Why Hold Long Bonds Now

[Kshartle]

My argument is the same one Roberto is making.

Long-term bonds currently have significant risk and very little upside. They cannot fill their intended role right now except on a very short term fluctuation. If your focus is extremely short-term ok.

If it's longer term then maybe 1/3 cash, 1/3 gold 1/3 stocks makes a lot more sense.

If you're like me and focused exclusively on the long-term (10 years plus), I'm happy with 50-50 stocks and gold. It's not that volitile.

The PP is brilliant......it's just that one of the pieces right now is looks terrible for the medium to long term. I can't think of a good reason to own it. Either rising rates or inflation are going to offset the interest, even if they rise in price.

They look like a lotto ticket to me except the odds are worse.

[Roberto]

I guess part of what I'm trying to understand is how the market actually places value on bonds.  The bonds I bought last week are already up almost 2.5%.  How does that happen, although there has been no new mention anywhere of pending  Fed interest rate manipulations?  If I sold these bonds a year from today, would my total rate of return be  6.125% (=3.625%  + 2.5%)?

Nuts and bolts now:  I have accounts with Fidelity and Interactive Brokers;  Fidelity executes my bond transactions immediately, but with IB, even though I price the purchase at the market, the order sits there for days, or until I give up.  Is 5 -10K at a time too small a quantity to get their attention maybe?

[Pointedstick]

[quote="Roberto"]
I guess part of what I'm trying to understand is how the market actually places value on bonds.  The bonds I bought last week are already up almost 2.5%.  How does that happen, although there has been no new mention anywhere of pending  Fed interest rate manipulations?  If I sold these bonds a year from today, would my total rate of return be  6.125% (=3.625%  + 2.5%)?

https://en.wikipedia.org/wiki/Bond_valuation



But essentially, your bond is up 2.5% because interest rates have fallen a bit since you bought the bond, meaning that people who bought a similar bond today would be getting a slightly worse deal. So your bond can command a higher price to reflect the better deal you have.

[Kshartle]

Desert,

Can you make a case for deflation? Do you think it's a possibility and what do you think would happen?

I realize you might not care, and that's fine.

If you state you hold bonds for deflation I think you should be able to state there is some possibility of it and how the bonds would help you.

It's not enough to say that it can happen and rates will fall. That's not an argument. What is deflation, how would it drive up bond prices and how would the government continue paying the interest?

[Gosso]

Desert,

Can you make a case for deflation? Do you think it's a possibility and what do you think would happen?

I realize you might not care, and that's fine.

If you state you hold bonds for deflation I think you should be able to state there is some possibility of it and how the bonds would help you.

It's not enough to say that it can happen and rates will fall. That's not an argument. What is deflation, how would it drive up bond prices and how would the government continue paying the interest?

Japanese 10-Year Yield

Source: http://www.tradingeconomics.com/japan/g ... ebt-to-gdp

I don't understand it either but there you go.  Japan had/has zombie banks, while the west has zombie consumers.  Money is created via new loans, if the economy is sluggish then new loans will slow down and monetary growth will slow (see this new report from the BOE).  The wild card is if the government does something really stupid, which is one of the reasons why we hold 25% in gold.

[Kshartle]

I think deflation is a possibility, yes.  One scenario I can imagine is this: corporate profits drop, unemployment rises, wages drop, pricing power is reduced, prices fall.  Stock markets fall in response to all this, and investors flock to safety (Treasuries), causing bond prices to rise and yields to fall. 

I'm not predicting deflation, by the way.  Nor am I predicting inflation.  I honestly don't know.  I'm not saying that so I can sound like HB or something, I just truly don't know.  I wish I did.

That's not deflation Desert. No offense. That's just a stock market crash. Why did corporate profits fall? Is the crash temporary?

I agree the stock market can crash and investors can bid up bond prices but only so much and only for so long. Once stock prices get attractive again people will sell out of the bonds and go back.

BTW - If corporate profits fall what do you think will happen to the government's corporate tax revenue? What about payrolls and income tax revenue? What about the numbe of people who will be added to unemployment and welfare rolls?

How will the government pay for all these people with decreased tax revenue when it's already deep deep deep in the red and getting deeper by the day?

Do you think foreign central banks will want to keep their T-bonds? Do you think investors will not question the ability of the government to make good on it's bonds?

[moda0306]

Kshartle,

What do you think about Japanese deflation/disinflation, and their bond market with 200% debt/GDP ratio?

Maybe you've commented on this subject before.  It just seems like your argument has little historical context?

And you're right... the stock-market crash isn't deflation (though it CERTAINLY is volatility in my portfolio, reducing my purchasing power)... but a general fall in prices of goods and services IS generally recognized as deflation, and it COULD result in positive real interest rates (as a matter of logic... rates can't go negative), which (if we can agree this is what drives the price of gold), could leave us in quite a predicament.

