Why would anyone buy a government bond?
"Great question. There are several reasons; I'm going to list the few that I can think of off the top of my head right now. First, even if institutional bank holdings in such a term account are covered by deposit insurance (this, as well as the amount covered, varies geographically), the amount covered is generally trivial when seen in the context of bank holdings. An individual might have on the order of $1,000 - $10,000 in such an account; for a bank, that's basically chump change, and you are looking more at numbers in the millions of dollars range. Sometimes a lot more than that. For a large bank, even hundreds of millions of dollars might be a relatively small portion of their holdings. The 2011 Goldman Sachs annual report (I just pulled a big bank out of thin air, here; no affiliation with them that I know of) states that as of December 2011, their excess liquidity was 171,581 million US dollars (over 170 billion dollars), with a bottom line total assets of $923,225 million (a shade under a trillion dollars) book value. Good luck finding a bank that will pay you 4% interest on even a fraction of such an amount. GS' income before tax in 2011 was a shade under 6.2 billion dollars; 4% on 170 billion dollars is 6.8 billion dollars. That is, the interest payments at such a rate on their excess liquidity alone would have cost more than they themselves made in the entire year, which is completely unsustainable. Government bonds are as guaranteed as deposit-insurance-covered bank accounts (it'll be the government that steps in and pays the guaranteed amount, quite possibly issuing bonds to cover the cost), but (assuming the country does not default on its debt, which happens from time to time) you will get back the entire amount plus interest. For a deposit-insured bank account of any kind, you are only guaranteed (to the extent that one can guarantee anything) the maximum amount in the country's bank deposit insurance; I believe in most countries, this is at best on the order of $100,000. If the bank where the money is kept goes bankrupt, for holdings on the order of what banks deal with, you would be extremely lucky to recover even a few percent of the principal. Government bonds are also generally accepted as collateral for the bank's own loans, which can make a difference when you need to raise more money in short order because a large customer decided to withdraw a big pile of cash from their account, maybe to buy stocks or bonds themselves. Government bonds are generally liquid. That is, they aren't just issued by the government, held to maturity while paying interest, and then returned (electronically, these days) in return for their face value in cash. Government bonds are bought and sold on the ""secondary market"" as well, where they are traded in very much the same way as public company stocks. If banks started simply depositing money with each other, all else aside, then what would happen? Keep in mind that the interest rate is basically the price of money. Supply-and-demand would dictate that if you get a huge inflow of capital, you can lower the interest rate paid on that capital. Banks don't pay high interest (and certainly wouldn't do so to each other) because of their intristic good will; they pay high interest because they cannot secure capital funding at lower rates. This is a large reason why the large banks will generally pay much lower interest rates than smaller niche banks; the larger banks are seen as more reliable in the bond market, so are able to get funding more cheaply by issuing bonds. Individuals will often buy bonds for the perceived safety. Depending on how much money you are dealing with (sold a large house recently?) it is quite possible even for individuals to hit the ceiling on deposit insurance, and for any of a number of reasons they might not feel comfortable putting the money in the stock market. Buying government bonds then becomes a relatively attractive option -- you get a slightly lower return than you might be able to get in a high-interest savings account, but you are virtually guaranteed return of the entire principal if the bond is held to maturity. On the other hand, it might not be the case that you will get the entire principal back if the bank paying the high interest gets into financial trouble or even bankruptcy. Some people have personal or systemic objections toward banks, limiting their willingness to deposit large amounts of money with them. And of course in some cases, such as for example retirement savings, it might not even be possible to simply stash the money in a savings account, in which case bonds of some kind is your only option if you want a purely interest-bearing investment." "Building on the excellent explanation by ""Miichael Kjörling"": Why would you rather ""term deposit"" your money in a bank and only earn interest of certain percentage but not not invest in stocks / real state and other opportunities where you will not only earn much higher dividends / profit but will have an opportunity for capital gains, multiple times like Apple's last 4 years(AAPL) ?? This is all down to risk / reward and risk taking.  More risk             = More profit opportunities / More Losses ( More Headache) Less risk(Govt BONDS) = Less profit / Less Losses (peace of mind)" There are a few other factors possible here: Taxes - Something you don't mention is what are the tax rates on each of those choices.  