Wars are expensive. Americans have become newly reacquainted with this reality since the U.S. and Israel attacked Iran at the end of February. Since then, the U.S. government has spent more than a billion dollars a day on the war, according to reliable estimates.
Where does all that money come from? “Broadly speaking, there are two ways governments pay for increased spending,” says Stijn Van Nieuwerburgh, the Earle W. Kazis and Benjamin Schore Professor of Real Estate and Professor of Finance at Columbia Business School. “Either they tax you more or they pay for it through debt.”
New research from Van Nieuwerburgh—along with Northwestern professor Zhengyang Jiang, Stanford professor Hanno Lustig, and University of Texas at Austin professor Mindy Z. Xiaolan—investigates how countries use the latter, in the form of government bonds, to fund major wars.
Bonds are generally viewed as safer investments than ostensibly risky assets like stocks and real estate, making them popular options for investors during times of war. But the new research may make investors think twice. “There’s very clear evidence that returns on government bonds are much lower in wars than in any other period,” Van Nieuwerburgh says.
Overwhelming Historical Evidence
More than three centuries of history back up Van Nieuwerburgh’s conclusion.
The data set he and his co-authors assembled covers the full portfolio of U.S. and U.K. government debt stretching back as far as the early 18th century, tracking real and nominal returns across major wars and comparing them with returns on equities, housing, and overall economic growth. To make these comparisons meaningful across different eras, monetary systems, and market structures, the researchers standardized returns and followed asset performance in the years before and after the crises.
The numbers they landed on are overwhelming. On average, investors experience about a 14% real loss in government bond returns over the first four years of war. Perhaps even more surprising, bonds underperform equities by about 23% during those years. They also lag housing and GDP growth.
The authors identified two main culprits for this underperformance: inflation and financial repression. Inflation typically rises significantly during wars—about 20% cumulatively over the first four years. That means that even if bond returns appear to be positive, inflation can erode real gains. “Governments don’t generally default on debt, but during wars we see them inflating away the debt,” Van Nieuwerburgh says.
Financial repression—policies that channel savings into government debt at below-market rates—amplifies the effect. These policies can include central bank bond purchases, interest rate caps, and regulations pushing banks to hold government bonds. Taken together, they suppress nominal yields even as inflation rises, further reducing real returns for investors.
The intuition that government bonds perform well during difficult periods isn’t entirely wrong, though. The authors found that during financial crises, bonds behave as expected, outperforming stocks and acting as a safe haven for investors. The difference comes down to fiscal pressure. Wars simply require far larger increases in government spending than financial crises, forcing governments to pull new levers to generate the funding needed.
Curious about whether pandemics—another kind of multi-year crisis that requires massive government spending—might function similarly, the researchers looked at the performance of bonds during COVID-19. Indeed, government bonds delivered large negative real returns and underperformed riskier assets like stocks.
Why Today’s Investors Should Be Wary of Bonds
The lesson is not that government bonds aren’t safe. Most of the time—including during financial crises—they are. What the research shows, however, is that safety isn’t an intrinsic property of government debt. Repeatedly, over the course of centuries, governments have used bonds to help fund massive expenditures on logistics, fuel, and supplies required for pandemics and wars.
“Investors are sort of getting fooled,” Van Nieuwerburgh says. “The question is why are they getting fooled over and over again? I’m not sure I have a good answer to that other than these wars are infrequent and people have short memories.”
The phenomenon is unlikely to change during the current war with Iran, according to Van Nieuwerburgh. That’s partly because U.S. debt has roughly tripled over the past 15 years, leaving little fiscal space with which the government can operate. “This war is coming at a time when we’re already fiscally fragile,” he says. “And every one of these missiles we’re shooting off costs millions of dollars.”
