“There has been significant flattening on the long end of the curve…This reflects the re- emergence of deflationary fears. The U.S. is at the center of de-levering as opposed to accelerating growth.” – Bill Gross via Bloomberg
Pimco’s Gross Buys Treasuries Amid Deflation Concern [Bloomberg]
Promoted From Comment To Post: Satchel Does Deflation [SocketSite]

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Comments from “Plugged-In” Readers

  1. Posted by polip

    transaltion:
    Hi, my name is Bill Gross and I have some long bonds to sell you.
    For the record, I happen to agree.
    This is a multi year story.

  2. Posted by Trip

    Thanks for re-posting the long piece from Satchel. That was classic. Nothing like that guy’s lectures to get the real brains (Robert, polip, tipster, others) on a roll! I really miss those threads.
    By the same logic Bill Gross is following to conclude that seemingly low 3.7% treasury yields are a great deal, could it not be concluded that the seemingly low 5% conforming mortgages are not the great deal they appear to be?

  3. Posted by Outsider

    If Bill Gross is correct and we have deflation rather than the feared inflation, ARM may be the better choice over a 30 yr. fixed as had been the case for the majority of the past three decades. You could be paying well under 3% for your mortage…

  4. Posted by polip

    Trip
    I’m goign to pretend you weren;t being sarcastic (wrt the 5% mortgage statement).
    IF you truly will pay the mortgage for 30 years AND you face zero liquidation risk, then I would argue that a 30 year mortgage at 5%, held to the very end will probably turn out to be OK (but far from great), depending of course on the value of the underlying asset.
    Since virtualy no one holds a property for 30 years, and zero liquidiation risk is hard to come by, yeah, by the same logic a 5% conforming mortgage with 10-20% down on a (still, but not by as much) overpriced asset is not a great deal.
    There will be an inflection point. Perhaps unlike previous RE cyscles the inflection point will mark the start of a rapid rise in prices. I’m doubting it.
    Until then, cash is still the prince, and 3.5% risk free on cash is still king.

  5. Posted by polip

    Outsider – if your holding period is 5 years or less – yeah, probably.
    But deflation won’t last forever.
    If we get inflation, and your mortgage can’t be refinanced, you are dead in (under?) the water.
    Liquidation risk matters. It is the reason that margin and leverage are more than just borrowing at the risk free rate + x.

  6. Posted by OneEyedMan

    Laughing Millionaire
    Gone now but not forgotten
    Missed by friends and foes

  7. Posted by Trip

    polip, thanks. No, I was not being sarcastic. A bit rhetorical, but only a bit as I really did not know the answer to the question I posed.
    So if one expects a period of deflation over the next few years, then — in simplified terms — the prudent move is to avoid taking on debt, or even avoid buying assets period, and to be a lender instead, correct? Then reverse course at the whiff of inflation several years hence? I believe that is consistent with ex SF-er’s advice over the past year or so.

  8. Posted by NoeValleyJim

    Thanks for the link to that old Satchel post. Note the basis of his theory that we would suffer deflation was that The Fed would not be willing to increase the monetary supply enough to stop one:
    I would suggest that the moment the Fed atempts a real quantitative easing or hints at monetization, interest rates will spike and cause a collapse of the credit complex the likes of which the world has never seen.
    Dead wrong.

  9. Posted by BT

    I admire Bill Gross hugely, but he isn’t always right. In this case, he has done a rather dramatic about face on the value of Treasuries and both positions can’t be correct. IMHO, he was correct before he switched. He isn’t taking into consideration the government response to deflation if there is any which will be to massively print money.
    The only good example we have of a modern deflation has been in Japan, a country with a shrinking and simultaneously aging population that is nothing at all like the US. There is simply no reason to believe our economy would behave like theirs.

