Why treasuries are TERRIBLE long term investment in the current economy

[tenant13]

We've had quite a few discussions on this board about bonds and how they are an essential part of a long term investment portfolio. I pretty much agreed with that POV up until 2008 but in the environment of perpetual negative interest rates (in real terms, nominally we're still above zero) I can't buy into that mantra anymore.

I just read a great article by Lyn Alden: A Century of Fiscal and Monetary Policy: Inflation vs Deflation which is worth perusing for anyone interested in macro economic trends. Here's a long quote from the end:

"The money supply and velocity collapsed in 1930’s when monetary policy ran into its limits, and it wasn’t until fiscal policy took over with massive deficits, that velocity picked back up and inflation started to show its head. At that point, monetary policy united with fiscal policy to hold rates below the prevailing inflation rate while spending a lot of currency into circulation, which devalued a large portion of the existing debt bubble.

Despite the U.S. reaching superpower status and creating strong underlying growth, cash savers and Treasury holders lost a considerable portion of their purchasing power in the 1940’s. The federal debt was therefore paid down as a percentage of GDP partially through inflation.

All-in-all, there was a roughly four-decade period, from the mid-1930’s to the mid-1970’s, where 10-year Treasuries that were bought and held to maturity, spent most of their time in a state that failed to maintain their purchasing power vs consumer price inflation, and especially vs gold."

This is historical data that you may or may not want to dismiss while thinking about the future; it depends on whether you believe that the Fed will eventually increase interest rates while keeping inflation in check. I don't. The actual inflation - when measured with things that people actually need and want to buy is already way higher than their just abandoned 2% target. Like buying a modest pension: in a 2007 a bond that would pay 50k/year cost 1 million, this year such a bond would cost 10 million... A 1000% inflation... (10 Year Treasury Rate - 54 Year Historical Chart)

 

[njhowie]

Like buying a modest pension: in a 2007 a bond that would pay 50k/year cost 1 million, this year such a bond would cost 10 million... A 1000% inflation... (10 Year Treasury Rate - 54 Year Historical Chart)

- And if you had bought the 30-year bond then? You could sell it today for a tidy profit.

- And if going forward the Fed takes interest rates lower? Negative, and then potentially more negative?

- You are looking at "inflation" of the price of the bond, not "inflation in the economy" and purchasing power of the dollar. All you've done is shown the obvious - that interest rates have cratered...and the inverse relationship between interest rates and price.

The Fed has just indicated that they intend to keep interest rates near zero (at least) through 2023.

This is historical data that you may or may not want to dismiss while thinking about the future; it depends on whether you believe that the Fed will eventually increase interest rates while keeping inflation in check. I don't.

Are you saying you believe we will have runaway inflation? Then buy TIPS.

That the Fed will eventually increase rates or not?

If you don't believe interest rates will eventually go higher, the point you're trying to make falls apart.

If you believe interest rates will stay at current rates and go lower, you should be buying longer term bonds, as the prices will go even higher.

If you believe interest rates will go higher, then buy short-term bonds until rates do rise and justify purchasing longer term maturities.

If you believe the dollar will collapse as a currency, or that the government will default on its debt, then there are a lot bigger issues to be concerned with and you should put everything in to gold or other hard assets as they will be the only things which maintain or increase in value.

 

[tenant13]

- And if you had bought the 30-year bond then? You could sell it today for a tidy profit.

- And if going forward the Fed takes interest rates lower? Negative, and then potentially more negative?

- You are looking at "inflation" of the price of the bond, not "inflation in the economy" and purchasing power of the dollar. All you've done is shown the obvious - that interest rates have cratered.

The Fed has just indicated that they intend to keep interest rates near zero (at least) through 2023.



Are you saying you believe we will have runaway inflation? Then buy TIPS.

That the Fed will eventually increase rates or not?

If you don't believe interest rates will eventually go higher, the point you're trying to make falls apart.

If you believe interest rates will stay at current rates and go lower, you should be buying longer term bonds, as the prices will go even higher.

