THE BOND MARKETS are in trouble. What's going wrong--and does it make any difference to anyone but bond traders? Suppose that, in a triumph of courage over caution, you buy a bond. Perhaps, like many, it was issued by a company that wants to build a new factory. It's a 20-year $1,000 bond paying an interest rate of 15 percent a year. If inflation continues at 8 percent a year until the bond matures in 2001, it will then be worth, not the $1,000 that you paid, but $188.69 in today's dollars. That's what inflation does. It's not a very attractive proposition.
But maybe, instead, the inflation rate will fall to zero, and your interest earnings--$150 a year, or $3,000 over the life of the bond--will be worth as much in 2001 as they are today. Does that enormous return balance the enormous risk? Bonds were once bought only for solid security. You can see why they are now being bought increasingly by speculators who trade them whenever the market bounces for quick capital gains-- or losses. To buy a bond is to gamble on inflation.
Suppose that, instead of holding your bond to maturity, you need the money and want to sell it. But perhaps interest rates have risen since you bought it, and similar bonds now carry a rate of 20 percent. That makes your bond worth only $750, and you take a loss of $250. A great many people have taken precisely that kind of loss in the rise of long-term rates that began last year and suddenly accelerated sharply this summer.
If the federal government's borrowing needs rise unexpectedly, as they did this summer, the competition to borrow gets hotter. That's why interest rates jerk nervously upward with each new rumor and report of next year's budget deficit and the borrowing that will finance it.
Perhaps, on considering all of these possibilities, you decide that bonds are too speculative and you'd better put the money into fixing up the house instead. A lot of investors have made exactly that decision which, by taking money out of the markets, pushes interest rates still higher.
While the federal government is paying enormous interest costs, it is always able to sell its bonds. But what about the other long-term borrowers--industrial companies, the utilities and state and local governments? As the costs and perils of long-term borrowing rise, every kind of long-term investment becomes more expensive and difficult--power plants, factories, schools and libraries.
It's worth noting that the United States is the only country in the world that still has strong and active markets for long-term bonds. Elsewhere those markets have been destroyed by war and inflation; in those countries only the government can borrow for more than a few years at a time. The bond markets have been a traditional source of the money invested for the decades ahead. If inflation wrecks those markets now, with violent fluctuations in interest rates, the effects on American development will be incalculable. There will be less money spent for the future, and more of it will have to come, one way or another, from the federal government.