Hamilton And Sovereign Debt

Bastard_OrphanHow does a profane, hip-hop, hit of a show, and a chapter, dropped in the middle of a behemoth book on Alex Hamilton, by Ron Chernow capture the current zeitgeist, show us to treat our debt with sacred honor?

Hamilton, the musical by Lin-Manuel Miranda, swept through my household this Summer like a hurricane, buffeting us as if we lived in a forgotten corner of the Caribbean. While the beautiful nerds of my household joyfully sing about the Revolutionary War, I tackled Ron Chernow’s biography Alexander Hamilton, upon which Miranda based his amazing show. A story Chernow tells about national debt illustrates Hamilton’s particular genius.

Serving President George Washington as the first Treasury Secretary of the United States, when the new country flirted with financial ruin, every action Alexander Hamilton took carried particular weight. He faced a terrible choice.

Soldiers in the Revolutionary War had received state IOUs in return for their military service. Years after the end of fighting with the British, many of these debts remained unpaid. In addition, different states had repaid debts to different degrees. Virginia was nearly debt-free for example, while Massachusetts still owed tremendous amounts to soldiers.

Some believed this new federal government would not, and could not, pay off its debts to soldiers. Chernow writes that these debts traded at fifteen cents on the dollar as former soldiers sold early, in part because they needed the money, and in part because full payment seemed doubtful. Speculators bought the debt at extreme discounts, hoping to make money if the young government could restructure the debt somehow. At that price, even a settlement of thirty cents on the dollar offered a financial windfall to debt-buyers.

What kind of deal would Hamilton, as Treasury Secretary, offer on the debt? Should he restructure it and offer a lesser amount? Should he seek a way to punish the speculators? Could he track down the former soldiers who had sold their IOUs, to compensate them, instead of the investors? Wait for it…

Let’s pause for a moment and really wallow in the awful optics and politics of Hamilton’s choice. Nobody deserved more respect than the first patriots who suffered and died under Washington, when his “ragtag volunteer army in need of a shower” defeated a global Superpower, in Miranda’s purposefully anachronistic phrasing. But most of the government debt issued to soldiers wasn’t owed to them anymore, but rather to buyers of their debt. These were some of the least sympathetic people. You know, Wall Street-type people.

Jefferson and Madison

The most powerful member of Congress, James Madison, and the Secretary of State, Thomas Jefferson, vehemently opposed rewarding the speculators. As Virginians, they also argued that consolidating the debts at the federal level would reward less prudent states at their state’s expense.

Picture, as well, Hamilton’s childhood as a near-destitute orphan in the Caribbean. He was not a natural friend of Wall Street. He’d served as a captain of an artillery company under fire in the Battery in Manhattan and the Battle of Kips Bay; he had personally led a bayonet charge on an entrenched position of Redcoats at Yorktown. Was Hamilton prepared to honor commitments that would enrich these greedy speculators who bought government debt at pennies on the dollar from his fellow soldiers? Wait for it…

He was, and he did. He consolidated the states’ debt into federal debt. On his first and second days after confirmation as Treasury Secretary in 1789, he took out fresh federal loans from the Bank of New York and The Bank of North America in Philadelphia.

Hamilton understood the value of communicating a policy of honoring one’s debts, a policy that strengthens the nation. “In nothing are appearances of greater moment than in whatever regards credit. Opinion is the soul of it and this is affected by appearances as well as realities,” he wrote in his 40,000-word Report on Public Credit, delivered to Congress in January, 1790.

He further set the precedent that the government does not interfere in private transactions of its public securities, even if the optics and politics would make it expedient to change terms, after the fact.

As Chernow reports, Hamilton reframed the moral issue into one of honoring private property and “security of transfer.” The soldiers were not as heroic as they seemed, nor the speculators as greedy. Investors after all, had risked their capital. The ex-soldiers, in turn, had shown little faith in the government. That the buyers of soldiers’ debt made extraordinary short-term fortunes was, in the far-seeing perspective of Hamilton, irrelevant to the more important work of establishing a solid financial footing for the country. Meanwhile, Madison and Jefferson fumed.

The United States has never defaulted on its debt. Not through the ruin of a burned capital in 1812, nor through a crippling Civil War, nor the World Wars and Depression of the Twentieth Century. Hamilton’s honoring of national debts – against all the political, fiscal and moral pressure of his day – bolstered us as a nation. It set us up for national prosperity.

