Government Bonds Are the Latest Bubble, Probably Not the Last

These days U.S. Treasuries can do no wrong. No matter how much interest dips, they're just the hottest thing in town. The bird in the hand theory of finance, I suppose. But is this bird really in hand, and for how long?

One would think that the bond market has already factored in the upcoming big-spending stimuli planned by a number of G20 players; but, even though the printing presses have already begun their magic in earnest, the amounts that have already been distributed have yet to have an impact on the economic outlook. Recession and deflation seem to be what are on everyone's mind.

But for how long? We know that markets are fickle. And supple. They can turn on a dime.

Once the presses get churning at billions a minute, and whether or not deflationary pricing stops, what will the markets do? Could they turn this bond boom into another burst bubble?

The world has been awash in credit and in the chimera of purchasing power the sheer mass of it seemed to engender. It flowed into the real estate bubble until 2006, then to the stock market bubble in 2007, then to commodities in 2008. Each one came rushing down like something at Magic Mountain, only to see the remaining cash hop on again for another loop with bonds.

Government bonds are the last safe haven before ... there's only one thing left after government bonds: Gold. But that would mean a flight from paper currencies altogether. Are we that far gone?

We'll soon find out. Foreign bonds will have a tremendous amount of competition soon, once the U.S. and other debtor nations begin to borrow to the max. Cash may still flow into these government bonds for a while, but as stated in this editorial in Friday's Financial Times, "finance ministers must make plain how they intend to keep paying creditors without resorting to debasing their currencies. Those who have not already credibly done so are living on borrowed time."

And just which have done so in a credible fashion? I'm hard-pressed to name one.

So I'm betting that gold will be our next, and perhaps last, bubble, at least for this time around. (Disclosure: Yes, I do own some gold-related assets. I'd be a hypocrite if I didn't.)

In case you haven't seen my mantra, I'll repeat it for you:

"You can take the gold out of the standard, but you can't take the standard out of gold."

Comments

[derryl:]

Katy wrote,
"Government bonds are the last safe haven before ... there's only one thing left after government bonds: Gold. But that would mean a flight from paper currencies altogether. Are we that far gone?"

I agree that 'full faith and credit' fiat instruments are going to take a serious credibility hit as the G20 start pumping money to battle deflation, and that gold will shine brighter when gov't bonds begin to lose their luster as fears of money supply inflation emerge. But I'm beginning to think we could go so far that people will lose faith in 'money' per se, including metal money.

If this happens then the last safe haven will be in useful physical assets like houses, commodities and companies who produce life-essentials that we cannot do without. This would really be an 'end of the monetary world' scenario where values are measured in utility and are essentially 'bartered'.

It's far fetched but in uncharted monetary territory it is not totally out of the question. I think at the very least we will see some degree of flight to essentials.

On the other hand it may be possible for the G20-G100 to successfully navigate these monetary waters with minimal loss of faith in currencies. And if money pumping fails to stop deflation then currencies will be the best store of value, not the worst. I say hedge all bets because right now it's pretty much impossible to see which way this thing will go next.

Jan 13 06:21 AM

[retired avi...:]

I think a ton of institutional money during and since the fall panic moved into US Treasuries because the fund managers can appear 'blameless' for being in what has historically been the safest harbor. It's not their own money, so maybe they are yield-blind.

I also know personally of instances of individual retail investors rolling over their treasurydirect.gov accounts in complete ignorance of current yield! I pointed out to a smug acquaintance of mine who recently rolled over $200k in 6 month bills (and has done this for years), that the next maturity payment is going to have a shocker for interest - APY is only .27%, down from 7 times that for their last interest payment! This bozo had no idea what the yield was, even with the statement in hand!

I think the splash of cold water these investors get when their T-bills start maturing in Q1-Q3 2009 will have to start releasing significant air from the Treasury bubble as they bail for better yield.

Jan 13 11:23 PM