If you believe interest rates will go higher, then buy short-term bonds until rates do rise and justify purchasing longer term maturities.

I believe rates will stay near zero for years. Way beyond the announced 2023. They don't necessarily need to go negative - in real terms they already are. But the main thing is that I don't consider treasuries a speculative investment so while you're absolutely right that with lower rates, their prices will go up, the point of buying them for me was producing small income (after inflation) while preserving capital. I'm not doing that anymore since neither objective can be achieved.

As to TIPS, they're only worth considering if you believe in CPI . I think it's a joke but more importantly I also think that inflation is something very individual. And I think that including the cost of purchasing a pension - something that most people want and need - should be included in it.

As a childless, non-driving vegetarian I will never know how much the cost of college education, cars, cruises or steaks increased over the years but those numbers determine a lot of people financial decisions. I'm however highly sensitive to prices of organic produce, Broadway tickets or long distance flights and hotels (when those things are back).

 

[njhowie]

I agree with your points/thoughts.

 

[Running_Man]

The Federal Reserve has backed themselves into a corner where they are willing to buy 2-3 trillion annually of bonds in order to supress rates. The growth of their balance sheet is going to be astronomical to accomplish this. Of course as they hold all these bonds the only thing that will save the government in the long run from all this accumulated debt is inflation to eliminate the cost of borrowwing. But that will be years of inflation while the FED keeps rates low, in order to let the GDP grow on a nominal basis to support higher interest payments.

But this goal of keeping the stock market up is creating intergenerational animosity as in previous generations the recession/depression was accompanied by a large decrease in stock prices but now all the older people with their stocks are being propped up by the financial arms of the system while all the jobs evaporate for the younger generation. This is the craziest solution to financial panics ever and has never in the history of the world been tried before so please — throw out all your financial backtesting because never has any country undertaken what the US Fed is trying to accomplish. Investors don’t even realize the historic nature of what they are investing in as wealth becomes more and more concentrated like a nuetron star, but when they explode it is quite a violent explosion.

The forced low interest rates has forced the value of long term investments to unbelievable present values as the FED buys all the debt and forces the money into capital investments and the people who are jumping into the belief of zero for 30-50 years are presently making billions, because a zero value return has infinite value in a negative rate enviroment. Apparently, even in an era of 10-20 percent unemployment.

Small business cannot compete because they rely on labor which is being priced out of the market in favor of capital to automate and replace in large project that need little labor and cost little in way of interest payments in present long term manipulated enviroment.

A friend’s business with 500 million in sales is looking at building a plant that will double present capacity with 20% of the labor cost for a 175 million for automated machinery to reinvent their manufacturing process, because the loan has only a 15 million annual cash need while the labor costs will drop more to offset that it is easy to see the direction these interest rate manipulations are driving the investing world and the deflationary impact these decisions have in the intermediate term.

If the Federal Reserve did not exist, as the world did before 1914, these investments could never have occurred. Are long bonds a good investment? How could anyone possibly know, but issuing debt/stock as a result of the FED market actions it is the way to get rich in the present market scenario.

 

[njhowie]

If the Federal Reserve did not exist, as the world did before 1914, these investments could never have occurred. Are long bonds a good investment? How could anyone possibly know, but issuing debt/stock as a result of the FED market actions it is the way to get rich in the present market scenario.

Indeed.

The Fed is giving a wide open window for corporations and state and local governments to refinance all high interest debt down to almost nothing. Similar for homeowners. It is also providing the means for companies to invest in the future for practically nothing. Similar for folks looking to purchase their first home or move up - cheap, cheap, cheap...but it will drive housing (hard asset) prices higher.

Unfortunately, it also encourages malinvestment - taking wild risks because the opportunity cost of doing so is minimized. We also have a good size stable of zombie corporations which deserve to be in bankruptcy, however, the low interest rate environment provides additional opportunity to stay alive for a bit longer as they can just issue more debt, and so long as they offer some yield above where the rest of the market is, some investors will jump and throw money at them.

