If there is deflation, how does that affect bonds?

[67walkon]

We have a lot of our retirement next egg in tax free bonds. They are pretty well laddered, and my thoughts have always been that if we get the effective yield we bargained for, we can handle inflation; as lower rate bonds mature, we would invest in higher rate bonds.

But I'm not sure how deflation might affect us. I think deflation would be mostly short term. But if $100 will buy more in 2 years than it will buy now, aren't we better off with the fixed income bonds, so long as we aren't trading them? Seems to me we would be, but I haven't ever thougth about it.

A guy on Bloomberg radio this morning was talking about his expectations of deflation. We've seen it in housing and right now in gas prices. I think I would be happy if I had $100,000 in tax free income (which I don't yet), plus SS, if the cost of housing, gas and everything else went down.

I have assumed our country's financial mess would lead to inflation, but what do you guys think about deflation? And what do you plan to do to deal with it?

 

[audreyh1]

Deflation hurts borrowers and helps people who already own assets such as cash and bonds. It means prices go down, not up, so things get cheaper over time.

But it is very bad for an economy. Economies need a little inflation to thrive. Deflation causes economies to contract as people wait for things to become cheaper as this means less demand. It can become a vicious cycle. We've seen this in housing already.

Your instinct about deflation being good for bonds is correct.

Audrey

 

[donheff]

Well, if we get into a deflationary trend now I hope the stats through August result in a good COLA for me (CSRS) and all the SS folks. That will help us smile through the next years with none again.

 

[arebelspy]

Deflation causes economies to contract as people wait for things to become cheaper as this means less demand. It can become a vicious cycle. We've seen this in housing already.

Exactly. I'm anecdotal evidence of this. I'm purchasing real estate right now (purchased two houses last year, looking to purchase 2-3 before the end of 2011), but Ive had several deals fall through that I may have pressed harder for or made more allowances on were prices rising. As it is, prices are dropping and time is on my side. With more people feeling this same thing, it causes buyers to not purchase, which in turn causes prices to fall, etc. Very bad if you're a seller.

 

[Amethyst]

Waiting anxiously to see whether Congress changes the COLA formula to be less generous - it would affect their retirement, too.

Amethyst

Well, if we get into a deflationary trend now I hope the stats through August result in a good COLA for me (CSRS) and all the SS folks. That will help us smile through the next years with none again.

 

[donheff]

Waiting anxiously to see whether Congress changes the COLA formula to be less generous - it would affect their retirement, too.

Amethyst

I have already discounted that in my plans. Gonna happen.

 

[ChrisC]

Deflation also means, in today's economic and political climate, that the phobia over deficits and balancing the budget has essentially won out over reseasoned approaches to digging us out of the financial crisis of 2008. Gold and U.S. Treasuries are the way to go when faced with the prospect of Japanese-like deflation. Why are Treasury prices rising after the S&P downgrade? - Glenn Greenwald - Salon.com

 

[brewer12345]

I plan to construct a massive tinfoil helmet.

 

[Gone4Good]

Bonds are great . . . unless the borrow defaults because he can't shoulder the increase in real debt burden. In that case, not so good.