QUESTION: If we truly are a moving to a cashless society as is evident, and that is massively deflationary, which I agree with, wouldn’t that drive govt. yields LOWER? How do you reconcile a sovereign debt crisis and rising yields with a massive slowdown in inflation and growth that these misguided policies are driving us towards? Given all the cash out there looking for stores of value (like the $170mm Picasso), wouldn’t they just park it into government bonds if there is a massive slowdown of both the velocity of money and economic growth? Or perhaps we see some sovereign yields like in Europe spike while others like the US go sharply lower based on the cap flows? Although that wouldn’t match your prediction that ALL sovereign yields will rise together.
ANSWER: This complexity will twist many minds. All of what you say is logical under NORMAL conditions. People park in government bonds when they distrust the private sector, but what happens when they distrust government? The tables reverse and the dealer is now the people.
It is always a matter of confidence. When capital loses confidence in government, it flees to the private sector, but you have to understand at that point it is not about profit – it is about survival. At the peak of the crisis in 2009, rates on government short-term paper went negative. People were willing to pay for safety. The person who purchased the $170 million Picasso is by no means expecting to make a profit, they are parking money.
Yields will rise, as we just saw in the bunds, as capital is shifting from long to short end. But then with the first crack in government debt, capital will look around and ask, who is next? Read Herbert Hoover’s Memoirs 1931 chapter, and note that what he describes as the movement of capital is the same way capital moved in 2010. Look at the difference between corporate and government bonds during the Depression. Granted, the U.S. did not default, but it did devalue the dollar in 1934. That is a reduction in the value of an outstanding bond so it is a partial default. Capital shifted to the private sector after the first fake out to the upside side in rates with the Sovereign Debt Crisis in 1931. As cities in the U.S. began to default, the premium on corporate paper over government dropped sharply illustrating that smart money figured out that the problem was government, despite what the press was reporting.
As capital withdraws from the public sector (both federal & state/local worldwide), that will drive rates higher. Lower rates are setting in motion a massive collapse in pensions and the elderly cannot survive off of their savings. Moreover, the Fed will be compelled to raise rates if the share market rises, despite the economic decline. If they do not, they will be accused of creating the bubble.
All of this is intertwined. Try to open your mind and be like a trader just following the trend and the capital flows. The market is always right – it cannot be wrong. Only we are wrong for when the market does something we did not anticipate our analysis is at fault – not the market.