  10. Posted by BT

    By the way, where can you get 3.5% on “cash”. 10-year treasuries are not “cash”–they carry the risk that your analysis of rates and inflation/deflation will be wrong. Actual “cash”, meaning, if you chose, 3 month T bills, are paying almost nothing now and therein lies the problem with being in “cash”. It is a bet on deflation and it might be right or it might be wrong.
    I prefer to buy 5 to 10 year munis (mostly revenues bonds on essential services) and corporates, and hold them to maturity. I loaded up 6 – 9 months ago and am now collecting 5% tax free.

  11. Posted by NoeValleyJim

    Munis were a great buy 6 months ago, not so great today. You can get 4% on a high yield checking account, but it is only for your first $50k and you have to jump through a couple of hoops.

  12. Posted by polip

    I don’t make bets on deflation or inflation. Will we face deflation in the near to intermediate term? Yup. Will we see inflation again at some point? Yup. Can I tell you when one will end and the other will begin? Nope.
    So, 3.5% nominal on a presumably risk free principal for half of fixed income, 2-3% real on presumably risk free principal for the other half. Intermediate treasuries and long date TIPS.
    3.5% return on Treasuries is a nominal return – in deflation that is great, with inflation that is awful. 5% tax equiv on munis is also great, though there is a bit of trivial default risk (even on GO’s) and some long dated issues carry call risk.
    Cash, nominals carry real interest rate and inflation risk, TIPS carry real interest rate risk only.
    They each have their own purpose – unless you have a crystal ball, it’s just better to hedge your bets.
    CA GO muni’s had a tax equiv yield well over 8% (at the long end of the curve) – those were a good deal. Now, not so much.

  13. Posted by tony

    Sorry, slight tangent… Did Satchel officially say goodbye (and I missed it) or are we all just assuming he’s gone since he hasn’t been seen in a while? Thanks.

  14. Posted by JustWondering

    Hmmmmmm…….”NoeValleyJim: The only good example we have of a modern deflation has been in Japan, a country with a shrinking and simultaneously aging population that is nothing at all like the US. There is simply no reason to believe our economy would behave like theirs.”
    >>>>>Job losses, early retirements hurt Social Security
    By STEPHEN OHLEMACHER (AP) – 2 days ago
    WASHINGTON — Big job losses and a spike in early retirement claims from laid-off seniors will force Social Security to pay out more in benefits than it collects in taxes the next two years, the first time that’s happened since the 1980s.

  15. Posted by NoeValleyJim

    BT said that, not me, though I mostly agree with him. I think there are other reasons that America is unlikely to follow the Japan path, the biggest one being that Americans are much more willing to spend fiscal stimulus checks. We are also likely to start wars to stimulate the economy and soak up excess unemployment, which Japan could not do. Finally, we are not dedicated to a mercantilist economic policy based on exports. This really restricted Japan’s monetary policy (and continues to do so today).

  16. Posted by dub dub

    You folks should focus on the “qualitative easing”, not the quantitative easing. Much of the former was not legal a year ago, and to suggest some of it would have been pure tinfoil.
    The latter is a sideshow, so far.
    The libertarians underestimate the power of government when it finally decides to cross the Rubicon, while the cheerleaders ignore the crossing’s significance. The *qualitative easing* has never been done before (correct me if so). You can’t just ignore it. Caesar might have been arrested and imprisoned. No big deal.
    It’s far too early to know how this is going to pan out, so enjoy your life, solvency taxes, chasing yields and ignoring black swans. And let’s hope that balance sheets don’t matter! No big deal :)

  17. Posted by radar

    NoeVallyJim………………Please tell me where one can obtain 4% on a high yield checking account…even at 50K ?
    I have searched rates on Bankrate.com and have accounts with some of the online banks such as ING, Everbank and now Ally getting no more than 1.75%……..but where does one find 4% ??

  18. Posted by 45yo hipster

    Bill gross’ deflation speculation is an outlier opinion. I agree with the others here that japan is not the model for the USA. On the contrary, inflation is the only remedy we williston likely have for all the fiscal stimulous.
    Think about it, if the USG can engineer an even halfway measured inflationary cycle, they pretty much get a free pass on dealing with the cost of all the stimulus. The key is to engineer an inflationary cycle that does not run wild. That, IMO, will be the real challenge for geitner, bernanke, etc. And of course, this will be a major boom for all holders of real assets. I have a feeling that 10 years from now today’s prices for everything will look like prices of the eighties do today. Upwards and onwards!