If the 4% gain is taxed at 33% while the 3% government bond is taxed at 0% then it may well make more sense to have the government bond that makes more money after taxes. Potential changes in rates - Could that 4% rate change at any time?  Yield curves are an idea here to consider where at times they can become inverted where short-term bonds yield more than long-term bonds due to expectations about rates.  Some banks may advertise a special rate for a limited time to try to get more deposits and then change the rate later.  Beware the fine print. Could the bond have some kind of extra feature on it?  For example, in the US there are bonds known as TIPS that while the interest rate may be low, there is a principal adjustment that comes as part of the inflation adjustment that is part how the security is structured. "Why would a bank buy government bonds? Why couldn't they just deposit their money in another bank instead?  Generally, banks are limited by laws and regulations about how much they must set aside as reserves. Of the money they receive as deposits, they may loan a certain amount, but must keep some as a reserve (this is called ""fractional reserve banking""). Different countries have a different amount that they must set aside in reserves.  In countries where bank deposits are guaranteed, there is almost always some upper limit to how much is guaranteed. The amount of money that a bank would deposit in another bank would be far greater than the guarantee."
When you buy a bond - you're giving a loan to the issuer. The interest rate on the bond is the interest rate on the loan. Usually (and this is also the case with the treasury bonds), the rate is fixed for the term of the loan. Thus, if the market rate for similar loans a year later is higher, the rate for the loan you gave - remains the same. This is a perfect example of why bonds are confusing at first glance.  Think about it this way...  You buy a 30-year Russian Bond at 4%.  An event happens that makes Russia risky to invest in.  You want to buy another bond but fuck 4%, you and the rest of the market want 6% to compensate you for the risk.  Now let's say you want to sell your 4% bond... Well you're going to have to drop the price of that bond in order for it to appeal to an investor that could go out and get a 6%. On a 30-year bond of that kind, you're looking at about 75% of what you bought it for.   So to wrap it up, high bond yields are great for buyers that don't already own them, but bad for sellers who want to get rid of their old ones. It is the opposite intuition as stocks and almost everything else. It's the rate of return on new opportunities. The rate on existing projects isn't relevant. If you buy a bond 10 years ago when market Interest rates were 8%, and you have cash to buy another bond today, it is today's interest rates that are relevant, not the rates 10 years ago. "This is an easy question - The US government has demonstrated, repeatedly, that it **will** bail out the ""established"" auto industry.   Tesla is very very cool, and may well bury the rest of the auto industry eventually, but they're not viewed as ""too big to fail"".   Thus, Ford's bonds, even if *practically* ""junk"", are essentially backed by US Treasury; that's a pretty good deal, if you're looking for ultra low risk." Businesses have bond ratings just like people have credit ratings. It has become common for businesses to issue low rate bonds to show that they are strong, and leave the door open for further borrowing if they see an opportunity, such as an acquisition.  One of the reasons Microsoft might want to build a credit reputation, is that people become familiar with their bonds and will purchase at lower rates when they want to borrow larger amounts of money, rather than assuming they are having financial issues which would lead them to demand higher rates. The U.S. treasury sells Treasury Bonds directly to consumers at: http://www.treasurydirect.gov/ I believe it’s because the old ticker machines only had 32 symbols making each symbol (1/32) a tick. (Back in the London Stock / Debt exchange in the 18th century) . The first ever government bond was issued by the Bank of England in 1693 to raise money to fund a war against France "Its definitely not a stupid question. The average American has absolutely no idea how this process works. I know this might be annoying, but I'm answering without 100% certainty.   The Fed would increase the money supply by buying back government bonds. This increased demand for bonds would raise their price and therefore lower the interest return that they deliver. Since U.S. treasury bonds are considered to be the very safest possible investment, their rate is the ""risk free"" rate upon which all other rates are based. So if the government buys billions of these bonds, that much money ends up in the hands of whoever sold them. These sellers are the large financial organizations that hold all of our money (banks and large investment vehicles). Now, since bond rates are lower, they have an incentive to put that money somewhere else. It goes into stocks and investment in business ventures.   