In a prior blog, I questioned the wisdom of two financial advisors, Dr. Lacy Hunt and Van Hoisington who were recommending that investors put their money in long term obligations of the US Government. I consider this advice to be financial suicide. Enter Roger, a new blog reader, who has left a slew of comments yesterday saying that I did not really understand that the true genius of these two and the power of US Treasury Bonds as we continue on in our deflationary environment. Before we get to the meat of Roger’s feedback, let’s take a look at how US Treasury bonds have done over the past few years.
As you can see from the picture I attached below, the the thirty year bond has been on a bit of a tare lately. The perfect time to have gotten in would have been right around the start of the new millennium at a price of $880 or so. If you held it through today, it’d be roughly worth $1280. That’d be a price appreciation of $400 or so, plus coupon payments of, let’s say, $40 a year, so $40 x 9 = $360. So your initial investment of $880 would have yielded roughly $1640 or so. That’s a yield of 86% or so over nine years, which is 9.5% annualized return. That’s not shabby, but not amazing.
However, Dr. Lacy Hunt is a contrarian. By that I mean that she is not bullish on the prospects of the American economy over the next few years. The most run-of-the-mill contrarians (such as Daniel Arnold who wrote The Great Bust Ahead) tend to recommend Treasury Inflation Protected Securities because it should protect your wealth in an stagflationary scenario provided the government continues to pay their bonds and doesn’t lie to you about actual inflation. Then we’ve got contrarians such as myself and Bill Bonner who recommend gold because we figure the American dollar is going to be toast. In his book Crash Proof, Peter Schiff recommends a portfolio of 30% gold and the rest foreign stocks and Real Estate Investment Trusts.
Dr. Lacy Hunt is fairly unique in her position of being a contrarian who recommends US bonds. I reiterated the heart of this position in my prior post (which did nothing to stop Roger from accusing me of not reading it) but it boils down to this:
- We are in a deflationary recession.
- Deflationary episodes tend to drag on a while
- Money gains value during a deflationary stage
- Therefore, buy US Government bonds because interest rates will effectively be negative over the next few years as money gains value and that 3% yield will seem like a godsend.
While most can agree with the idea that we are currently experiencing a deflationary recession, the rest of her argument is absurd. As for how long deflationary episodes tend to last, a lot of that boils down to definition. Few tend to define The Panic of 1907 as a deflationary recession because it was over and done with in a year or so whereas virtually all economists tend to define The Great Depression or Japan’s ongoing financial mess as a deflationary recession. Therefore these events tend to be long because the shorter ones are excluded from the definition.
Furthermore, as I wrote in my book, we’ve got Helicopter Ben Bernanke running the Fed and he’s studied both of those deflationary periods. He talked about how to make sure it “doesn’t happen here” in a speech he gave on Nov. 21. 2002 in which he said:
But the U.S. government has a technology, called a printing press (or, today, its electronic equivalent), that allows it to produce as many U.S. dollars as it wishes at essentially no cost. By increasing the number of U.S. dollars in circulation, or even by credibly threatening to do so, the U.S. government can also reduce the value of a dollar in terms of goods and services, which is equivalent to raising the prices in dollars of those goods and services. We conclude that, under a paper-money system, a determined government can always generate higher spending and hence positive inflation.
Ben’s got a point here. Last year was the first time we saw any evidence of deflation. Dr. Hunt believes that deflation will continue for year after year but she has precious little evidence to show for that except for how these things have played out in the past. What she’s neglected to factor in is that economies are dynamics because they are made up of intelligent actors who can crunch the numbers just as well as you can.
Ben Bernanke is one such figure and he knows how long these things tend to go on. He figures the best way to stop money from gaining value is to print a lot more of it. Dr. Hunt’s got historical precedent. Ben’s got a printing press. Who’s right? I don’t know about you, but when I see monetary aggregates looking like they do in the graph below, deflation is the last of my worries.
Given this kind of activity, I don’t see how anyone can credibly make the argument for long term deflation. The market seems to agree with me given that the price of bonds has been falling. In fact, bonds have fallen more than stocks since the new year.
But let’s say, for the sake of argument, that the dollar manages to gain value somehow. Let’s say that Dr. Hunt is entirely correct in saying that, despite the frantic activities of Helicopter Ben, that the dollar will gain value year after year. I don’t see how this could happen, but even if it could, US bonds would still be a poor investment because of the opportunity cost of investing in gold. You see, while bonds have returned less than 10% over the last ten years, gold has quadrupled in value. Even last year, the most deflationary year on record for the American economy since The Great Depression, gold still eked out a gain of almost 6%. Furthermore, because gold will always be valuable, I don’t have to worry about whether the dollar will go into default, or whether deflation will continue for the next few years. Gold is the true safe haven in this economy just as it has always been.
