The Not-Dry Primer on Bonds and Deficits They Never Explain Properly

Step 1.

Every time there’s a budget announcement, you hear it again—

“Deficits are bad”

Because the government borrows money (by issuing bonds on which they pay 'interest') to fund their spending—accruing loans and interest payments like a household.

But that’s a leftover narrative from the gold standard era—one that even many market professionals still cling to.

It’s not the operational reality for a currency-issuing government like the U.S., UK, Japan or Australia.

Here’s what really happens:

When the U.S. government runs a deficit (spends more than it taxes back), it creates new money.

That money flows into the private sector—credited into bank accounts as new reserves. This is how the deficit spending process works in a fiat currency system—it's not a mere borrowing scheme, but the creation of new money.

To make it clearer, take a look at this chart: it shows the relationship between government deficits and private sector reserves.

As you can see, every time the government spends more than it collects in taxes, it adds reserves to the private sector, which is crucial for understanding how money actually enters the system.

Source: UNDERGROUND NETWORK underground-'dot'-net

So the next time you hear ‘deficit = debt,’ remember this chart—it’s not what most people think.

Step 2.

So what about those bonds?

The part everyone nods at... but few can explain properly.

Debt instruments like Treasury Bills, Notes, and Bonds—despite the different names and maturities—are all government securities.

Collectively, they’re referred to as treasuries.

But they’re not issued because the government “needs” to borrow money. They’re issued after government spending occurs.

That spending has already added dollars to the system. Issuing bonds simply swaps those dollars (reserves) for a different asset—government securities.

This helps the central bank maintain control of interest rates by draining excess reserves from the banking system, a key part of the monetary plumbing.

It’s a monetary operation, not a funding requirement.

In short: bonds help manage the side-effects of spending—not enable the spending itself.

So where does this all happen?

There are two markets to know:

Primary market: This is where the government issues new bonds via public auction. Banks and financial institutions buy them directly from the Treasury. This is how new treasuries enter the system.
Secondary market: Once those bonds exist, they can be traded—bought and sold like stocks. Venues like the CME or over-the-counter markets allow this. But no new bonds are created here—just repriced. This is the market people refer to when they talk about a "bond sell-off."

Why would anyone buy them?

Aside from banks meeting reserve requirements, treasuries are considered a safe place to park capital.

For example, countries like China receive U.S. dollars through trade and often recycle those dollars into treasuries to earn interest.

Yields 101

To illustrate how bond prices and yields move:

Let’s say Stock ABC pays $5.00 per share in dividends.

Buy it at $166, and that’s a 3% yield.
Buy it at $100, and that same $5.00 is a 5% yield.

Bonds work similarly. The fixed interest they pay—called a coupon—acts like a dividend. If the bond’s market price drops, the yield goes up.

What’s behind the recent bond sell-off?

In recent market turmoil, some hedge funds needed liquidity and started offloading government bonds. That selling added supply, pushed bond prices down, and yields up.

But someone else is happy to step in and buy—because now the bond’s yield (just like our stock example) is more attractive.

Does a bond market sell-off mean the economy’s in trouble?

Not necessarily. It usually just means investors expect higher inflation, shifting interest rates, or are adjusting their portfolios.

People jump to conclusions. Higher yields can pressure borrowers, yes—but it doesn’t mean the government is broke or that the system’s collapsing.

It means expectations have changed.

The next time someone says ‘we can’t afford it,’ you’ll know where the flaw in that thinking begins—and if they’re trading off it, they’re likely playing the wrong game.