How does T bills and T bonds controls inflation,money supply and overall economy
Treasury Bills and Treasury Bonds are not just investment portfolios similar to shares; they are also powerful tools that influence everyday prices, such as grocery prices, which many people do not usually consider.
Treasury Bills and Bonds can be simply explained as financial instruments used by the government to control the money supply. Whether this really impacts prices will be discussed in detail later. First, let us understand the theory behind Treasury Bills and Treasury Bonds.
Treasury Bills were introduced in 1923 by the British government to fulfill or fund the short-term requirements of the economy. This instrument was used to control the government’s short-term money requirements. Later, it was realized that while Treasury Bills were effective for short-term needs, they were not suitable for long-term requirements. As a result, Treasury Bonds were introduced to fulfill long-term requirements such as funding highway projects, ports, and large budget deficits.
Treasury Bills can be understood as papers issued to the public to fund short-term liquidity.
Short-term liquidity refers to short-term money requirements, similar to funds used as petty cash or for short-term investments. Treasury Bills have maturity periods of 91 days, 181 days, and 362 days. After maturity, investors receive a fixed profit for each bill. This profit is predetermined and effectively written into the value of the bill itself.
Treasury Bonds, on the other hand, are used to fulfill long-term liquidity needs and long-term budget deficits. Bonds have maturity periods such as 2, 5, 10, 15 years, and more. They offer an interest rate that is paid every six months.
How does this affect food prices?
As mentioned earlier, when short-term liquidity conditions change, Treasury Bills are either issued or purchased by the government. A simple explanation is that when there is excess money in the public, the government issues Treasury Bills to reduce the money supply. When the money supply is low, the government encourages money to flow into the economy by purchasing back the bills at higher prices to attract the public.
Money supply refers to the total amount of money circulating in the economy. When the money supply is high, people’s purchasing power increases, which leads to higher demand. Increased demand often results in inflation, as people are willing to buy goods at higher prices. This eventually leads to an increase in market prices, including food prices.
To control this, the government issues Treasury Bills at attractive rates so that people purchase them. When people invest in Treasury Bills, their money becomes less liquid. Cash is considered the most liquid asset, whereas Treasury Bills lock money for 91 or 181 days. This absorption of money reduces purchasing power, lowers demand, and helps stabilize inflation.
Similarly, when the government notices a shortage of money supply, it attempts to buy back previously issued Treasury Bills by offering higher prices. This encourages the public to sell their bills before maturity, increasing the flow of money into the economy. This process helps reduce money shortages by increasing liquidity.
This is the basic objective and purpose of Treasury Bills and how they influence the price levels of goods and services.
How do Treasury Bonds fulfill the requirement of long-term liquidity?
When the government has a long-term liquidity requirement or a long-term budget deficit, it attracts the public by issuing Treasury Bonds at higher coupon rates. A coupon refers to the fixed interest paid every six months to investors while the government holds its funds for long-term requirements.
Treasury Bonds typically mature in 2, 5, 10, or 15 years. The principal amount is repaid at maturity. This structure allows the government time to invest in long-term projects or manage deficits while repaying investors later, bearing the cost of capital in the form of the coupon rate.
Can Treasury Bills or Bonds be refunded before maturity?
Treasury Bills and Bonds are generally redeemed only at maturity. However, ownership can be transferred. Treasury Bills can be sold in the secondary market before maturity, allowing investors to obtain funds earlier. In some cases, they may be sold back at a discounted price, meaning a price lower than the face value.
How does this operate?
Although the government issues and buys back Treasury Bills and Bonds, it does not usually deal directly with the public. Instead, there are intermediary institutions called Primary Dealers who act on behalf of the government.
When an investor sells Treasury Bills or Bonds, this usually happens in the secondary market, where they are sold to primary dealers, banks, or other financial institutions.
Why are people more attracted to shares than Treasury Bills and Bonds?
One major reason is the lack of promotion and awareness. The share market receives extensive publicity through media and influencers, who frequently encourage people to invest in shares. In contrast, Treasury Bills and Bonds are government instruments and are not actively advertised.
Many people are unaware that such instruments even exist. This lack of awareness leads to greater attraction toward shares.
The key difference is that when you buy shares, you become a shareholder, meaning you gain ownership in a company. As an owner, you bear both profits and losses. Returns from shares come in the form of dividends and capital gains, but share values can also decline, resulting in losses.
In contrast, Treasury Bills and Bonds represent lending money to the government, not ownership. In return, the government provides a predetermined return, usually measured as yield. The coupon or return is fixed, and the government repays the face value at maturity along with the agreed interest.
In summary, shares represent ownership, while Treasury Bills and Bonds represent lending. Share returns fluctuate based on market conditions, whereas returns on Treasury Bills and Bonds are generally stable and predictable.