Thursday, April 18, 2013

Are Bonds Going to Be the Next Investment Fad?

CNBC "reports"  (LINK):
Get Ready to Play the Coming Deflation Trade
  What seemed like economic fantasy could soon become cold reality as the global economy wrestles with deflation despite hundreds of billions in central bank money creation.Investors have been fleeing assets normally linked with economic growth such as materials stocks, energy commodities and copper...
And one prominent Federal Reserve member this week openly discussed whether the U.S. central bank needs to accelerate, rather than pull back, its asset purchase program.
 Meanwhile, the intellectual underpinnings for minimal price inflation have been updated by Lacy Hunt of Hoisington Management (LINK) in a speech given last fall.  In it, he criticizes those who call themselves Keynesians, who simply want more and more government borrowing.  He raised the question of whether Keynes himself would have approved of this policy.  In any case, he makes the argument for the possibility of debt deflation.  In Hoisington's recent quarterly update (LINK), he and Van Hoisington reiterate a point they have made before.  They differentiate between base money at the Fed as a result of quantitative easing and M2.  They point to M2 acting very differently from base money and note that M2 has not been rising lately.  Both are good reads.

They are also relevant to the recent flap about Rogoff-Reinhart's 90% level for government debt.  They bring up other research that supports the concept.  It's really not the amount of debt that counts, it's how wisely it was lent and how well the borrowed funds were spent.  That said, it makes sense that there are usually only a certain percent of a country's wealth or yearly production that allow for sound investments.  The US clearly went beyond that point last decade, resulting in the multiple insolvencies and near-insolvencies.  Since 2008, some debts were written off, but most were not.  Numerous more debts have now been incurred.

With gold the yellow canary in the coal mine, and Dr. Copper the redbird acting the same way, and with Mr. Bond now singing a bearish song, the following economic portent from Goldman Sachs comes as no surprise (LINK):

Note this is global, not US.  But as the US shrinks its deficit spending as a share of GDP, its economy begins to revert to the mean.  The US does however have two identifiable tailwinds that many other countries lack.  One is the diminution in war-fighting from the Afghan stand-down.  The other is the well-publicized hydrocarbon output upsurge.  So it may be that the US will again outperform the global economy; but Europe could go from bad to worse post-Cyprus and this could be cold comfort.

If it pans out that Europe is finally the cause of a major global recession as the US was in 2008, then the US will be part of it, debt deflation will hit again, and bonds may actually become respected and even sought after.  If so, they will trade at undreamt of yields.

When CNBC starts banging the deflation gong, it may just mean something.

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