3 Things I Think I Think - Myths That Never Die

Summary

• It’s time to end the debt ceiling and stop disrupting the bond market and government operations over a meaningless “debt limit”.
• Just like falling yields didn’t cause the bond bull market, rising rates wouldn’t necessarily cause a bond bear market.
• Any good financial planner has to make some estimates about future returns, future inflation, etc.

SinArtCreative/iStock via Getty Images

Here are some things I think I am thinking about.

1) The government is running out of money - NOT. It's hard to kill old myths. Really hard. I've spent countless hours trying to debunk the idea that the US government is "running out of money". But here we are having another debate about the "debt ceiling" and this fake idea that a government with a literal printing press is somehow going to run out of money because we imposed a fake credit limit on it. I've explained the absurdity of the "debt ceiling" before so I won't bore you with it again. But what really bothers me is that we're now engaging in all these silly counterproposals to overcome the silliness of the "debt ceiling". For instance, there has been endless chatter about this "trillion dollar coin". An idea, which, interestingly, first gained momentum on my blog when a commenter and friend of mine brought it up back when I had comments here. I actually promoted the idea for a brief while in order to highlight how absurd the debt ceiling was. But I never thought it might actually come to fruition.

Anyhow, I guess absurd problems sometimes require absurd solutions. Personally, I am with Janet Yellen at this point and I think the coin idea shouldn't be on the table unless we're actually on the verge of self imposed default (which, I don't think will happen). I wish we would stop entertaining all of these silly ideas. And the root cause of the silly ideas is the debt ceiling and this farcical "limit" on how much debt we can issue. So, again, it's time to end the debt ceiling and stop disrupting the bond market and government operations over a meaningless "debt limit".

2) Bond Prices Fall When Bond Yields Rise - NOT. One of the first things you learn in finance is this idea that bond prices fall when interest rates rise (and vice versa). But this is only true in the short-term. For instance, if you invest $100 in a 5 year bond yielding 2% and you hold that bond to maturity then you'll just clip a 2% coupon every year and you'll get your $100 back at maturity. If rates rise that entire time you'll still earn your 2% and you'll still get your $100 back at year 5. Of course, if you try to trade that bond in the short-term then you'll incur a cost to trade up to the higher yielding instrument. So, it's better to say that changing bond yields cause changing bond prices in the short-run.

I got to thinking about all this because of a great thread from Corey Hoffstein on twitter. The basic gist of the thread is, the narrative we usually hear about how falling rates caused good bond returns, is misleading. The reason past bond returns were so good is because past rates were so high. Full stop. It wasn't about falling rates causing higher bond prices. It was about higher rates yielding higher coupons on average. The opposite is also true though. Just like falling yields didn't cause the bond bull market, rising rates wouldn't necessarily cause a bond bear market. Sure, it's factually true that lower rates mean lower future bond returns. But as I've shown in the past, rising rates don't mean bonds won't generate positive returns going forward.

Of course, the natural response here is that bonds will lose value in real terms if rates rise. And that's absolutely true. But I'd argue that bonds aren't an inflation hedge. They're a principal hedge. And if you want principal stability then you need to accept a basic trade off of short-term liquidity certainty in exchange for short-term pricing power instability. And that's where all your other assets come into play. It's not an either or choice. You can have good inflation hedges in your portfolio AND also have certain liquidity instruments that will lose purchasing power in the long-term in exchange for principal certainty. That's one of the main reasons we diversify. You can have your cake and eat it too. If you diversify properly you'll have liquidity buckets AND inflation hedging buckets that help your overall portfolio maintain some level of purchasing power while also helping you meet short-term expenditures by creating liquidity certainty.

