bond to maturity?

Solving the Problem
Step 1: Review the chapter material. This problem is about why bond prices fluctuate, so you may want to review Money, Banking, and the Financial System, Chapter 3, “Interest Rates and Rates of Return,” particularly the section “What Happens to Bond Prices When Interest Rates Change?”

Step 2: Answer part a. by explaining what Grant meant by bonds changing hands at less than 45 cents on the dollar. By “changing hands” Grant is referring to buying and selling bonds in the bond market. By “less than 45 cents on the dollar,” Grant means that bonds with a face value of $1,000 are selling for less than $450.

Step 3: Answer part b. by explaining why someone would be willing to sell you a bond for only $450 even though the bond has a face value of $1,000. In the bond market, as bonds are bought and sold, bonds of the same characteristics should have the same yield, as measured by the yield to maturity on the bonds. The 30-year bonds the Treasury issued in August of this year currently have a yield to maturity of about of about 5.31%. (The yield to maturity on these bonds is greater than the bonds coupon rate of 5.125% because the prices of the bonds are currently less than $1,000.) As an investor, you would only be willing to buy the 30-year bonds the Treasury issued in 2020 with a coupon rate of 1.25% if the price of the bonds will result in your receiving a yield to maturity of 5.31%.

The expression that links the price of a coupon bond, P, to the yield to maturity on the bond, i, is:

Keeping mind that the coupon, C, on a bond is fixed once the bond is issued, an increase in the yield to maturity must cause a decline in price of the bond. Because the gap in coupon rates between Treasury bonds issued in 2020 and in 2026 is so large, the 2020 bonds must have much lower prices in order to have the same yield to maturity.

Extra credit. The U.S. Treasury only started regularly issuing coupon bonds in the 1970s as the federal government began to run substantial budget deficits nearly every year. Prior to that, individuals rarely bought Treasury bonds with the exception of the tens of billions of “war bonds” the Treasury issued to raise funds during World War I and World War II.

Image from the American Museum of Natural History

As the following figure shows, since the 1970s, the yields on 30-year Treasury bonds have changed dramatically over time, from more than 15% in 1981 to less than 2% in 2020. These variations in yields reflect the higher or lower coupon rates the Treasury needs to offer investors as a result of fluctuations in inflation and in other factors that affect the demand for bonds.

Solved Problem: The Fed and the Value of Money

Supports: Macroeconomics, Chapter 15, Economics, Chapter 25, Essentials of Economics, Chapter 17, and Money, Banking, and the Financial System, Chapter 15.

Image generated by ChatGTP-4o.

In a book review in the Wall Street Journal, the financial writer James Grant referred to “the Federal Reserve’s goal to cheapen the dollar by 2% a year.” 

  1. Briefly explain what “cheapen the dollar” means.
  2. Briefly explain what Grant means by writing that the Fed has a “goal to cheapen the dollar by 2% a year.”
  3. Do you agree with Grant that the Fed has this goal? Briefly explain.

Solving the Problem
Step 1: Review the chapter material. This problem is about the economic effects of the Federal Reserve’s policy goal of a 2 percent annual inflation rate, so you may want to review Chapter 15, Section 15.5, “A Closer Look at the Fed’s Setting Monetary Policy Targets.”

Step 2: Answer part a. by explaining what “cheapen the dollar” means. Judging from the context, “cheapen the dollar” means to reduce the purchasing power of a dollar. Whenever inflation occurs, the amount of goods and services a dollar can purchase declines. If the inflation rate in a year is 10 percent, than at the end of the year $1,000 can buy 10 percent fewer goods and services than it could at the beginning of the year.

Step 3: Answer part b. by expalining what Grant means by the Fed having a goal of cheapening the dollar by 2 percent a year. Congress has given a dual mandate of high employment and price stability.  Since 2012, the Fed has interpreted a 2 percent annual inflation rate as meeting its mandate for price stability. So, Grant means that the Fed’s 2 percent annual inflation goal in effect is also a goal to cheapen—or reduce the purchasing power of the dollar—by 2 percent a year.

Step 4: Answer part c. by explaining whether you agree with Grant that the Fed has a goal of cheapening the dollar by 2 percent a year. As explained in the answer to part b., there is a sense in which Grant is correct; the Fed’s goal of a 2 percent inflation rate is a goal of allowing the purchasing power of the dollar to decline by 2 percent a year. One complication, however, is that most economists believe that changes in price indexes such as the consumer price index (CPI) and the personal consumption expenditures (PCE) price index overstate the actual amount of inflation occurring in the economy. As we discuss in Macroeconomics, Chapter 9, Section 9.4 (Economics, Chapter 19, Section 19.4, and Essentials of Economics, Chapter 13, Section 13.4), there are several biases that cause price indexes to overstate the true inflation rate; the most important of the biases is the failure of price indexes to take fully into account improvements over time in the quality of many goods and services. If increases in price indexes are overstating the inflation rate by one percentage point, then the Fed’s goal of a 2 percent inflation rate results in the dollar losing 1 percent—rather than 2 percent—of its purchasing power over time, corrected for changes in quality.