I'm not 100% sure gold would tank in an overtly-deflationary scenario, but I wouldn't be at all surprised, especially if we weren't in "financial crisis lockdown" mode like 2008/2009.

[Kshartle]

Kshartle,

What do you think about Japanese deflation/disinflation, and their bond market with 200% debt/GDP ratio?

Maybe you've commented on this subject before.  It just seems like your argument has little historical context?

And you're right... the stock-market crash isn't deflation (though it CERTAINLY is volatility in my portfolio, reducing my purchasing power)... but a general fall in prices of goods and services IS generally recognized as deflation, and it COULD result in positive real interest rates (as a matter of logic... rates can't go negative), which (if we can agree this is what drives the price of gold), could leave us in quite a predicament.

I'm not 100% sure gold would tank in an overtly-deflationary scenario, but I wouldn't be at all surprised, especially if we weren't in "financial crisis lockdown" mode like 2008/2009.

I have commented on Japan quite a bit. The situation has very little in common with the US. Perhaps I can dredge it up.

[Kshartle]

I think deflation is a possibility, yes.  One scenario I can imagine is this: corporate profits drop, unemployment rises, wages drop, pricing power is reduced, prices fall.  Stock markets fall in response to all this, and investors flock to safety (Treasuries), causing bond prices to rise and yields to fall. 

I'm not predicting deflation, by the way.  Nor am I predicting inflation.  I honestly don't know.  I'm not saying that so I can sound like HB or something, I just truly don't know.  I wish I did.

That's not deflation Desert. No offense. That's just a stock market crash. Why did corporate profits fall? Is the crash temporary?

Actually, it is deflation.  Deflation and stock market declines often go hand in hand. 

I agree the stock market can crash and investors can bid up bond prices but only so much and only for so long. Once stock prices get attractive again people will sell out of the bonds and go back.

BTW - If corporate profits fall what do you think will happen to the government's corporate tax revenue? What about payrolls and income tax revenue? What about the numbe of people who will be added to unemployment and welfare rolls?

How will the government pay for all these people with decreased tax revenue when it's already deep deep deep in the red and getting deeper by the day?

Do you think foreign central banks will want to keep their T-bonds? Do you think investors will not question the ability of the government to make good on it's bonds?

They are generally keeping them now.  Where else will they put their dollars?  The Euro?  The pound?  Where? 

Listen, I'm not a deflationary apologist by any means.  But to argue that it's impossible is to ignore history, described beautifully by Gosso's charts above.

This will be a little curt I'm sorry, trying to get to the point:

1. Stock market declines are not deflation. Do you know what deflation is? When the stock market goes down or the price of your cell phone goes down that is not deflation.
2. Ignoring history is completely irrational. I'm not ignoring history. I love history.
3. The Japanese situation is different than the US situation and not a refution of any points I raise about the US. It's not even deflation, they've been printing trillions of Yen for years and expanding the money supply.
4. You didn't answer my question about where the US will get money to pay it's bonds if there is deflation as well as pay for all the baby birds flocking to it. Where will it get the money?

[moda0306]

K,

Back to definitions ... Are you defining "deflation" as a "lowering of the money supply," or a "general decrease in the price level of goods and services?"

Or something else?

When we talk about pressures on these assets, mainly (not to speak for desert), I think we're talking about general decrease in price levels.  As part of this, it can have profound affects (to the negative) on both gold (moving on REAL interest rates (assuming REAL is a measurement of general price level)), and the stock market (moving on expectations of future earnings.... deflationary pressures could be REAL tough on this, just as it could be a boon for long-term bonds).

For instance, right now, the market "expects" the fed to keep inflation within a certain range (whether they're right or wrong is a different story!).  That's baked into the long-term earnings expectations of the overall stock market, and gold's current price against current interest rates.  If that "expectation" moved from "+2% per year" to "-2% per year," this would have HUGE affects on the current price of the stock market and gold.  That doesn't mean that these assets are representative of the "deflation percentage," but it's certainly an effect of deflation (defined as a general drop in price level) entering the picture.

So K, you HAVE to be clear with definitions.  Gold OBVIOUSLY moves much more in relation to general price levels and interest rates rather than "Monetary Base" and interest rates.  You can say that printing money is immoral, but looking at history, it's obvious gold doesn't really care about the MB... it cares about real interest rates as measured against the general price level of goods and services.

[Kshartle]

If you don't think Japan has experienced deflation, then you need to go do some studying before any of us waste any more time debating this with you.

I think we're just disagreeing on the definition. It's ok. You think stock prices falling and other prices falling are deflation. I'm saying that's a consequence of deflation which is the shrinking of the money supply. It's an important distinction but it's ok Desert. I'd rather find common ground than disagree.