  19. Posted by tipster

    You RE cheerleaders are so funny. Not like Japan? No, because they had a property bubble that needed to be unwound slowly or the banks would take a hit, so they engineered a decades long deflation that kept housing prices higher than an equilibrium level, causing unemployment to remain high, requiring massive fiscal stimulus.
    No different than here. A bunch of irrelevant arguments (Well, they eat a LOT more rice than we do) to identify differences is laughable, the fact is a decades long deflation is really the only sustainable way out. That’s why they did it to the consternation of the rest of the world and that’s why we’ll do it too.
    Attempting to engineer an inflation with 10%+ unemployment is not politically possible. People would riot in the streets because wages are not going to go up, but down. So they are stuck with a deflation as the only way to get back to a reasonable level of employment.

  20. Posted by Trip

    There’s obviously room for debate, but I would not call Gross’ position an outlier. The yield curve between short- and long-term treasury yields has flattened considerably. The market as a whole seems to be in line with Gross.
    http://www.bloomberg.com/apps/news?pid=20601103&sid=aCAV9lOj6OiQ
    High inflation would be helpful for those with long-term, low-interest loans, but it would not be particularly helpful for those who actually own SF real estate, as opposed to other assets, unless SF prices out-pace inflation, which is a different debate from the inflation/deflation question.

  21. Posted by NoeValleyJim

    Inflation is not really a great outcome, but then you are left arguing that somehow the United States collectively is going to actually repay the massive amount of debt. What did Satchel identify it at 420% of overall GDP? Even at 5% interest rates that would mean that 21% of our collective national income would go just to debt service. And right now we are not even making the interest payments hence the trade and budget deficits. Reducing people’s standard of living enough to pay off the debt would cause rioting in the streets.
    In 1975, unemployment was 9% and inflation was 9%. In 1981 unemployment 8.5% was and inflation was 10%. Tell us again tipster, how this is impossible. Deflation does not increase employment, the exact opposite happens. What kind of strange economic kool-aide are you drinking now?
    Stagflation is crappy for a lot of people, it is not any kind of outcome I would like to see, I just think it is likely, given the course we are on.

  22. Posted by Trip

    Well, the mid 70s-early 80s problem was a wage/price spiral, caused by inflation and an attempt by the various constituencies to get ahead of it, which exacerbated inflation and unemployment. This was precipitated by the oil shock and high demand. I don’t think one can reasonably forecast wage pressures with rising unemployment and so much surplus capacity of everything. And good luck trying to raise the price of anything these days — except perhaps the price of oil which only further dampens everything else in today’s environment.
    Printing money and a devaluation of the dollar appears to be a more likely means of paying the public debt than inflating our way out of it — but I’m in way over my head on that issue and I’ll leave that point to the economist eggheads here.

  23. Posted by dub dub

    Think outside the box, though.
    We could have a negotiated repudiation (called something fancy), kind of an “inverse” QE — When our bonds mature, we give China signed copies of our constitution instead of cash (priceless!), with China marking it to mythology.
    Later, they can write it off themselves. But they are flush, so no biggie.
    Companies with strong balance sheets do this all the time (goodwill writedowns). So it’s not too tinfoil, especially given what has happened so far.
    There are so many ways for this to play out it’s not even funny! I wouldn’t worry, but they have to get the unemployment and the deficits under control somehow.

  24. Posted by Shza

    Printing money and a devaluation of the dollar appears to be a more likely means of paying the public debt than inflating our way out of it
    I’m surely being an ignoramus here but what’s the difference? Doesn’t devaluation of the dollar = inflation?