3) Market Forecasts are Bad - NOT. Here's Vanguard talking about why long-term passive investors should utilize market forecasts. I fully endorse their view here and I don't think there's any inconsistency in making forecasts while investing. I think where people start getting into trouble is when they start trying to predict what GDP is going to be next quarter and they start day trading around these ideas. That's the wrong way to do this. The right way to do this is to start from a reasonable foundation where we try to create a probability set of future outcomes and then apply an allocation that is consistent with our behavior and financial goals that is within the range of those predicted outcomes. Any good financial planner has to make some estimates about future returns, future inflation, etc. There's nothing wrong with that. And as I've described in the past, great investors think in terms of probabilities. And the further out we tend to forecast the more accurate those forecasts tend to look. For instance, I have no idea what stocks will do over the next 24 hours or 24 months. But I know with a pretty high level of certainty that stocks will generate positive returns over the next 24 years.

In short, be skeptical of people making short-term forecasts trying to entice you to make short-term portfolio decisions, but embrace the need to make long-term forecasts in the process of constructing of practical portfolio that is applied to specific future (mostly long-term) time periods.

Original Post

Editor's Note: The summary bullets for this article were chosen by Seeking Alpha editors.

Comments

[nestor7]

True, the gov will never run out of money. At least not until the great reset when all debts will be extinguished and everyone except the billionaires will be starting at ground zero.

At some point even probabilities become improbable because the past occurrences on which probabilities are based may shift. You assume the probability that stocks will be higher in the next 24 years is a decent assumption as long as the foundations for that assumption remain unaltered. That may not always be the case.

[Eponymous One]

"Anyhow, I guess absurd problems sometimes require absurd solutions. Personally, I am with Janet Yellen at this point and I think the coin idea shouldn't be on the table unless we're actually on the verge of self imposed default (which, I don't think will happen)"

Yup, its the theater of the absurd!.

In soccer as well as legacy juris prudence, intent is impossible to prove and yet the effects are clear.

As debates over outdated legends distract the public from the real issues and effectively undermine the full faith and credit of the US, the corrosive effects are manifested not only in economic terms, but increasing levels of human suffering

So as explained in great detail by another widely respected commentator here on our favorite discussion board, this would be a good time for all of us to take 10 minutes to go back and review the XIVth (14th) Amendment.

I say U say, "You SA!" I say U say,"You SA!" I say U say," You SA!"

Thanks Cullen!
-E1

www.google.com/...

[pktasap]

A few observations missing from the article. Raise the debt ceiling and more interest cost is incurred. The USA is a debtor nation so the spending above the debt ceiling is from borrowed money. Raise the ceiling and more insipid government spending occurs, better said as government waste and creating more government dependency

Yes you get the principle for a $100 bond at maturity, but if yields double to say 4%, a $100 bond’s value in the real world has diminished in value because what the principle return can buy is less than $100, that dirty little word called inflation.

[Salmo trutta]

"Visualizing The Rise Of Cryptocurrency Transactions"

www.zerohedge.com/...

[Salmo trutta]

"Cryptos Are Suddenly Exploding Higher"

www.zerohedge.com/...

[Salmo trutta]

re: "The government is running out of money - NOT."

"The Fed now owns nearly 25% of all public U.S. Treasury debt outstanding, as shown below. Since 2020, the Fed has bought more than half of the debt issued by the Treasury. Further, the Fed owns another $3.25 trillion of mortgages and other assets that also influence yields."

But inflation is still accelerating:

tradingeconomics.com/...

So, the government is running into a constraint, virulent inflation...

[reasonable2]

@Salmo trutta Please help me understand your post. The quote-marked paragraph about Fed holdings-- so what? What does that indicate?

and secondly, your link to tradingeconomics.com doesn't illustrate either continuing or virulent inflation. Isn't it a chart showing something else?

and the crypto remark? 'sup with that? Do we have to keep arguing that crypto is something for real serious investors? (Let's not)

[Sage of Remnant Cove]

@reasonable2 There is no subtler, no surer means of overturning the existing basis of society than to debauch the currency. The process engages all the hidden forces of economic law on the side of destruction, and does it in a manner which not one man in a million is able to diagnose . John Maynard Keynes (1919).

[reasonable2]

@Sage of Remnant Cove Keynes was clear in his indictment of alternative currencies.

But people don't learn when their confirmation bias smells profits.

I am one of you.

[jweissman]

Once again, Cullen comes through with common sense. Great info, thanks.