BTW - if you made a case for why you think gold was going to return less than the inflation rate over the next say...ten years....and I responded with....what if corporate profits fall and people sell stocks and buy gold...do you think that would be me really making a case for something happening? It looks to me like you said "I disagree that bonds will not have a real return, what if stocks tanked and people bought bonds". It's not really a scenario as far as i can see....just a fragment of one.

No one ever, and I mean ever, lays out a complete scenario of how they are going to make any money with LTBs in the long run. It's always just "deflation - people buy bonds" Like a robotic mantra.

I am asking for one single credible scenario. I am too dumb to think of any and I have tried. HARD That's why I don't own bonds. It always ends with the government having to print trillions and trillions until it decides to default.

[Kshartle]

K,

Back to definitions ... Are you defining "deflation" as a "lowering of the money supply," or a "general decrease in the price level of goods and services?"

Or something else?

When we talk about pressures on these assets, mainly (not to speak for desert), I think we're talking about general decrease in price levels.  As part of this, it can have profound affects (to the negative) on both gold (moving on REAL interest rates (assuming REAL is a measurement of general price level)), and the stock market (moving on expectations of future earnings.... deflationary pressures could be REAL tough on this, just as it could be a boon for long-term bonds).

For instance, right now, the market "expects" the fed to keep inflation within a certain range (whether they're right or wrong is a different story!).  That's baked into the long-term earnings expectations of the overall stock market, and gold's current price against current interest rates.  If that "expectation" moved from "+2% per year" to "-2% per year," this would have HUGE affects on the current price of the stock market and gold.  That doesn't mean that these assets are representative of the "deflation percentage," but it's certainly an effect of deflation (defined as a general drop in price level) entering the picture.

So K, you HAVE to be clear with definitions.  Gold OBVIOUSLY moves much more in relation to general price levels and interest rates rather than "Monetary Base" and interest rates.  You can say that printing money is immoral, but looking at history, it's obvious gold doesn't really care about the MB... it cares about real interest rates as measured against the general price level of goods and services.

That's why I asked him what he thought deflation was. It doesn't matter what I think it is and I don't have to define it. He said bonds make sense because if we have delfation they will go up in value. When I asked what he meant when he said deflation he said a stock crash.

I'm glad to see you accurately recognize that a stock crash is not deflation.

"And you're right... the stock-market crash isn't deflation"

[moda0306]

(No offense, Kshartle)

I love how Austrians try to define inflation or deflation as whatever they want in any given argument.

Sometimes it's CPI ("Dollar has lost 97% of its value since derpy derp flurp!"), unless we're actually looking at CPI to measure the more short/mid-term effects.

Sometimes it's the price of gold!  Unless gold goes down for two decades... then "it's a steal" or "the fed is keeping its price artificially low" (which never, interestingly, EVER means that interest rates are artificially high."

Sometimes it's the monetary base!  Unless monetary base goes stagnant, and prices increase.

Sometimes it's the price of a gallon of gas, milk, etc!  Unless (like gold) it goes down for any period.

Sometimes it's Shadow Stats!  Unless it's pointed out that SS has reduced its subscription charge.

Sometimes, if they really need a bump, it's the average value of every fiat currency that is no longer in use (aka, we've already hyperinflated... we just don't know it yet).

It's like f*cking economic wack-a-mole.

[Kshartle]

Desert I was just hoping for a more complete scenario where the bonds actually give you a real return. That would mean rates staying above inflation for a long time. I don't see how it's possible.

Yes if there is a deflation then all rates are positive but this would be very short-lived as the government will blast it with inflation or be forced to default as the budget is swamped with baby birds and starved of tax revenue.

They are closing in on 18 trillion in debt. The current deficit is between 600BN and 1TR. It is not pretty. I think they are going to print print print.

[moda0306]

K,

Back to definitions ... Are you defining "deflation" as a "lowering of the money supply," or a "general decrease in the price level of goods and services?"

Or something else?

When we talk about pressures on these assets, mainly (not to speak for desert), I think we're talking about general decrease in price levels.  As part of this, it can have profound affects (to the negative) on both gold (moving on REAL interest rates (assuming REAL is a measurement of general price level)), and the stock market (moving on expectations of future earnings.... deflationary pressures could be REAL tough on this, just as it could be a boon for long-term bonds).

For instance, right now, the market "expects" the fed to keep inflation within a certain range (whether they're right or wrong is a different story!).  That's baked into the long-term earnings expectations of the overall stock market, and gold's current price against current interest rates.  If that "expectation" moved from "+2% per year" to "-2% per year," this would have HUGE affects on the current price of the stock market and gold.  That doesn't mean that these assets are representative of the "deflation percentage," but it's certainly an effect of deflation (defined as a general drop in price level) entering the picture.

