Once upon a time, long ago, before Professor Pennywise was either a professor or very wise in the way of pennies, I attended a liberal-arts college.
There I aspired to think Great Thoughts. I walked through shady groves between red-brick buildings with gargoyles for downspouts. Hipster students with long bangs smoked clove cigarettes and listened to jangle pop. (Like I said ... ages ago.)
Ever since, Professor Pennywise has happily roamed from mass public institution to mass public institution, never hired by a liberal-arts college. For much of this summer, however, I have found my mind drifting back to my alma mater, which instilled, almost subconsciously, a veneration for the glory that was Greece, the grandeur that was Rome.
Herodotus, Aristotle, Plato, Aristophanes, and Thucydides: All were taken on board in the first year. No matter what one's major, the classics, beginning with the Greeks, laid the foundation for all higher learning. One could not help but acquire a quiet reverence for the wisdom of the Peloponnesians, despite occasional acknowledgment of slavery, war, and empire—even African precedent.
How is it, Pennywise fell to thinking this summer, that Greece now seems the epitome of folly and recklessness? What went wrong? Haven't Greece's rulers read their own famous philosophers? What ever became of the Aristotelian mean or the virtuous Platonic republic?
Greece has for most of this year been consumed by a "sovereign debt crisis" of huge proportions. The country is so deep in hock that it is almost surely unable to pay it all back, despite the maneuvering and scheming of European central bankers, who don't want French banks, especially, to go bankrupt if Greece were to default.
As this week's financial terror reminds us, however, those who live in foreclosed houses shouldn't throw stones. A Greek might well rejoin, "And what has become of Poor Richard's Almanack?" In the United States, our looming national debt is not of the scale (as a proportion of GNP) and immediacy of Greece's, but it is just as much a genuine problem, and our classics of sound bourgeois practice have been traduced in the process.
Still, Pennywise cannot help but wonder if first-year students moving into dorms this fall at liberal-arts colleges—the ones, that is, that still tout the wisdom of ancient civilization—are in for an intellectual experience somewhat a different than the one I had in scrutinizing maps of the Aegean world in The Penguin Atlas of Ancient History. Twenty-five years ago, Greece seemed remote, a faraway and distant land. Today a student may actually make a contemporary connection or two.
If the continuing financial crisis indicates anything, it is that our world is awash in debt—personal and public.
The bubble decades were built on a mirage, primed by personal and governmental overspending, and our children will spend their lifetimes paying it off. When Pennywise embarked on college life, public and household debt were at negligible levels. All that changed with the credit card and the modern Republican Party.
If that sounds unfair, it's because it is. The credit card is not solely to blame. Still new in the 1970s, and only widely embraced in the 1980s and 1990s, it was one obvious cause for the amassing of personal debt. But so, too, is the gigantic inflation of housing prices and the expansion of student debt.
What is wholly accurate is the role of the GOP in creating a vast national debt. Perhaps you were left under a misapprehension by this summer's absurd national debt-limit debate. Republicans forced deeper spending cuts than Democrats preferred, after all. But study the fiscal history of the past three decades.
Here is a synopsis: Reagan greatly increased military spending and cut taxes for the rich, never once balancing a budget. A brief, fleeting Clinton surplus vanished in Bush's cut taxes for the rich and two unfunded wars. One garden-variety recession under Bush was followed by the Mother of All Recessions. Revenues declined along with the economy, and Bush bailed out the giant, unregulated banks, thereby saving capitalism, which Tea Partiers call "socialism." Obama continued the bailouts, adding his own touch, a comparably small stimulus. Et voilà: $14-trillion in debt, for which the Republican presidential administrations are, without question, overwhelmingly responsible.
What does any of this have to do with your retirement portfolio? This: Debt must, by definition, be borrowed from someone. That someone may—in fact, should—be you. When we think of Wall Street, we think of the stock exchange, but stocks are positively dwarfed by the market in bonds. The bond market is as vital for your retirement planning as the stock market.
What do bonds have to do with debt?
Bonds, in essence, make debt tradable. Illustration: Let's say the federal government has a 30-year Treasury bond auction and issues securities with a face value of $1,000 each. Buyers purchase them at that price, and the federal government promises to pay back the purchasers, or bondholders, that exact same amount in 30 years, while paying interest regularly in between. Now you see that "bond" and "borrowing" are just different ways of expressing the same transaction.
If, however, a group of bondholders decides, six years later, that they no longer want their money tied up in Treasuries, what can they do? They can't get their money back from the federal government, which isn't required to pay them back until the end of the 30-year period. They can, however, sell the bond to someone else in the secondary market. That is the bond market.
Like all markets, the bond market is dominated by the giant players, the institutional investors and big traders: sovereign-wealth funds, hedge funds, university endowments, billionaires, and the like, not to mention the investment banks. It's always worth remembering that in this ocean of sharks, you are a minnow.
Treasuries, or federal-government bonds, are just the start. There is also the market for municipal and corporate bonds. When a company or county government wants to build a new building, for example, but doesn't want to take it out of current operating expenses, it issues a series of bonds. Wall Street calls that "leveraging"—and happily handles that, pocketing the fees.
Then there are mortgage-backed securities. Take your house. (Really, they just might take your house one of these days, the way things are going.) It is likely that your lender sold off that mortgage right away to another institution, which then bound it up, sliced and diced, with a lot of other mortgages from all over. Now it's one element in a fat security owned by some pension fund in Alabama.
Some theorists call all of that the "financialization" of the economy, because that kind of activity is now vastly more important to the American economy than manufacturing and industry were back when your grandparents were young. Debt is where the money is.
You cannot ignore that reality. Some of your money should be in bonds—not all, but some, as part of a well-balanced portfolio. The question remaining is how to do that well.
This is particularly difficult to answer now. It shouldn't be, because Treasury bonds have for the entire period since the Second World War been considered one of the least-risky investments in the world. However, they look less and less attractive as a long-term investment given America's political dysfunction and fiscal imbalance, not to mention rock-bottom interest rates. The dollar remains the world's reserve currency, and U.S. Treasury bonds remain highly valued as safe havens in the midst of market turmoil. But Standard & Poor's downgrade of U.S. debt was not completely inappropriate given that U.S. bonds are now overvalued and given that one major U.S. political party is dogmatically against restoring taxes on the wealthy to rational levels, and inanely willing, despite its ideological ardor for capitalism and America, to push the country to the brink of default and panic world markets just to have its way.
U.S. debt is more attractive than Greek bonds, to be sure, but it looks weak when viewed in the light of Poor Richard's adage that "the Indies have not made Spain rich, because her outgoes are greater than her incomes." (Spanish bonds, in fact, are looking only a hair better than Greek at the moment, with Italian, Irish, and Portuguese debt in between, and all of them worse bets than U.S. debt.)
There's a lot more to go over. In my next column, we'll tackle the details of how to invest in bonds soundly.
Editor's Note: This is the seventh column in Pennywise's retirement-investing series. The earlier installments are "Investing for Retirement"; "How Much Should I Save?"; "Tolerance, Risk, and Reward"; "Saving, Speculation, Investment"; "Diversification Still Works"; and "Choosing Investments for Balance."