As the fictional Jefferson of the Hamilton musical ruefully admits: “I’ll give him this: His financial system is a work of genius. I couldn’t undo it if I tried, and believe me, I tried.”

Or the fictional Madison: “He took our country from bankruptcy to prosperity. I hate to admit it, but he doesn’t get enough credit for all the credit he gave us.”

Contemporary debates

Shifting to 2016 for a moment, what would Senators Bernie Sanders or Elizabeth Warren have done with Hamilton’s conundrum? Historical hindsight isn’t necessarily fair, but I’ve listened to their views on Wall Street, the industry where I previously worked, and which they consistently attack as a cesspool of greed, corruption, and speculation.

unhappy_trumpWe also have GOP presidential candidate Donald Trump’s views on the record on our national debt. In stark contrast to Hamilton, Trump presented his approach in an interview with CNBC in May. He explained “I’ve borrowed knowing that you can pay back with discounts. [As President,] I would borrow knowing that if the economy crashed, you could make a deal.”

See, that’s not really how the bond market works. Hamilton had the foresight to know that once you default on debt – which is what “pay back with discounts” means – you set a precedent for how lenders view your credit in the future. I would even argue that once you even say that out loud – if anyone takes you seriously – you risk submarining your nation’s future ability to borrow.

Think about how lucky we are to be alive right now, with Hamilton on our side.

A version of this post ran in the San Antonio Express News.


Please see related post:

Trump: Sovereign Debt Genius


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Donald Trump – Sovereign Debt Genius

USA_Debt_to_GDPOne of The Donald’s great strengths is that he latches onto a partial truth – or an unspoken but widely held belief – and then expands upon it for his own purposes. Obviously this can veer into disgusting territory, when it comes to expressing sexually insecure men’s feelings about women, or insecure workers’ feelings about economic threats from China or Mexico. As Matt Taibbi eloquently expressed, he effectively uses this same talent of partial truth-telling to bash government and media elites who do, in fact, disdain, misunderstand, or ignore ‘regular Americans.’ Trump scores these points against Establishment elites because really, we sense some truth in what he says, that others before him won’t say.

Earlier in the week Trump stepped in a pile of it when he expressed truths about US sovereign debt which political leaders cannot openly discuss. Unconstrained by good taste, judicious character, or political consistency – he can pop off in any direction, occasionally hitting on an important point that more people should understand.  The Donald said:

“I’ve borrowed knowing that you can pay back with discounts. I’d borrow [as President, on behalf of the US] knowing that if the economy crashed, you could made a deal.”

This is so crazy that he said it – as a person running for President – that you kind of have to laugh at his gall. On the other hand, he’s right. This is what happens when countries borrow too much. And also, we don’t really know – or have any kind of open discussion in this country – about what constitutes too much national borrowing.

Those fingers tho…

When I worked as an emerging market bond salesman in the late 1990s – slinging bonds from places like Pakistan, Ukraine, Ecuador, Argentina, Russia, and Ivory Coast – we used to put out economic research for our clients that pointed out that a 70% Debt/GDP ratio marked a kind of scary ‘Do Not Cross’ line. If the total amount of sovereign debt exceeded 70% of the economic output of country, you might have to start worrying about whether that country could reliably pay back its bonds. Once you hit 100% Debt/GDP, history seemed to show, emerging market countries would enter a red-zone of risky sovereign renegotiation, or possible default. Their cost of new borrowing would rise, which in turn would hurt their ability to service their existing debt. At between 70% and 100% Debt/GDP, countries could get into a vicious death-spiral of borrowing, ending in sovereign debt restructuring.

At that time, Japan alone among rich countries represented a weird exception to that guideline, with seemingly ‘safe’ bonds offered at very low interest, while maintaining a Debt/GDP ratio of around 100%. Post 9/11, the US and Europe embarked on a new low-interest era, and developed countries seemed to be able to borrow a greater amount than ever before, without adverse consequences. Debt was cheap, borrowing levels rose, and many more countries – developed, and emerging – breached ‘the red zone.’

Present-day debt levels

These days, the US (seemingly comfortably) shoulders a 100+% Debt/GDP ratio, while Japan’s ratio has climbed to 180%. Are either of these ratios too high?

