The bubble in US bond markets

Aug 19, 2010

Ouzilly, France,

Nothing much happened on Wall Street yesterday.

And there's not much in the press today. The Financial Times talks of mergers and acquisitions, Australia's upcoming elections, and South Africa's drift towards Zimbabwe.

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The International Herald Tribune (the overseas version of the New York Times) is concerned with elections in Haiti, Iraq bombings, and China's banking system.

Generally, you are better off not reading the paper. It causes you to think like everyone else, which is to say, not to think at all. Instead, you spend your time getting worked up about things too remote and too complex to understand...things that you can't do anything about anyway.

The issues are complex...but the motives are simple. The NYT and the FT want to sell papers. So they come up with stories that confirm readers' prejudices, flatter their vanities, and distract them from their own concerns and challenges. Readers are encouraged to ignore their own problems and meddle in the affairs of other people.

All we find of interest in the news this morning is that bankruptcies have risen to a 5 year high - just what you'd expect in a major correction.

The Wall Street Journal, meanwhile, carries an article entitled: "The Great American Bond Bubble." The authors worry that bonds have gotten themselves into a bubble similar to tech stocks in 1999. You'll recall that back then investors were so sure new technology would pay off that they were prepared to pay astronomical prices for dizzy tech companies. Many of these companies had no realistic business plans, no revenue, no employees, and no hope of making money. Others were embryonic, with a tiny stream of income that they were sure would grow into a flood. It was not unusual for investors to pay 50 times earnings, or even 100 times earnings, for these stocks.

Well, just look at what is happening, in the bond market, say the authors. Prices have gone so high - for government bonds - that investors once again are paying sky-high prices for tiny streams of income. In the case of America's inflation-adjusted 10-year notes, the TIPS, for example, investors are now paying more than 100 times the expected annual return.

Why? know the answer. Because there's a Great Correction going on. There's more evidence of it every week. The recent jobs unemployment claims...the latest consumer spending figures...Japanese GDP...European industrial output...
...and sinking yields on Japanese and US government debt...
...all point to a Great Correction.
What can you do with your money during a Great Correction?

If you're smart, you know that most asset values are vulnerable. If you're investing for retirement in 5 years, for example, you're taking a big chance in stocks. If they follow the Japanese example they could go down for the next 5...10...15 years. If they follow the example from the US from the ‘30s...they've still got another 50% decline coming. Maybe more.

If you're 20 or 30 years old, heck, you can take the risk. Sometime between now and retirement stocks are likely to trade at prices at least as high as they are now. But if your 55 or 60 you've got to think about it carefully. The risk is that half your money will be gone when you need it. The reward is what...maybe a 10% gain? Maybe 20%? Not worth it.

The stock market has been shilly-shallying around -- up, down, up - for the last 10 years. Investors have made nothing. The boomers are getting ready to retire. They figure they'd rather hold onto what they've got than take a chance on losing it - especially when the performance of stocks has been so poor.

The nice thing about US bonds is that you're sure to get your money.

The bad thing is that you're not sure how much the money you get will be worth.

But that's a problem for another day...

*** "Maria, you're a great investor... you've made good money."

We were asked to look at our daughter's finances. She was afraid she was missing opportunities or taking unnecessary risks.

But when we looked at her account statement we saw that she was doing very well.

"Maria, it says here that if you had invested your money in world stocks, generally, over the last five years you would have turned $10,000 into just a bit more than $11,000. But your investment portfolio has gone from $10,000 to more than $25,000 over that period. Very good. How did you do it?"

"I just bought that stock you told me to buy."

"What stock?"



"But I think the stock went down recently. It's probably time to change to something different, don't you think, Daddy?"

"Hmmm... I don't know. You're not in a hurry. What you want to do is to find something that is likely to pay off and just stick with it until it does.

"Gold will probably go down if the economy continues to slump into deflation - which I think it will. But I don't think it matters. The bigger risk is getting wiped out by inflation. And the big opportunity, for you, is that when inflation comes a knockin' the price of gold is likely to start a rockin' and rollin'.

"So even if the price goes down, it's not likely to go down too low or stay down for too long. On the other hand, when people realize that their savings could be wiped out by inflation, you're going to see gold really fly. It's probably worth waiting for."

Bill Bonner is the President & Founder of Agora Inc, an international publisher of financial and special interest books and newsletters.

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2 Responses to "The bubble in US bond markets"

Swapan Sanjanwala

Aug 19, 2010

There is nothing magical happening. Since last two years a vast majority of so called pundits were worried that government spending in developed countries will drive up interest rates. They all have been proved wrong. Deficits in a liquidity trap don't drive up interest rates. Interest rates will go up only when expectations of economic recovery come back in developed world. US is more like Japan than Argentina, where in face of record deficits interest rates have depressed to record lows (under 1% for 10 years !!). That's basic macroeconomics a realization which the author above Bill Bonner has yet to arrive with his faulty Austrian economics framework.
Paul Krugman (author's bete noire) has been arguing about this since last year and a half and as with most things professor Krugman is right. He explains it again in his column in NYT today.

An interesting post on Krugman's blog few months back, when Alan Greenspan had written something similar to the author above:
There are many things to say about Alan Greenspan’s op-ed yesterday, none of them complimentary. But what struck me is the passage highlighted by Tim Fernholz:

Despite the surge in federal debt to the public during the past 18 months—to $8.6 trillion from $5.5 trillion—inflation and long-term interest rates, the typical symptoms of fiscal excess, have remained remarkably subdued. This is regrettable, because it is fostering a sense of complacency that can have dire consequences.

You know, some people might take the fact that what’s actually happening is exactly what people like me were saying would happen — namely, that deficits in the face of a liquidity trap don’t drive up interest rates and don’t cause inflation — lends credence to the Keynesian view. But no: Greenspan KNOWS that deficits do these terrible things, and finds it “regrettable” that they aren’t actually happening.

The triumph of prejudices over the evidence is a wondrous thing to behold. Unfortunately, millions of workers will pay the price for that triumph.



Aug 19, 2010


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