What is the foundation of the modern financial market? What will cause a doomsday scenario? Why? Complex topic simplified. Let's explore.

The theory is never wrong but it is usually the assumptions.

1.     The theory: US Treasury interest rate yield is risk-free.

2.     The assumption: The United States will never default on debt payment obligations and the world will continue to lend to the US forever.

The theory and assumption are the core foundation on which the modern global financial market is built

Why?

The United States is the largest economy in the world and continues to lead in innovation, entrepreneurship, and business creation.

US GDP is 25% of the world’s GDP and the US equity market cap is more than 50% of the total world stock market equity market cap.

The United States' unmatched scale and formidable taxation capabilities allow it to borrow on its own terms.

All others will have to pay higher interest = risk premium + risk-free rate

How does it impact you?

Your mortgage rate or credit card APR: The lender demands an additional interest rate on top of the base rate a.k.a risk-free rate to compensate for your risk of default.

The stock market equity premium is the difference between US stock market performance and US Treasury bond performance over the past 100 years, is about c.5%.

Your stock portfolio should return at least 10.5% considering US T-bill's current yield is c.5.5%.

What could go wrong?

“All models are wrong but some are useful” – George Box.

When the useful model becomes useless, it is a doomsday scenario.

The US national debt is £34 Trillion, + £10 Trillion post-Covid since 2020. The US national debt is more than 100% of GDP.

The D-Day

The day when US Treasury auctions fail i.e. world refuses to lend to the United States Government.

The risk-free rate spikes to Infinity, and everything falls apart.

The mortgage rate will be infinity + and the stock market expected return will have to be infinity ++

Until then,

The entire financial market trusts US treasuries.

And US Treasuries says “In God we Trust” (see the dollar bill image below).

On a lighter note,

By inference, let God do his job from the heavens and run the financial market.

What do you think?

Note: Views are personal, It is a joy to let the mind wander during the weekends.

You can read all my “Notes to Self” at view all blogs.