By way of comparison, Greece – which effectively restructured its debt with the rest of Europe in recent years – only had a 150% Debt/GDP ratio. The US now enjoys a previously unthinkable Debt/GDP ratio, seemingly without consequences. I point out these ratios to say that it’s also not impossible that the US would have to renegotiate its debts at some point. Which is why, crazy as Trump is, he’s sort of inadvertently pointed out an important thing.


Don’t get me wrong. In no way do I ‘predict’ a US sovereign debt crisis is imminent.1 Permabears and goldbugs like Peter Schiff like to talk about a coming US debt crisis like it’s a guaranteed future – like it’s a rational reason to:

1. Start buying gold and

2. Buy empty farmland and build bomb shelters.

It’s not. Shortly after the 2008 Crisis in particular, commentators tried to argue that increasing our national debt at our post-Crisis rate would lead to financial Armaggedon.  It didn’t.

I just think that – without any current limits on US sovereign borrowing, we might have the impression that we could borrow indefinitely.

Trump’s comments recently made explicit the problem of excessive borrowing that other countries have dealt with on a semi-regular basis. Greece, Pakistan, Ukraine, Ecuador, Argentina, Russia, and Ivory Coast – to name a few – have faced the problem of excessive debt in the past two decades and done exactly what Trump talked about. You sit down with your creditors and have a difficult, adult conversation. We “US exceptionalists” think this is ‘unthinkable’ but really it shouldn’t be. It happens and has happened on a regular basis with many countries. Plenty of unpleasant but semi-banal developments (war, recession, political instability, a Kanye/Miley Cyrus Democratic Party platform in 2024) could put the US’ ability borrow and pay its debts at risk.

Currency control

One of the great advantages Japan and the US hold over Greece (and the rest of the Eurozone) and many emerging market countries is that we control our own currency. Here again, The Donald is our resident genius, in explaining why this is such an advantage:

“First of all, you never have to default, because you print the money. I hate to tell you, okay, so there’s never a default.”

Again, this is totally irresponsible of him to say this out loud as a person running for President, but he’s technically correct and therefore to be credited with bringing complicated unspoken semi-truths to the surface. Dollar-denominated debt becomes only half as expensive in real terms, if you just double the amount of available money, or experience a quick bout of 100% inflation.

There are some nuances here that would make that harder than it sounds coming from Trump’s mouth. Like, you don’t get to trick your lenders more than once this way, because they (the lenders) quickly raise future interest rates to adjust to inflation.2 Also, significant sovereign debt obligations like Social Security, Medicare, federal pensions, and TIPS (an inflation-linked type of bond) adjust payments upward with inflation. But like I said, I admire Trump for bringing up an important unstated half-truth about currencies and sovereign debt.

The US also enjoys another huge advantage relating to its currency – the fact that everybody in the world still wants dollars as a preferred method of trade, and store of value.

The ‘Reserve Currency’ Advantage

In addition to our ability to inflate away too much debt, we enjoy the advantage of a special ‘reserve-currency’ status in the world which acts as an amazing kind of subsidy for our profligacy.

What do I mean by that? I mean something kind of like that joke about the two hunters and the hungry bear. We don’t have to run a great economy or run a great political system, we just have to run our operation better than all the other choices.3 So if you can create (at least the illusion of) the Rule of Law (China and Russia can’t), Growth (Europe and Japan can’t), and Political Predictability (Africa and Latin America can’t) at a Big Scale (Canada, Switzerland, New Zealand can’t) then you get to be the country that controllers of massive amounts of capital want to be invested in.

We attract excess Chinese, Saudi, Singaporean and Norwegian money into our bonds because where’s else can they park huge amounts of wealth? We may have deep structural problems, but so does everywhere else, to an even greater extent. From a sovereign debt perspective, we can outrun the bear better than the others. At least for now.

That’s the part, unfortunately, with which The Donald is not actually helping, though.

Some Ways In Which The Donald Isn’t So Genius

He’s perfectly correct in saying that if the US got in trouble with too much borrowing, we could sit down and renegotiate our obligations. Lots of countries have done this. He’s also perfectly correct that our control over our own currency allows us to ‘inflate away’ the problem, to some extent. What he’s absolutely putting at risk, however, is our special ability to ‘outrun the bear’ in the form of maintaining (at least the illusion of) the Rule of Law, Growth, and Political Predictability.