So K, you HAVE to be clear with definitions.  Gold OBVIOUSLY moves much more in relation to general price levels and interest rates rather than "Monetary Base" and interest rates.  You can say that printing money is immoral, but looking at history, it's obvious gold doesn't really care about the MB... it cares about real interest rates as measured against the general price level of goods and services.

That's why I asked him what he thought deflation was. It doesn't matter what I think it is and I don't have to define it. He said bonds make sense because if we have delfation they will go up in value. When I asked what he meant when he said deflation he said a stock crash.

I'm glad to see you accurately recognize that a stock crash is not deflation.

"And you're right... the stock-market crash isn't deflation"

What real use is monetary base if gold doesn't even react to it?  (EDIT: This was poorly asked.  If gold truly is the canary in the coal mine, and increasing the monetary base is truly the mine about to explode, then why doesn't gold mimic much more closely the increases in MB?)

And yes... a stock market crash isn't deflation... expected deflation, though, can cause a stock market crash, or at least serious stagnation.  And, almost as importantly, bond/stock market spikes are NOT inflation.

Rises in the price of gold are NOT inflation.

Rises in the monetary base are NOT inflation.

In economics, inflation is a sustained increase in the general price level of goods and services in an economy over a period of time.

[Kshartle]

That's not deflation Desert. No offense. That's just a stock market crash. Why did corporate profits fall? Is the crash temporary?

Actually, it is deflation.  Deflation and stock market declines often go hand in hand. 

Ok I thought this meant you thought a stock market crash is deflation. Perhaps my reading comprehension is really bad.

[moda0306]

If today's definition of inflation is the swelling of the vein on my forehead when I get in economic discussions with Kshartle, then we're about to see the Weimar Republic colonize Zimbabwe!



JK, man.  I'm so happy about our moral/logic thread that I couldn't be mad at you right now.

[Kshartle]

Moda,

Why does the general price level increase?

[moda0306]

Because we have too many units of exchange chasing too few goods faster than we can produce those goods.

MB is just a piece of this overall equation, and can be reduced upon certain economic stimuli (Full employment or high inflation).

[Kshartle]

Because we have too many units of exchange chasing too few goods faster than we can produce those goods.

MB is just a piece of this overall equation, and can be reduced upon certain economic stimuli (Full employment or high inflation).

How can we have too many? What does that mean too many?

I think what you mean is "more".

Yellen said the Fed controls the long-term rate of inflation. What do you think she meant by that?

[moda0306]

Like I've said recently, if the government (including the fed) said the following:

"We are going to buy another $300 billion in bonds with freshly "minted" reserves, but we're going to also start a program where the government pays interest on reserves of 10%, our fed window will be set at 8%, and we will set the rate on savings bonds for Americans at 7%..."

We would have 1) increased the monetary base, but 2) probably created an extremely deflationary environment (decrease in general price level).

Do you disagree?

So can you see how MB is just a small piece of the equation?

[Kshartle]

Like I've said recently, if the government (including the fed) said the following:

"We are going to buy another $300 billion in bonds with freshly "minted" reserves, but we're going to also start a program where the government pays interest on reserves of 10%, our fed window will be set at 8%, and we will set the rate on savings bonds for Americans at 7%..."

We would have 1) increased the monetary base, but 2) probably created an extremely deflationary environment (decrease in general price level).

Do you disagree?

So can you see how MB is just a small piece of the equation?

Yes i've always agreed with that.

MB is only a small piece.

[moda0306]

Because we have too many units of exchange chasing too few goods faster than we can produce those goods.

MB is just a piece of this overall equation, and can be reduced upon certain economic stimuli (Full employment or high inflation).

How can we have too many? What does that mean too many?

I think what you mean is "more".

Yellen said the Fed controls the long-term rate of inflation. What do you think she meant by that?

Yep.. more works.. in relation to both the amount of goods producible (productive capacity), and the speed at which people are willing to move it around (velocity).

And let's not forget foreign demand for our confetti as a savings tool that leaves less for us to spend.

Yellen means that via controls on interest rates and the base money supply, as well as other lending stimuli, the fed has control over the long-term inflation rates.

I don't see what is so crazy or controversial about that.

[Kshartle]

If the money supply was static.......and prices fell over time because we got better at producing stuff....more productive etc.....would you say we were in deflation?

[moda0306]

Like I've said recently, if the government (including the fed) said the following:

"We are going to buy another $300 billion in bonds with freshly "minted" reserves, but we're going to also start a program where the government pays interest on reserves of 10%, our fed window will be set at 8%, and we will set the rate on savings bonds for Americans at 7%..."

We would have 1) increased the monetary base, but 2) probably created an extremely deflationary environment (decrease in general price level).

Do you disagree?

So can you see how MB is just a small piece of the equation?

Yes i've always agreed with that.

MB is only a small piece.

Ok, so let's quit using it as the main measure of what should affect price level, or the robustness of stock/gold portfolio.