How Savings Bonds Impact the US Economy

The flow of money in and out of the United States accounts for a percentage of the bottom of line of economic profitability over the short and long run terms. Savings bonds are a financial instrument that can and do influence the U.S. economy in terms of cash flow in and out of the country and in relation to the yield of those bonds.

Essentially, principles of economics demonstrate when more interest is paid out to a foreign country then the net gain to an economy declines unless there is an equal or greater inflow of interest and/or income payments from a foreign source or through offsetting increase in annual national domestic production and economic expansion.

Types of Savings Bonds and their Owners

Savings bonds may be Governmental or Corporate which is a significant distinction in terms of impact on the economy. If savings bonds are corporate i.e. from banks, financial institutions, or large company's the money saved from those bonds does not generally exit the American economy unless those bonds are owned by non-Americans who reinvest the interest elsewhere.

Government bonds may be owned by foreign creditors i.e. governments seeking to balance their financial budgets, individual investors or financial institutions. Additionally, foreign government bonds may be owned by both the U.S. Government, and U.S. individuals and corporations. Consequently, the distinction of which bonds one is referring to is quite important in calculating the impact of savings bonds and on the U.S. economy.

The cash flow of the United States

Until recently, the U.S. had more income from foreign investments than payments from investments in U.S. debt instruments such as treasury bonds. What this means is that unless other areas of the economy do not increase at a greater rate than the total amount of U.S. payments out, the net economic affect could be a shrinking of the U.S. economy and or loss of confidence in the ability of the U.S. Government to manage economic growth.

To illustrate the above points, if Gross Domestic Product increases at an average rate of 2.5% annually and the total annual payments the U.S. Government pays out is equivalent to 1.5% of GDP then the net GDP increase of 1%. Thus, a negative balance on U.S. treasury bond payments does not necessarily cause and mean a shrinking economy but does serve to slow it down.

Economic factors that cushion the cost of debt

A low dollar can actually have a positive benefit on the U.S. national debt. The reasons being not only does a lower dollar shrink the trade deficit, it also makes the cost of payments on treasury bond interest lower in relation to the inflow from U.S. owned international bonds of higher currency value.

For this reason it is important to realize that a seemingly large or negative inflow may not always be as terrible as it seems although a negative debt structure is generally not favorable unless that debt is financing a national economic expansion that is percentage points above what it would normally be without the debt.

Assessing the Variables:

To assess the overall impact of bonds on the economy they must be identified in terms of ownership and indebtedness i.e. what is the total U.S ownership of bonds in comparison to total U.S. payments on bond interest. Additionally, other economic indicators weigh in on the overall economic situation and those indicators are as listed:

• Trade imbalance
• Budget deficit
• GDP growth
• Bond debt disparity
• Inflation
• Value of the dollar

Essentially, the bottom line is does more money in terms of total value get generated and come in to the U.S. economy than goes out. To calculate the influence on bonds on this equation one must first identify which bonds one is discussing i.e. corporate, governmental or foreign, the ownership structure, interest rates and then calculate the net worth in terms of the U.S. economy.

Summary

Bonds have some influence on the U.S. economy but are not a stand alone item in the numerical factors of econometrics i.e. economic measurements. Generally, if interest payments on foreign ownership of U.S. bonds is greater than U.S. ownership of foreign bonds, the net cash flow will be negative. However, this one value is not sufficient to determine the overall effect on the U.S. economy because as a percentage of total economic variables it may be small, relatively insignificant or marginally low.

Even though a negative balance of payments may serve as a drag on economic growth it is not absolutely the case this must be so. The reason being, debt financing through bonds may be utilized to invest in a country, its people and the economy itself. If such investment yields a greater percentage growth return to an economy overall, that debt can be a positive influence an economy.

Overview: U.S. Savings Bonds

U.S. savings bonds are essentially loans to the Government from whoever is willing to make them. Due to the stability of the U.S. Government, these bonds are considered safe i.e. low risk investments. The receipt for the loan is called a Bond and carries an interest rate paid to the bond holder along with the final face value of the Bond. Depending on the type of bond interest payments vary, and maximum holding periods are between 20-30 years.

Options: If one includes Treasury Inflation Protected Securities, there are four types of U.S. savings bonds according to the U.S. 'Treasury Direct' website http://www.savingsbonds.gov. These bonds can be purchased directly from the U.S. Treasury Department of Public Debt website or through financial institutions such as commercial banks. The U.S Treasury's Bonds are illustrated as follows:

• EE/E: These bonds are fixed rate bonds are fixed rate bonds with interest rates competitive with some money market accounts and less than some Certificates of Deposit. The interest and face value of these bonds are payable upon maturity and/or redemption and the income is state and locally tax free.

• I: Also known as I-Bonds or Inflation Bonds. These bonds offer fixed rates of return competitive with some money market accounts and interest is payable upon redemption.

• HH/H: Pay bi-annual taxable interest through direct deposit at a lower interest rate but are not currently being issued by the U.S. Treasury.

• TIPS: Offer higher yields that vary in accordance with the consumer price index inflation gage. Interest and face value are paid upon redemption and interest is applied bi-annually.

Benefits: Holding savings Bonds almost guarantees the bond holder savings that yield between 1-7% if EE, 3-4% for I 1-4% and 5-7% for TIPS. These benefits can be useful retirement savings tools because all but the HH/H bonds can provide state and local tax free or tax deferred interest income at a higher rate than savings, checking and some money market accounts. Bonds can also be held, bought and sold electronically essentially eliminating the need to go to a bank for bond related activities.

Risks: An opportunity cost presents itself in the holding of bonds. For example, if a U.S. Savings Bond is paying 4.75% interest and a commercial certificate of Deposit is paying 5.5% one is losing 75 basis points in opportunity cost. Additionally, U.S. savings bonds are locked money until the non-redemption period expires, and even though they can be redeemed prior to expiration, there is an interest forfeit penalty associated with early redemption.

Costs: Bond prices vary based on the type of bond issued. I-Bonds and EE/E bonds come in denominations as small as $50 and as large as $10,000 whereas HH/H bonds' smallest face value is $500.00.

Ideas to Consider before Purchasing Bonds:

In terms of getting the most return on money loaned, TIPS offer the best interest rates of the bonds discussed above. However, depending on what one's needs are the HH/H Bonds might be a useful source of liquidity if held in a large volume. Since EE/E bonds and TIPS have tax deferred interest income both these financial instruments are possible considerations for a retirement portfolio.

The time value of money is also an important consideration because the longer one holds a Bond the greater the potential decrease or increase in savings is in relation to alternative financial investments. For example, in reverse of the opportunity cost risk mentioned above, there may also be adversity protection from harsh market conditions, recessions or any other event that might reduce the value of non-Government backed investments. As time progresses the combination of market forces, economic conditions and investment decisions amount to either an opportunity cost or gain depending on the circumstances.

Bonds are generally secure and stable investments that can anchor an otherwise volatile investment portfolio. However, if one invests entirely in HH/H or I bonds, one may forfeit higher returns available through other investment vehicles. Since some bond rates are variable the rate can become more favorable after one has purchased them. In this respect it can be wise to consider past, present and possible future prices of bonds when deciding whether or not to buy them.