One of the champions, for a rather long time, of the deflationary outlook has been my friend David Rosenberg (formerly chief economist at Merrill and now with Gluskin Sheff in Toronto). He has been talking for years about a target of 1.5% for the ten-year US bond. Today we got down to 1.5% and did not even pause, ending the day at 1.47%. I noted that in a phone conversation to Rich Yamarone, the chief economist at Bloomberg, and he said he believes we will scare 50 basis points before we are through. To which Rosie replied in a later text, “He’s nuts.” We will all be at a special evening for the University of Texas McCombs School of Business next Thursday. I will offer to hold their coats while they have a lively discussion.
Since I was thinking about bond yields, I called Dr. Lacy Hunt (one of the more brilliant economists in the country, and not just in my opinion). He has been forecasting interest rates for a long time and been the guiding light at Hoisington Asset Management, which has established perhaps the best track record I know of for bond returns, if a tad volatile. They have been long bonds for a very long time, which has been the correct position, if a difficult and lonely one. Most bond managers think rates are set to rise.
Not Lacy. He thinks we will get close to 2% on the 30-year bond and has said so for decades. (Interestingly, he will be in the audience on Thursday, along with Van Hoisington. I think I will refrain from saying anything about bonds that night and talk about something more predictable, like politics or Europe.)
Dr. Gary Shilling wrote his first book, called simply Deflation, in 1998 and followed it up recently with another great work, titled The Age of Deleveraging. He first went long bonds in 1982, which has been one of the great trades of the last 30 years. He lists a whole host of reasons for a deflationary period over the next few years.
The argument for deflation is rather straightforward. The boom in the US and much of the world from 1982 until 2008 was partially the result of financial innovations and massive leveraging. That process has come to its end, and the private sector is deleveraging and will do so even further as the economy softens and we slip into the next recession.Read it at The Big Picture
First Deflation, Then Inflation. But the Timing…?
By John Mauldin
As Maudlin correctly notes, Rosenberg, Hunt and Shilling have been on top of the deflationary outlook for at least several years. The latter two have been recommending positions in long-duration Treasury bonds for nearly three decades, a period that saw bonds actually outperform stocks (which was never supposed to happen)! Anyone thinking about shorting Treasuries should give strong consideration to these views and why, after thirty years of being both correct and the minority, the near future will prove them wrong.
Separately, a look at history will show that severe deflation is often a precursor to hyperinflation. Part of the reasoning is that the economic environment only becomes ripe for truly massive money printing after economic conditions become so bleak that all other hope is lost. As a currency issuer, the US does not risk losing the “ability to borrow money at reasonable rates” (as suggested by Mauldin) since the US does not, in fact, need to borrow money in order to spend. Hyperinflation, however, is a potential outcome for sovereign currency issuers but remains highly improbable for the US unless significant deflation is witnessed first. A word of caution for those betting on hyperinflation, be prepared for massive pain/losses before those bets pay off. As for my money, the deflationary environment is likely to persist for at least a couple more years but the end result will be a leaner private sector ready to power the next great growth cycle.
Talk of Deflation Begins
David Rosenberg - The 3-D's Deflation, Deleveraging and Demographics
Inflation Fears Are Misplaced