We’re in an interesting situation where most developed country governments are borrowing at a rapid rate, and their central banks are financing it.? Public old age retirement and health plans are underfunded.? Most major developed countries can’t grow rapidly, and there’s really nothing that can be done about it — competition from cheaper labor in developing countries is forcing developed country wages down.? We can’t grow out of the debt.
We wait for the tipping point.? When will investor sentiment change from believing debts will be paid in equivalent purchasing power, to believing that they will not get paid back in equivalent purchasing power terms?
Greece is past the tipping point.? Other nations in Europe teeter.? Is Japan nearing such a point?? They rejoice to see the Yen weakening as the BOJ finances the government deficit.? Be careful what you wish for, Japan — what is good in small, can become self-reinforcing if lenders lose confidence in the Japanese government.
Part of the trouble is with central banks repressing savers, deficits are considerably lower than they otherwise would be because short bond yields are low.? If rates rose, deficits would begin to rise gradually but distinctly in proportion to the maturity structure of the country.? That’s the tipping point.? There are only two states with an unstable equilibrium between them — government debt is trusted, and government debt is not trusted.
Now there is no simple answer here — how will the government react?
- Raise taxes dramatically?
- Cut spending dramatically?? Tell seniors that Medicare will no longer do what it used to?
- Inflate the currency?
- Default?? (Can make sense when a country does not need access to the debt markets.)
- Try to drive a debt reduction deal, like Greece has done, and Argentina sorta did.
Each situation has a different best investment.? That’s a boon to governments, or disaster would have happened already.? Doubt as to policy blunts the rush to panic.? There may be worry but they don’t know what to do.
One more note: when one nation passes the tipping point, the question will be raised on other nations.? Imagine a world where many developed nations default on their debts.? There would be few certainties and silver and gold would likely become new currencies.
These are just some musings of mine; all sorts of kooky things could happen, but the pressure to use the five reactions listed above will be considerable globally.? Prepare as best you can; this one isn’t easy.
You’re analysing government debt as if it was a midcap bond. It isn’t.
Investors who want an asset with the characteristic of sovereign bonds have no alternative. Everyone rushing into gold and creating mad volatility isn’t one, these guys are specifically not looking for volatility. There’s basically no alternative, so rates can stay permanently low.
If for some reason demand did nevertheless go down, rates are set by the central bank so cannot go up unless they decide to put them up. There can be a shortage of demand, in which case issuance can be used to make up for the shortfall.
The only residual risk is then inflation. That is not directly produced by issuance: inflation comes when people have more money to spend than can be supplied, not when people just sit on savings. So you get inflation only when you have full employment and the economy at full capacity, that is a boom, that is when it is easy to raise taxes, indeed the tax take naturally goes up if you don’t touch the tax system.
@ Cig –
You are correct. Perhaps more importantly (in terms of investment opportunity) is that these points are largely not acknowledged, even by the ‘experts’.
I’m not singling out the author of this blog in particular; for the only source (I read probably ~20-30 regularly) that correctly called the monster move in long-dated US Treasuries over the past two years was Hoisington (www[dot]hoisingtonmgt[dot]com).
Most analysts I’ve seen just caution readers to watch for inflation, without thinking through (much less describing) all of the drivers that must occur in order for inflation to materialize.
Gary Shilling has been calling for 3% on the 30-year T-bond since the mid-1990’s and he predicts continued low-inflation or deflation until the next big war or natural catastrophe brings about inflation again.
Peak debt = peak wealth = unlikely. There are bottomless pits out there (pockets of rich people) which can absorb infinite amounts of government debt. The more debt, the more wealth, with much of that wealth concentrated in a few hands, making it easier to bribe the Government to take the steps necessary to ensure the wealth isn’t inflated away.
If the stock market crashes again, the middle-class will abandon stocks entirely. This will be a good time for the wealthy to trade their nominal bonds to the middle-class in exchange for stocks, and then maybe the wealthy will allow some inflation. In fact, 5 to 10% inflation combined with Argentina-style downwardly-distorted CPI statistics would be a great way to effectively slash entitlements and unburden corporations and the government of their pension obligations, thus keeping corporate profits high and eliminating the need to raise taxes, though such a scheme does have the downside of imposing taxes on purely inflationary gains. However, if the wealthy can arrange to keep capital gains taxes low, this won’t matter too much.
Definitely expect further cutbacks in Medicare so that the elderly end up picking up a bigger part of the tab. This will be accomplished in a complex and roundabout fashion, so that it won’t be apparent to the average voter what is going on. They will sense that they are being screwed and be angry, but no more angry than they are now and also no more cognizant of why they are angry–that is the key point.
Stocks and income-producing real-estate are the place to be–but only at a good price, and today’s US stock prices are not that good. European prices are better. Real-estate bargains are available for those who can buy individual properties. But no bargains in REIT’s that I’m aware of. Gold is foolish because it doesn’t pay a dividend, as Buffett wisely pointed out recently.