I'm less certain about how this turns into inflation that consumers will recognize. The short answer is that there is only a finite number of goods and services for us to buy. If the amount of money increases and there are still the same number of goods and services, the prices will increase slightly.   Your question about printing money to pay off debts is too complex for me to answer. I know that the inflation dynamic does play a role. It makes debts easier to pay off in the future than they seem right now. However, causing massive inflation to pay off debts brings a lot of other problems." Because US bonds have had the prior impression of absolute invincibility and safety that has helped the dollar become the world's reserve currency and the United States borrow essentially at will. For the people that care what S&P says, the aura of invincibility is broken and it is conceivable, in SOME universe, for the US to default on its debt. This is of little practical importance on its own, but it's yet another signpost on the road to Chinese or European economic hegemony. "Bingo, great question.  I'm not the original poster, ""otherwiseyep"", but I am in the economics field (I'm a currency analyst for a Forex broker).  I also happen to strongly disagree with his posts on the origin of money.  To answer your question:  the villagers are forced to use the new notes by their government, which demands that their income taxes be paid with the new currency.  This is glossed over by otherwiseyep, which is unfortunate because it misleads people who are new to economics into believing the system of fiat money we have now is natural/emergent (created from the bottom-up) and not enforced from the top-down.  Legal tender laws enforced in each nation's courts mean that all contracts can be settled in the local fiat currency, regardless of whether the receiver of the money wants a different currency.  These laws (and the income tax) create an artificial ""root demand"" for the fiat currency, which is what gives it its value.  We don't just *decide* that green paper has value.  We are forced to accumulate it by the government.  Fiat currencies are not money.  We call them money, but in fact they are credit derivatives.  Let me explain:  A currency's value is inextricably tied to the nation's bond market.  When investors buy a nation's bonds, they are loaning that nation money.  The investor expects to receive interest payments on the bonds.  The interest rate naturally rises as the bonds are perceived to be more-risky, and naturally falls as the bonds are perceived to be less-risky.  The risk comes from the fact that governments sometimes get really close to not being able to pay their interest payments.  They get into so much debt, and their tax-revenue shrinks as their economy worsens.  That drives up the interest rate they must pay when they issue new bonds (ie add debt).  So the value of a currency comes from tax revenue (interest payments).  If a government misses an interest payment, or doesn't fully pay it, the market considers this a ""credit event"" and investors sell their bonds and freak out.  Selling bonds has the effect of driving interest rates even higher, so it's a vicious cycle.  If the government defaults, there's massive deflation because all debt denominated in that currency suddenly skyrockets due to the higher interest rates.  This creates a chain of cascading defaults - one person defaults, which leads another person, and another, and so on.  Everyone was in debt to everyone else, somewhere along the chain.  In order to counteract this deflation (which ultimately leads to the kind of depression you saw in 1930's US), governments will print print print, expanding the credit supply via the banks.  So this is what you see happening today - banks are constantly being bailed out all over the Western world, governments are cutting programs to be able to meet their interest payments, and central banks are expanding credit supplies and bailing out their buddies.  Real money has ZERO counterparty risk.  What is counterparty risk?  It's just the risk that the guy who owes you something won't honor his debt.  Gold and silver and salt and oil aren't IOU's.  So they can be real money." "I don't like buying individual bonds for my own portfolio.  I actually used to buy long-term government strip bonds (Canadas or provincial bonds) but I stopped.  Here are some reasons why: My broker allows me to purchase bonds via their web application.  However, to sell a bond, I had to call in to the fixed-income trading desk.  That was inconvenient.  (But your broker may be different.) Bonds don't typically trade on a formal exchange.  So, there's no cheap & easy way (as far as I know) to get an independent quote for a bond's value – I had to trust what my broker said my bond was worth when assessing my portfolio performance.   I asked my broker once how they arrive at the ""market value"" shown – i.e. whether it was last bid, ask, or actual trade – and I was told they use a third party bond quotation / valuation information provider for the data, and that quotes are an estimate of what the bond would be worth, based on similar bonds.  I quickly learned that wasn't the value I could actually get when selling it: When you're dealing with your broker to buy and sell bonds, you're likely dealing with theirs or a related investment bank which makes a market for specific issues of bonds.  