The following policies will not help our reserve currency status, which is really the key to the US’ sovereign borrowing advantage:

  1. Building giant walls along our border
  2. Threatening to default on our bonds
  3. Threatening to massively devalue our currency
  4. Forbidding entrance to and/or deporting people based on their religion
  5. Threatening aggressive trade wars with major bond funders, like China
  6. Promising to rewrite libel laws in order to quell journalistic enemies
  7. Encouraging violence against political enemies during public rallies

Now, of course, The Donald will probably say he’s just kidding about all these things. He’s really a more serious person than that, you know he went to a really good school, and he’s really smart and handsome. Lots of women, and even the hispanics, you know, they like him. Maybe bond investors don’t take his little jokes and threats that seriously. Fine, maybe he’s just kidding about all that stuff.

But in my experience, the people who control real capital – the few thousands of wealth managers and bond traders on this planet who ultimately decide whether to continue to roll over the US debt every month – until now rolling it over like clockwork at attractive, low interest rates – in my experience they don’t fuck around.

And by “not fucking around,” I mean they really don’t appreciate heavily-indebted countries, led by hucksters, pushing trade wars and closed borders. They can choose whether – or not – to invest in bonds of countries led by an unserious racist xenophobe who jokingly threatens debt restructuring and inflation. Believe me, they don’t appreciate the joke.

I like our reserve currency advantage. We’ve built a good track record over time of responsibly handling our massive national debts. We’ve been a good bet, and just as importantly perceived to be a good bet up until now, for paying everyone back.

There’s quite a bit at stake here.



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  1. predictions like this are always made by cranks and people with things to sell you
  2. As our poet-President W. Bush once mumbled “Fool me once, shame on…shame on…You…fool me, can’t get fooled again.”
  3. At the risk of over-explaining the joke/analogy: We just have to outrun the other hunter.

Financial Repression = Less Crises

Please see earlier post on the Reinhart Rogoff IMF paper

I wrote a few days back about how a serious, academic, review of past and prospective debt restructurings can be on the one hand useful, on the other hand not particularly predictive of market conditions, and on the third hand (I have three hands!?!) easily manipulated by the Financial Infotainment Industrial Complex into unhelpful click-bait.

But I want to also highlight an interesting, but less noted, point of the Reinhart Rogoff paper.  Namely, a world of financial repression leads to a lot less financial crises.

The big, ignored point, of the Reinhart-Rogoff paper

The most interesting insight of their paper – although one which contrasts sharply with the narrative that the Financial Infotainment Industrial Complex in the US would like to tell – is that the Financial Repression period (1945-1979) of economic policy-making correlates to a lower incidence of financial crashes, inflation-shocks, and banking crises.

It’s worth clicking on this screenshot of the Reinhart Rogoff figure on historical crises.  They made an index of banking crashes, currency runs, hyperinflation, and debt defaults/restructurings, weighted by country.  Spikes in crises all occur in the the ‘open markets’ periods, but rarely happen during ‘financial repression periods.’

Financial Repression = Less Crises


Only in the more liberal (with a small “L,” meaning “less-controlled”) economic period they study (1900-1939 and 1980-Present) did we experience very high spikes in financial crashes, inflation-shocks and banking crises.  Correlation is not causation – I hasten to add – but it’s so clear from their graph of financial shocks that Reinhart and Rogoff have to acknowledge it.

Is financial repression a good thing?

Now, no card-carrying member of the mainstream Financial Infotainment Industrial Complex wants to be caught dead advocating a more interventionist financial regime.   Among the financial news I read on a regular basis – The Wall Street Journal, Business Insider, Bloomberg – basically nobody is going to write “Hey, let’s gum up the financial markets to reduce the probability of financial crises,” which led me at first to think that this under-reported correlation in the Reinhart Rogoff paper has no support in media and politics.

The more I thought about it,[1] however, the more I realized that the idea of financial repression leading to fewer crises actually does have plenty of support.  I just usually don’t read that media.

In Washington, Senator Elizabeth Warren – an ex-academic colleague of Reinhart and Rogoff – represents the view, as far as I can tell, that if we regulate Wall Street a lot more – to the point of financial repression – then we won’t experience a replay of 2008.