  25. Posted by corntrollio

    Are people here still talking about the U.S. inflating away the national debt? Wasn’t that myth busted already? If the feds try to cause inflation, then the servicing costs of the debt will become astronomical. The best way to deal with the national debt is to *deflate* it away by lowering servicing costs (i.e. low interest rates). I honestly have no idea why people keep repeating the “inflating away” line — it often sounds ideological more than anything else.
    Check out the chart here:
    http://ftalphaville.ft.com/blog/2009/08/04/65156/the-debt-inflation-myth-debunked-by-ubs/
    “The problem with the idea of governments inflating their way out of a debt burden is that it does not work. Absent episodes of hyper-inflation, it is a strategy that has never worked. Government debt: GDP burdens tend to be positively correlated with inflation. Market mythology has created the idea that inflation will help reduce government debt ratios. The facts do not support the myth. OECD government debt rises as inflation rises. Meaningful reductions in government debt will require a low inflation future.”
    Also, Mish posted on this too:
    http://globaleconomicanalysis.blogspot.com/2008/02/inflating-away-debt.html
    “Inflating debt away only stands a chance in an environment where there is a sustainable ability and willingness of consumers and businesses to take on debt, asset prices rise, government spending is controlled, and interest on accumulated debt is not onerous. Those conditions are now severely lacking on every front. [snip] Ironically, with massive interest payments on the national debt, about half of which goes to foreigners, the US government would be one of the biggest beneficiaries of deflation if it could drive long term interest rates down to 2% or lower then refinance the entire national debt at those rates.”

  26. Posted by NoeValleyJim

    Mish has some interesting perspectives and if the US can actually borrow money at real interests rates of 2%, that would great for the economy.
    Japan has had low borrowing costs for over a decade and its overall debt has ballooned, so it is not the panacea that Mish seems to think that it would be.
    The FT article is more balanced, but looking at the graph, it just looks to me that most of the time government debt as a percentage of GDP tends to increase. There aren’t a lot of dots below the line either in a low or high inflationary environment. I did not know that the US government rolled over 55% of its debt every two years, that is new information to me.
    You are still left with only three outcomes:
    1) Pay back the debt burden
    2) Default on the debt burden
    3) Devalue the debt burden via inflation
    Which one of the three is most likely to happen? Explain why you think so.

  27. Posted by NoeValleyJim

    If you think through a little bit about what would happen in a persistent deflationary environment, you can see how silly the idea of deflating away debt becomes:
    Imagine a 2% nominal interest rate and a deflationary currency at -4%/yr with an economy with a growth rate of 3%/yr. Start with total debt at 400% of GDP.
    Real interest rates are 6% and nominal GDP decreases 1%/yr. Debt/GDP increases 4% a year!
    Any situation where the deflation rate is higher than the real growth rate of the economy is going to put you in this terrible situation.
    Sure it is cheap to roll over the debt, but eventually the debt burden becomes catastrophic. Our only chance is to grow the economy faster than the debt burden. Both real and nominal growth helps.
    Here is what The Economist has to say about deflation vs. inflation:
    http://www.economist.com/opinion/displaystory.cfm?story_id=13610845

  28. Posted by Trip

    I think Shza’s question may be a key: Doesn’t devaluation of the dollar = inflation? NVJ’s three options for dealing with the expanding debt may not be the entire universe of choices.
    Devaluation of the dollar appears to be a great possibility. Does that necessarily lead to inflation? As I noted, I would need one of the eggheads (ex SF-er?) to weigh in. I think the answer is no, but it would require considerations of such things as Bretton Woods, aggregate demand, monetary supply, China, the balance of trade, the Federal Reserve, etc. that are way beyond my capabilities.

  29. Posted by 45yo hipster

    I think the logical answer is a blend of 1&3 (devalue via inflation, work towards reducing debt.) I am also not convinced that stagflation is the default outcome.
    The trick with inflation is that it’s hard to control. And no tipster, were not going to have sustained overall inflation without salary inflation following closely behind, for the reason you stated (street riots). Other countries delt with this dilema (israel in the 80’s, Mexico and SEA in the 90’s, Argentina in the 2000’s). The real key will be to keep interst rates in check so as not to stave off economic growth. Hence a controlled, multi-year inflation increase would be a better option than most discussed here.