 

[Time2]

Before we added a couple more trillion to the debt, I heard it suggested that the US government sell 50 year bonds at the low rates to finance the debt. I don't know why that is not a good idea, as long as it it is used to pay off higher interest debt.

 

[Blueskies123]

Before we added a couple more trillion to the debt, I heard it suggested that the US government sell 50 year bonds at the low rates to finance the debt. I don't know why that is not a good idea, as long as it it is used to pay off higher interest debt.

Unless you think interest rates are going even lower. When and if we do see 50, 100 year bonds, or even perpetual bonds that will be a signal, to me, that interest rates are at bottom.

 

[tenant13]

Before we added a couple more trillion to the debt, I heard it suggested that the US government sell 50 year bonds at the low rates to finance the debt. I don't know why that is not a good idea, as long as it it is used to pay off higher interest debt.

It's a great "idea" for the US gov since it will allow them to reduce their liability simply by debasing the USD which in turn will lead to inflation. Because what sane person/entity would want to buy these bonds? The only buyer I see is the Fed and the only source of funding: money printer. There's a political aspect to all that but if we just stick to economics there aren't many winners in this environment.

Obviously all that is very speculative and we could argue that the world's appetite for US currency will absorb all the newly printed $ without much hit to its value. I'm skeptical given how hard China is trying to develop digital yuan and how many countries would love to drop their dependance on US centric financial system.

 

[VFK57]

If you paid attention on the Feds actions vs our everlasting huge budget deficit, you surely understood that being the reserve currency #1 in the world, it hardly affected the inflation here. That is why Treasuries were best choice during recessions. Unfortunately for our current need for ever largest budget deficit, our status of the #1 world economy is challenged by two new candidates for the throne: EU and China. It is very difficult to predict who will come better and faster from the pandemic caused economic crises. The threat of high inflation is high and there is no secure investment to defend our savings.

 

[OldShooter]

... there is no secure investment to defend our savings.

Some of us think TIPS are pretty good.

 

[OldShooter]

... As to TIPS, they're only worth considering if you believe in CPI . I think it's a joke but more importantly I also think that inflation is something very individual. And I think that including the cost of purchasing a pension - something that most people want and need - should be included in it.

As a childless, non-driving vegetarian I will never know how much the cost of college education, cars, cruises or steaks increased over the years but those numbers determine a lot of people financial decisions. I'm however highly sensitive to prices of organic produce, Broadway tickets or long distance flights and hotels (when those things are back).

Not sure what "believe in" means, but the relevance of the CPI is not determined by citing random anecdotes, it is determined by the correlation of the CPI with an individual's personal inflation experience. IMO the correlation is a lot close to 1.0 than it is to zero and for sure it is not negative. As long as I believe that, CPI/TIPS is the only game in town. To refuse to play because the CPI is not perfect doesn't make any sense to me considering that there are basically no alternative inflation-protected investments available.

 

[kevink]

Not sure what "believe in" means, but the relevance of the CPI is not determined by citing random anecdotes, it is determined by the correlation of the CPI with an individual's personal inflation experience. IMO the correlation is a lot close to 1.0 than it is to zero and for sure it is not negative. As long as I believe that, CPI/TIPS is the only game in town. To refuse to play because the CPI is not perfect doesn't make any sense to me considering that there are basically no alternative inflation-protected investments available.

Good point about the CPI not being determined by random anecdotes. I've been rereading William Bernstein's excellent book "Deep Risk," in which he says:

"Some worry that the government may manipulate the CPI in a way that understates inflation and erodes the real purchasing power of TIPS. This is unlikely for the simple reason that the bond market would consider this a form of default, which would have two consequences: first, it would produce bond market turbulence of a sort that the Treasury could ill afford, and second, it would destroy the Treasury's future ability to offer them, possibly permanently."