Dr. Hunt ignores gold in her arguments for long term Treasuries and I can not fathom why. She writes articles and gives interviews as though she’s confident in what she’s saying, but she’s really just guessing. To predict that the dollar will continue to gain value despite the best efforts of the Federal Reserve is to fly in the face of conventional wisdom. And for what? A few percentage points a year if she happens to be right? That’s a bit like sticking your head in a fire to get a haircut. You might get the desired result, but it’s just not a good idea.
7 thoughts on “The Advisability of Investing in US Treasury Bonds”
The way I see it, the argument boils down to whether deflation or inflation will prevail over the course of the next few years. Over the long-term, we all agree inflation will prevail. OK, so let’s focus the discussion on deflation/inflation for the next few years. I think 2-3 years period is reasonable.
As an aside, you asked why she doesn’t mention gold. It is most likely because she is dealing with bonds only. Furthermore, gold doesn’t really tell we’re in inflation or deflation. In severe inflation/deflation, gold does well because of its dual role as commodity & money.
I see that your argument revolves around the money printing the FED is engaging. Perhaps, you should use a more telling chart, such as this one:
Definitely inflation right? We should then go look at this chart:
The Great Depression is definitely a deflationary depression.
Why can there be deflation while the FED can print money? Isn’t printing money inflationary? Well, yes if the credit is extended: banks are willing to lend AND borrowers are willing to borrow.
If these 2 conditions are not fulfilled, the condition will look like this: Sam has a printing machine that can print counterfeit bills perfectly and the FED cannot tell. Sam then prints 5T dollars, but Sam buries all the money in his backyard. Is that inflationary? Of course not. Not until Sam spends the money, i.e. money entering the economy.
This is what precisely happens right now. Capital injections by the FED are being hoarded by banks because they are so capital deprived. Roubini estimated the losses from SPM approximately amounts to 3.6T. That is a minimum of 3.6T the FED can print without causing inflation.
If you still argue there will be massive hyperinflation/stagflation coming in the short-term, the signs are just contradicting that:
1. home prices keep falling
2. stocks tank
3. unemployment soaring
4. GDP is turning negative all around the world
5. commodities tank really hard
6. businesses are falling
7. banks are unwilling to lend
8. consumers are unwilling to borrow
9. increasing savings rate
All of those are powerful deflationary forces/signs. None of those signs/forces are likely to reverse in the short-term. They are actually going to get more severe, hence more severe deflation. To ignore these by only pointing to significant money supply increase is just humpty dumpty-ish
At present there is a massive shortage of USD due to debt deflation. At present, US debt to GDP ratio is around 360%. In 1970s, it was around 110%. As this measure corrects to the norm, debt is being deflated (in a sense, a lot of USD are destroyed). This creates massive scarcity of USD, making it more precious. Our monetary system is called credit money system. Credits can be created (inflation) and destroyed (deflation). To understand the concept, please refer to a great paper by Steve Keen, an Australian economics professor, titled “The Roving Cavaliers of Credit”. The link can be found here:
I tend to view the deflation in US right now will be more severe than even the Great Depression and Japan, because the amount of debt being deflated is way larger and it starts with low savings rate (to increase savings rate -> more USD demand).
You are referring to Schiff’s strategy. The man is a total flop last year. Here’s an interesting article:
If you are not anti-Hunt. I suggest reading her quarterly 4Q 2007 report. It explains more concepts that should be included when calling/forecasting deflation/inflation. One of the very important concepts I haven’t discussed here is money velocity.
That is all from me for now.
Additional comments on bond prices:
Treasury prices indeed have plunged since the new year. But previously it had parabolic rise of 38% a year. Some correction, even massive correction, is just due. No doubt there was a bubble. This is a correction, not a turn of trend. If the outlook is inflation, look for treasury prices to plunge harder.
Same with gold, last year in October, it plunged to 600s from 900s. It did not justify the gold bull market has ended.
In deflation, treasury yields have been able to stay low for notoriously long periods. Just look at JGB yields since late 1990s till now. Since I am arguing for deflation to worsen, I would view this as a good buying opportunity for treasuries, especially the longer dated ones.
I had 1 previous post (relatively long), for some reason it just keeps getting rejected. It never appears.
I have no idea what you mean when you say: “You are referring to Schiff’s strategy. The man is a total flop last year.”
Where was I referring to Schiff’s strategy?