  30. Posted by 45yo hipster

    I think the logical answer is a blend of 1&3 (devalue via inflation, work towards reducing debt.) I am also not convinced that stagflation is the default outcome.
    The trick with inflation is that it’s hard to control. And no tipster, were not going to have sustained overall inflation without salary inflation following closely behind, for the reason you stated (street riots). Other countries delt with this dilema (israel in the 80’s, Mexico and SEA in the 90’s, Argentina in the 2000’s). The real key will be to keep interst rates in check so as not to stave off economic growth. Hence a controlled, multi-year inflation increase would be a better option than most discussed here.
    And trip, this would have a positive effect on prop values. With inflation rents would increase, increasing housing values.

  31. Posted by NoeValleyJim

    NoeVallyJim………………Please tell me where one can obtain 4% on a high yield checking account…even at 50K ?
    Look at High Yield Checking . Stuff comes and goes from that list, it looks like Patriot Bank in Florida is the only one with a yield above 4% on $50k of out of state money. We opened ours with Peoples Bank of Kankakee County, a little two branch bank in rural Illinois, but they are no longer taking out of state money. I forgot how good rural customer support could be! Much better than Well’s Fargo or even Patelco Credit Union.
    These banks can always change their yield, so this probably not something you can do forever but it is all FDIC insured, so no real risk.

  32. Posted by Fred

    The trick with inflation is that it’s hard to control. And no tipster, were not going to have sustained overall inflation without salary inflation following closely behind, for the reason you stated (street riots).
    Wrong on both counts. Inflation is quite easy to control when there is a large amount of debt outstanding. The difficulty the Fed faced in the late 1970’s was precisely the small amount of indebtedness, such that raising interest rates didn’t really bite until they raised them a whole lot. That plus the fact that the Fed waited too long to raise rate and thus lost credibility. Things are quite different now.
    American living standards WILL drop in the next decade, via a combination of stagnant wages and increased cost of living. Those who riot in protest will be marched off to jail. Again, things are different from the 1970’s. As a society, we are much less tolerant of disorderly behavior than we were then.
    The real danger is that of low inflation (the same 2% that the financial markets have been predicting for years now), thanks to high real rates of interest, thanks to a Fed which is determined not to lose its inflation fighting credibility again. This is the nightmare scenario for all investments but cash: stocks, bonds, gold, real-estate, commodities.

  33. Posted by tipster

    “In 1975, unemployment was 9% and inflation was 9%. In 1981 unemployment 8.5% was and inflation was 10%. Tell us again tipster, how this is impossible.”
    In that period, women entered the workforce in large numbers, particularly in professional positions. Families had way more money to spend, which pushed up prices. So in spite of higher unemployment, families in general were making more money. The fed had to engineer a horrific recession just to break the inflation. You also had an emerging OPEC that pushed inflation ever higher.
    So it’s not impossible, but politically infeasible for the fed to do on its own. Could it happen? Sure. Iran could launch a nuclear weapon aimed at Israel and that would be the end of cheap gas. But is it something the fed would be willing to engineer? I doubt it.
    What is always interesting to me is how the yield curve inverted a 6 months to a year before the recession started. It’s amazing how well the market can predict such things. And you can see the long term interest rates absolutely crashing right now. I’ve been saying wait until February for people to realize the governments actions have dug us deeper into a hole.
    Cash for Clunkers is turning into an almost immediate failure. That took, what? 30 days since it ended? Saturn is being shut down as fast as possible and GM has to be thinking about laying off half the company. When that happens, the banks will call every line of credit, every credit card they can. And the public will lose confidence in the government’s ability to solve anything. They THREW money and programs at GM and nothing worked. When the public loses confidence, and it will, look out. No one will spend a penny.
    The new homeowner tax credit is proving to be a hopelessly expensive giveaway to home builders. If they extend it, it will lose effectiveness as people will start to believe it will never go away. If they don’t extend it, demand will dry up like C4C and home prices will drop like a rock.
    Inflation? In your dreams.

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