In financial media, when I read Matt Taibbi in Rolling Stone or Gretchen Morgenson in the New York Times, my sense is that they share Warren’s basic view.  The point of regulating Wall Street is to create a system of financial repression sufficient to dampen financial excess, which will in turn dampen financial crises.

I don’t share what I interpret as the Warren/Taibbi/Morgenson[2] policy view, but I think Reinhart and Rogoff’s paper provides some academic ammunition for their views.

Please see related post on Academia, Markets, and Click-bait inspired by the Reinhart Rogoff paper

Please also see related post Reinhart Rogoff  and the irony of political affiliations



[1] Fine, it actually wasn’t me thinking about it, it was my wife who made the next point.

[2] I’m sure any one of this troika would be offended, each for their own reason, that I have lumped them together, as if they share a common world view.  No doubt there are important distinctions. Oh well.  My blog.  I get to do the lumping.  I lump them together because I don’t ever see evidence in their writing that they evaluate members of the for-profit financial world on the terms of the for-profit world.  In place of that, I see a lot of evidence of moralistic tsk-tsking about profit-seeking.  “Why oh why don’t those financiers consider the children first???”  I’m paraphrasing of course.

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1930s Style Debt Defaults?

1930s_breadlineA sometime gold-coin buyer and a frequent reader of Bankers Anonymous sent me a message a few days ago, linking to the CNBC headline “1930s-style debt defaults likely, says IMF,” and with the simple question: “Mike – True?”

Harvard economists Carmen M. Reinhart and Kenneth S. Rogoff’s latest paper, commissioned by the IMF and published in December 2013, re-raises the specter of sovereign default in the so-called ‘developed world,’ warning of restructuring, restrictive capital controls, and debt write-offs.

Their paper was rewarded and echoed with headlines from Business Insider like “Extreme Debt Means 1930s-Style Defaults May Be Coming to Much of the Western World” and CNBC’s “1930s-style debt defaults likely, says IMF,” the headline that prompted my reader’s email to me.

This seemed like a great opportunity to reflect on the problem of different, confusing, contradictory messages constantly streaming from the Financial Infotainment Industrial Complex.

Academia, Click-bait, and Markets

Those headlines, loosely based on the Reinhart and Rogoff IMF paper, are a great example of the giant gulf between financial academia, click-bait, and actual markets. Each information source follows its own rules and logic – but mixed up together provide a cacophony of worse-than-useless dis-information.

First, academia on its own terms

Professors of international economics should consider a wide variety of scenarios, and they should present historical data, as Reinhart and Rogoff have done, with their book This Time is Different: Eight Centuries of Financial Folly.

[I confess I have not yet read this, but I suspect I will find this a useful addition to other books I have enjoyed on sovereign debt defaults, such as A Century of Debt Crises in Latin America: From Independence to The Great Depression 1820-1930 by Carlos Marichal.]

I enjoyed the Reinhart and Rogoff paper, with its useful historical data, reminding readers that sovereign debt defaults in Europe are not particularly rare.  In addition, sovereign defaults sometimes come hidden in sheep’s clothing – as when a combination of capital controls, high inflation, or forced ‘savings’ from captive sources such as workers’ pensions effectively bail out overly indebted governments.

As a former emerging markets bond guy I read Reinhart and Rogoff’s work with much interest.  Here’s a summary of their main points, and my reactions:

  1. Drastic sovereign debt restructurings are historically more common than many realize, and come in a variety of forms.  [Totally agree]
  2. Financial repression, while brutal and inefficient, probably reduces financial excess, and therefore financial crises.   [Totally agree]
  3. The 5 year-old crisis we are in will involve more explicit restructuring of sovereign debt in the so-called ‘developed’ world, presumably peripheral Europe.  [Mmm. Squinting. That depends.  Doubtful.]
  4. We will see a return of ‘financial repression’ in the ‘developed world.’ [I see no evidence of this.  Or, I guess it depends how you define ‘financial repression.’]


But what about the click-bait?

Reinhart and Rogoff are legitimate economists (at a reasonably decent University) so it’s not surprising that they have produced serious work on historical sovereign debt restructurings.  I wonder, however, to what extent they anticipated (and even encouraged?) the click-bait aspect of their paper.

“1930s-style debt defaults likely, IMF says” is a totally misleading version of their report.

