Balazs Csullag, Jon Danielsson, and Robert Macrae write,
A rational buy-and-hold investor who trusts the central banks should not buy long-dated bonds. While a high degree of central bank credibility used to be important to bond holders, today this seems to be no longer the case, especially for those buying German bonds.
The only way to get decent long-term returns with current yields so low is to go back to the persistent deflation of the gold standard, because most post-war inflation rates imply losses. For example, there are only eight years in Germany with lower than breakeven inflation for our 30-year buy-and-hold investor today.
Pointer from Mark Thoma.
The thing is, once interest rates start rising, they could explode, because at that point people may doubt the ability of governments to pay back their debts.
What if the central banks hold all of the bonds? That means that those central banks will be sitting on losses. If their cost of funds rises (say, because the central bank has to pay a higher interest rate on reserves), then central banks become a drain on the treasury.
It all depends how firmly central banks are committed to their inflation targets. My guess is not-very. They will be scrapped when it becomes “evident” that we need “extraordinary fiscal measures” to combat an “unprecedented global lack of demand.”
The monetarists will be right there behind them cheering them on saying something about a “return to trend.”
Investing will be very hard in an age of low real returns but high nominal returns. Nothing will feel investment-worthy but you will have no choice but to be invested.
Think of it as a castle with three walls. The outer wall is trust (credit, in Latin) in the private borrowers’ ability to generate growth and repay debt. That wall is gone and the second wall is the new front line – trust in the governments’ ability to service public debt. Behind it is the third wall — trust in money being a store of value. The second wall was assaulted in 2011-12 but held after reinforcement from the third wall (QE). It’s a decades-long war.
The three walls are similar to Minsky’s three forms of finance (hedge, speculative, and ponzi)
Oh please, global lack of demand my ass. Considering demographics have reduced demand needed, it looks like aghast, demand is normalizing after a decade of living beyond the old demographic demand levels.
Libertarians and rightists in general have been hitting the bond bubble button for a long time, and they’ve been wrong for a long time. Many have been nutty enough to worship gold, bitcoin, or whatever else to protect their savings from government confiscation from inflation. One detects a moralistic paranoia about it, but morality doesn’t move markets.
This isn’t the say they are wrong, or even that I have a strong opinion myself either way. However, they have been wrong for a long time, so we before one believes prognostications about the future we ought to be able to get a satisfactory explanation of the past first. I haven’t found a great explanation from anyone on any side, at least nothing that made me want to place a large bet either way.
It seems to me that one of the big issues to be addressed is what exactly is inflation. We’ve seen a wide divergence in different kinds of inflation, and as such its very difficult to say what the real interest rate is. Buying bonds might be a great way to preserve wealth if you want to purchase flat screen TVs in the future, and a shitty way to preserve wealth if you want to pay college tuition.
Similarly we’ve seen a change in stakeholder power up and down society. I get the impression that its been better to be an elite manager then a shareholder these days. A possible exception being owners who take on managerial roles (active private equity). The same is likely true with government managers (bureaucrats, politicians, donors) then a passive shareholder (bondholder). However, if being a passive “owner” has become less valuable across the board, maybe there are no better alternatives.
Finally, the lifecycle of the baby boomers and the mostly automatic asset allocation swaps that implies in most peoples retirement account has to be a high ranking issue when debating asset prices.
Can anyone give me a non-moralistic reason for buying/selling bonds? Can someone give me a reason to buy something other then bonds (i.e. if all investment options are equally shitty, bonds could be a bad bet and still the best bet).
Don’t just try to convince me of doom and gloom. That alone isn’t enough to figure out what direction asset prices will go in.
” hitting the bond bubble button for a long time, and they’ve been wrong for a long time.”
That’s not how it works. You are right for as long as your estimation of intrinsic value is correct no matter how long the market stays irrational. I don’t think anyone can predict timing because catalysts are surprises. Now, you haven’t heard anything from me on this because I don’t know who is right.
But, for the market to be correct, “what else is true?” The post claims that it means inflation has to stay low for a really long time. That also makes a lot of the other pundits wrong. They are predicting growth as well as the absence of inflation.
Inflation has been low since 1997. Inflation is irrelevant.
But how many such long-term holders of such debt are there, and will be? As you wrote, the central banks are on track to own all government debt eventually. In the limit of full monetization, nominal rates on outstanding bonds should approach zero to equal the interest rate on cash. What I find interesting is that it seems to approach zero by first falling through to negative territory. People buying Bunds today are doing so in anticipation of booking a capital gain long before maturation. Bund buyers will eventually lose on this bet regardless of what happens, but we don’t know who this is.
As for losses at the central banks, once they buy up all the government debt, you are into full monetization. Then it isn’t just a drain on the treasury, it is a drain on the entire country. We don’t have to imagine what will happen at that point- history is full of examples, and we are witnessing one as I write in Venezuela.
Then oil prices go back to 90$ and Venzie is like, what debt? Trying to make this correlation is dumber than hell. Use your head fool.
Bondholders were spoiled during the Great Moderation. Those times are gone for our lifetimes.
The CB owning so much debt means they won’t have to raise short rates much, just sell off some debt though they would incur some losses. The greater the amount of debt involved, the less interest rates will have to change to have the required effect. That has been the problem with Fed policy. Ever increasing amounts of debt mean they will be bound to ever lower top interest rates and ever smaller changes in them over the cycle. This is the new normal. Only greater growth with greater capital needs will increase rates but they will also increase the means to pay them. This is as risk free as anything gets.
By not reinvesting its proceeds, the Fed is already tightening, and some losses can be absorbed through lower remittances to the Treasury.
Very very weak tightening. I would argue they are neutral.
Thinking about the bond bubble, it might be wise to use the null hypothesis here that long term interest rates are going to remain low. It has been nearly 8 years since the Financial crisis with low rates and Japan has had low rates since the Bush Sr. administration. That is a significant amount of time from an economic bubble and I do theorize we will see the bust in Japan government bonds first. So why might interest rates be low:
1) Demographics of both aging population (with high savings) and less young people to borrow money. (Also requires less infrastructure spending)
2) There is minimal inflation in the developed world. Even the strongest commodity, oil fell ~50% from 2014 highs.
3) Most investment with corporations are with Tech and Information space. This investment is both a lot cheaper than building factories but also not safe investment for bond buyers. (Also include solar which is getting lots of investment but like the 1990s dotcoms will burn investors who get it wrong.)
4) China has been crowding all other global savings and investment for 15 years.
5) Global military spending is down (from historical standards before 1990) and only increasing today with recycled petrodollars.
That is what happens when you think a “bond bubble” matters. Interest rates only mean pricing in new debt, not old debt. Even when prices “bust”, that doesn’t mean much. Frankly, it may be a positive.