While I wasn't being charged an explicit commission to buy or sell bonds, it was evident the broker makes money off the spread:  That is, the difference between what they would be willing to sell a bond for and what they would be willing to buy that same bond for.  They will buy your bond back from you cheaper than what they could turn around and sell it to somebody else for.  That's why they don't charge an explicit commission... it's built in and hidden! Anyway, when I finally discovered my broker would seldom actually offer me the ""market value"" quoted for my bonds (typically, it would be bought back for a few percent less than it were theoretically worth), I gave up.  I don't think bonds simply are liquid enough, nor the costs transparent enough for retail investors.  (Or maybe it's just me :-) However, I do think bonds remain an important part of a diversified portfolio:  Bonds ought to be represented in a diversified portfolio using low-cost bond index mutual funds or exchange-traded funds.  Since these funds buy & sell bonds in large quantities, they get a better deal on the spreads.  So, while you do pay an explicit management fee for a fund, you are probably saving since you're not getting shafted on the spreads." China actively SELLS US Treasuries.   http://online.barrons.com/article/SB50001424052748704097904577257030958775246.html  The Chinese are not stupid.  Why the fuck would someone buy a 2 year at .2% when inflation is over 1% PER YEAR?    So insolvent banks can park collateral at Central Banks for cash.  This is why the balance sheets of developed world nations have exploded since 2008.  http://www.alsosprachanalyst.com/economy/charting-central-banks-balance-sheets.html  edited: for unnecessary rudeness "There are tax free bonds in the United States.  They are for things like public housing and other urban projects.  They are tax free for everyone but only rich people buy them.  Why?   The issue is that the tax free nature of the bond is included in its yield.  So rather than yielding say a 5% return, they figure that the owner is getting 20% off due to not paying taxes.  As a result, they only give a 4% return but are as risky as a 5% return investment.  Net result, only rich people invest in tax free bonds.  ""Rich"" is defined here to mean people paying a 20% tax on long term investment returns.   Or take the State and Local Tax (SALT) deduction, which has been in the news recently.  Again, it is technically open to everyone.  But there is also a standard deduction that is open to everyone.  For the typical family, state and local taxes might be 5% of income.  So for a family making $100k a year, that's $5k.  The same family can take a $13k or so standard deduction instead of itemizing.  So why would they take the smaller deduction?   As a practical matter, two groups take the SALT deduction.  People rich enough to pay more than $13k in state and local taxes and people who also take the mortgage interest deduction.  So it helps a lot of people who are rich quite a bit.  And it helps a few middle class people some.   But if you are lower middle class with a $30k mortgage on a tiny house and paying 4% interest, then that's only $1200 a year.  Add in property taxes of $3000 and SALT of $2.8k and that's only $7k.  Even if the person gives $3k to charity, the $13k deduction is a lot better and requires less paperwork.   Contrast that with someone who has $500k mortgage at 3.6% interest.  That's $18k in interest alone.  Add in a SALT of $7k and property taxes of $50k, and there's $75k of itemized deductions, much better than $13k.  Now a $7k donation to charity is entirely deductible.  And even after the mortgage interest deduction goes away, the other $64k remains." Yes, the Fed has made a point of buying up longer-term bonds to push down rates on that part of the curve.  That's not an indication that they're having problems selling Treasuries, in fact far from it.  But apparently there's no demand for Treasuries and Bloomberg is just making up lies to help get Obama reelected?  &gt;Investors are plowing into Treasuries (USB2YBC) at a record pace as the supply of the world’s safest securities dwindles, ensuring yields will stay low regardless of whether the Federal Reserve  undertakes more stimulus to fight unemployment. Buyers bid $3.19 for each dollar of the $538 billion in notes and bonds sold this year, the most since the government began releasing the data in 1992 and on pace to beat the high of $3.04 in 2011. The net amount of Treasuries available will decline by 30 percent once proceeds from maturing securities are reinvested, according to data from CRT Capital Group LLC.  http://www.bloomberg.com/news/2012-04-09/record-treasury-demand-keeps-yields-low-as-supply-shrinks.html Running a fiscal deficit means a government is spending more money than it is taking in as taxes, fees, penalties, fines, etc, with the extra money that is being spent being borrowed by selling bonds to willing buyers.  Interest paid to said buyers is another government expense in future years, and of course, the bonds must ultimately be redeemed and the buyers paid off.  The buyers of the bonds must have some confidence that they will get the interest they have been promised as well as be paid off ultimately.  As the government's indebtedness increases, buyers are likely to demand higher interest rates as inducements to buy the bonds. And so it goes...