I’m going to quote directly from this Bloomberg article:
Treasuries surged, pushing 10-year note yields down to the least since January 2009, as tumbling stock markets sparked demand for the safety of government debt
Ok. Let me see if I understand this correctly. Last Friday, Standard & Poor’s downgraded the long-term sovereign credit rating of the United States from AAA to AA+. What this means in a nutshell is that they think the US is at a higher risk of defaulting on the national debt. Granted, the rating changed from essentially “no risk of default” to “very small risk of default,” but any change is a big deal because this has never happened before–the US has had a AAA rating ever since S&P started doing ratings.
So, how did investors respond to this news? Apparently, by heavily selling off their ownership stakes in private industries, and using that money to buy up more government debt. No, really! The S&P essentially said “We think the US is at a higher risk of defaulting on the national debt than at any other time in history” and investors responded by saying “Holy shit, I better buy up some more of that debt, then!”
Now, lots of people don’t understand this, but when you buy things like T-bills and other forms of government “investments,” what you’re doing is loaning the government money. In turn, they promise to pay you your money back plus interest. It’s no different in principle to you going to the bank and taking out a loan. This is precisely how the government got in debt to begin with. They spent more money than they brought in in taxes, and made up the difference by taking out these loans.
Most of the time, people figure these are “safe” investments. And as long as the government doesn’t default, they are safe investments–just not very good ones most of the time (you can generally make a lot more on your investments by taking just a tiny bit more risk.) But the boys over at Standard & Poor’s just got done telling everybody that these investments are not as safe as everybody used to think, and investors responded by buying more of them.
Think about it like this. Imagine if you missed a few credit card payments. This causes your credit rating to go down. Now suddenly, all the banks start selling off the loans they made to other people in order to loan you more money. This would never happen, right? Imagine if you stopped paying your mortgage, and instead of foreclosing and taking your house away, the bank instead sold off a few of its more solid mortgages in order to give you another mortgage on a vacation home! Nobody in their right mind would do this, right?
Well, this is exactly what investors are doing today. They’re selling off their ownership stakes in other companies in order to buy more US debt, because they’re suddenly afraid that the US Government might be… unable to pay their debts sometime in the future.