“Ex-Goldman bond salesman may make billions blogging his random opinions, says blogger,” is a headline I could write about myself, but it would have as much relationship to the probabilistic truth as that CNBC headline has to the IMF report.

Unfortunately, CNBC – and the rest of the Financial Infotainment Industrial Complex – runs on nonsense click-bait, so people like my reader who sent me the email query get pummeled with emotionally-charged or scary bullshit, on an hourly basis.

Market Data

How do I know that – on a probabilistic basis – both the click-bait headline as well as points 3 & 4 of the Reinhart-Rogoff paper can be safely ignored?

Because what neither academia, nor the click-bait-setting members of the Financial Infotainment Industrial Complex typically take into account is that we have a ton of aggregated financial information available in markets about exactly their topic.  Right now.  At all moments.

The bond market

At any given moment – with updates on a minute-by-minute basis – the most–informed people in the world on sovereign risk – with the most to gain or lose financially – are indicating the probability of default on all sovereign debts.

Bond traders – at mutual funds, hedge funds, banks, insurance companies, and broker-dealers – control the flow of capital into or out of investments in sovereign debt.

Yield or bond spread indicate aggregate market perceptions of risk by the most knowledgeable and interested people in the world.

The constant buying and selling of bond traders sets a price, in yield terms, that tells us a lot about what the odds of default are.  The higher the yield, the higher the controller of capital is demanding to take the risk of the bond.  In aggregate, the self-interested decisions of bond traders give a very full view of the total risk associated with these bonds.

The most common way bond traders compare the relative risk of sovereign debt is through a ‘spread,’ which means the additional yield investors receive over the yield of a riskless bond yield.[1]  A 1% bond yield spread, or as bond traders would actually say, “100 basis points”[2] spread over an equivalent riskless bond, indicates that highly informed and highly interested investors find the bond mildly, but not extraordinarily, riskier than a ‘riskless’ bond

Most of us do not see the minute-by-minute information on government bond spreads but we can access it, updated at least daily, on the global government bond yield pages of financial news sources like The Financial Times or Bloomberg or The Wall Street Journal.

Why so much about the bond markets?

Why am I going into this excruciating detail about the bond markets?  Because if you know something about how the bond markets work, and what information they convey, you can interpret both the Reinhart-Rogoff thesis on defaults and the Financial Infotainment Industrial Complex’s click-bait headlines for what they are.

In sum:

Reinhart-Rogoff: Improbable

CNBC’s headline: Nonsense

How do I know this?  Because the bonds markets give us bond spreads on the sovereigns they reference.  Here are some select 10-year bond spreads this week from The Wall Street Journal’s global government bond page:

Italy:  97 basis points (less than 1% yield premium)

Portugal: 225 basis points (2.25% yield premium)

Spain: 88 basis points (less than 1% yield premium)

The bond market is saying, with these spreads, that it finds these European bonds mildly risky, but not terribly risky.  Default, while possible, is highly improbable over the next ten years.

Of course, Greece already restructured its sovereign debt, so Reinhart-Rogoff’s ‘prediction’ came true.  But since they published their ‘prediction’ in December 2013, however, they really can’t take credit for being nearly 2 years late.

So, no, 1930s-style defaults are neither likely to happen nor likely to be widespread, as implied by the IMF paper, and by CNBC’s headlines.  Of course, anything can and will happen with markets, but the smart money’s not betting on that, and you shouldn’t either.  Leave the fear-mongering to Harvard economists and click-bait headline writers.

Please see related post:  The biggest, mostly ignored, point of Reinhart Rogoff’s IMF paper.


[1] Among bond traders primarily trading in US $ Currency, a ‘riskless bond’ for the purpose of determining bond spread, is usually a similar maturity US Treasury.  Bond traders in Europe or Japan might use a different riskless bond as the basis for comparing risk in their own currency.  We can argue about whether US bonds, or Japanese bonds, or German bonds are actually ‘riskless,’ and traders do, but traders also need a convention for comparison, so US Treasuries often serve that purpose regardless of whether its truly ‘riskless’ in the absolute sense.

[2] A basis point is 1% of 1%.  Hence, 100 basis points for every 1% in yield or yield spread.  If we say 5 basis points, or 5bps, (pronounced “5 bips”) that means 0.05% in yield, or spread terms.

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