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I am an independent investor writing at Scott's Investments (http://www.scottsinvestments.com). My site is dedicated to discussing and publicly tracking historically successful investments strategies and sharing free investment resources. I emphasize empirical, historical, and quantitative... More
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  • A Contrarian Take on Inflation and Treasuries 0 comments
    Apr 21, 2009 10:54 PM

    From John Mauldin's Outside the Box newsletter, an outstanding contrarian piece from Van Hoisington and Dr. Lacy Hunt of Hoisington Investment Management Company on why deflation, and not inflation, is going to be our biggest problem. Their conclusion is that Treasuries still remain the premier asset class. Some excerpts:

    The bottom line, however, is that it is totally incorrect to assume that the massive expansion in reserves created by the Fed is inflationary. Economic activity cannot move forward unless credit expansion follows reserves expansion. That is not happening. Too much and poorly financed debt has rendered monetary policy ineffective.

    The highly ingenious monetary policy devices developed by the Bernanke Fed may prevent the calamitous events associated with the debt deflation of the Great Depression, but they do not restore the economy to health quickly or easily. The problem for the Fed is that it does not control velocity or the money created outside the banking system.

    Washington policy makers are now moving to increase regulation of the banks and nonbank entities as well. This is seen as necessary as a result of the excessive and unwise innovations of the past ten or more years. Thus, the lesson of history offers a perverse twist to the conventional wisdom. Regulation should be the tightest when leverage is increasing rapidly, but lax in the face of deleveraging...

    ...Since the 1870s, three extended deflations have occurred--two in the U.S. from 1874-94 and from 1928 to 1941, and one in Japan from 1988 to 2008. All these deflations occurred in the aftermath of an extended period of "extreme over indebtedness," a term originally used by Irving Fisher in his famous 1933 article, "The Debt-Deflation Theory of Great Depressions." Fisher argued that debt deflation controlled all, or nearly all, other economic variables. Although not mentioned by Fisher, the historical record indicates that the risk premium (the difference between the total return on stocks and Treasury bonds) is also apparently controlled by such circumstances. Since 1802, U.S. stocks returned 2.5% per annum more than Treasury bonds, but in deflations the risk premium was negative. In the U.S. from 1874-94 and 1928-41, Treasury bonds returned 0.9% and 7% per annum, respectively, more than common stocks. In Japan's recession from 1988-2008, Treasury bond returns exceeded those on common stocks by an even greater 8.4%. Thus, historically, risk taking has not been rewarded in deflation. The premier investment asset has been the long government bond...

    Therefore on a historical basis, U.S. Treasury bonds should maintain its position as the premier asset class as the U.S. economy struggles with declining asset prices, overindebtedness, declining income flows and slow growth.

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