How government debt actually works
The government bond yield is the risk-free rate, and every other asset on earth is priced against it.
Understand why a bond auction can topple a government.
How government debt actually works works, in one picture
The same argument as the text, as a chain. Each step is what makes the next one possible.
Normal, and inverted
Inversion means investors will lock in today's rate for a decade rather than roll short-term debt. They are betting rates, and therefore growth, will be lower later.
- 1
The government sells IOUs at auction
It offers bonds and investors bid. If demand is strong, the government borrows cheaply. If demand is weak, it must offer a higher yield to attract buyers. Nobody is obliged to lend to it.
- 2
That yield becomes the risk-free rate
It is treated as the return you can get without taking credit risk. Every other asset must offer more than it, or nobody would bother. When it rises, the hurdle for every share, every property and every corporate bond on earth rises with it.
- 3
Which is why a failed auction is so violent
If investors demand a much higher yield, government borrowing costs spike, the risk-free rate jumps, and every asset priced against it reprices downwards, all at once. Pension funds holding long bonds take losses precisely when they need liquidity.
This is not an abstraction. It is what happened to the UK in 2022, and it took weeks, not years.
- 4
And why credibility is the real asset
A government that can be trusted to repay in a currency it controls borrows cheaply almost regardless of the size of the debt. One that cannot pays a premium immediately. The market is not pricing the debt, it is pricing the promise.
You can explain why a rising government bond yield is bad news for your shares.
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The government bond yield is the risk-free rate, and every other asset on earth is priced against it.
We screen for yield AND the balance sheet behind it, because the biggest yields belong to the companies least able to pay them.