That said, it's certainly not true that TIPS are the only - or even necessarily the best - inflation-protected investment. They only work for that purpose if they are held to maturity (as Bernstein also discusses), while internationally-diversified equities, precious metal and natural resource stocks and (last not least) cash in the form of T-bills as well as (in particular situation) inflation-adjusted annuities also offer inflation protection.

Also worth remembering is that iBonds are a far better option at the moment than TIPS, as unlike the latter they offer a positive nominal return and generate no taxable income until they are sold. The only issues with them are the 10K per person per year purchase limit and having to open and maintain a Treasury Direct account in order to buy them.

The OP states that Treasuries are a TERRIBLE investment without proposing an alternative. But I maintain that as long as the U.S. dollar is the worldwide reserve currency (and admittedly our politicians and the Fed seem to be doing everything they can to endanger that status at the moment) U.S. Treasury bonds will remain (in the wry phrase coined by J.M. Lawson) "the best horse at the glue factory." Even with negative returns they are the only bonds that can save your bacon during flights to safety - as we have been reminded already more than once this year.

Highly-regarded finance writer Jonathan Clements keeps all of his (modest) bond allocation in a "barbell" of equal parts short-term Treasury and short-term TIPs and makes sure his equities are globally diversified and value-tilted. I pretty much do the same with a slice (10-15%) of gold added to the mix as a hedge against further currency debasement as well as sequence-of-returns risk. Like Clements, I don't see any point in taking credit quality or duration risk with my bonds.

 

[VFK57]

Some of us think TIPS are pretty good.

TIPs are protection from the inflation, if only they would reflect the true inflation and investor must be sure that the Feds will be solvent. I wonder how many people worry about Feds solvency with $26.79 trillions Debt and current $3.13 trillions budget deficit on the top of the ballooning Feds balance sheet of $5.3 trillions.

 

[OldShooter]

Good point about the CPI not being determined by random anecdotes. I've been rereading William Bernstein's excellent book "Deep Risk," in which he says:

"Some worry that the government may manipulate the CPI in a way that understates inflation and erodes the real purchasing power of TIPS. This is unlikely for the simple reason that the bond market would consider this a form of default, which would have two consequences: first, it would produce bond market turbulence of a sort that the Treasury could ill afford, and second, it would destroy the Treasury's future ability to offer them, possibly permanently."

I agree with Bernstein but I think TIPS would be the sideshow on CPI manipulation; Social Security would be the main event.

... it's certainly not true that TIPS are the only - or even necessarily the best - inflation-protected investment. They only work for that purpose if they are held to maturity (as Bernstein also discusses), while internationally-diversified equities, precious metal and natural resource stocks and (last not least) cash in the form of T-bills as well as (in particular situation) inflation-adjusted annuities also offer inflation protection.

Maybe simply semantics but I'd argue that "protection" is too strong a word for the other assets you mention. I might buy "resistant," but you only have to look at the oils to see that equities are affected by different and sometimes stronger forces than simple inflation.

Also worth remembering is that iBonds are a far better option at the moment than TIPS, as unlike the latter they offer a positive nominal return and generate no taxable income until they are sold. The only issues with them are the 10K per person per year purchase limit and having to open and maintain a Treasury Direct account in order to buy them.

I know nothing about Ibonds. $10K/year is a pittance and probably makes them irrelevant to most posters here. Maybe nice things to give as gifts to young children.

Highly-regarded finance writer Jonathan Clements keeps all of his (modest) bond allocation in a "barbell" of equal parts short-term Treasury and short-term TIPs and makes sure his equities are globally diversified and value-tilted. I pretty much do the same with a slice (10-15%) of gold added to the mix as a hedge against further currency debasement as well as sequence-of-returns risk. Like Clements, I don't see any point in taking credit quality or duration risk with my bonds.

The "barbell" idea is one that Nassim Taleb advocates. Not sure whether the term originated with him, though. Our approach is similar but I don't see the point of short-term TIPS. The inflation risk is not short-term and the yield penalty is still there. Re gold, I have never seen the sense in buying a crazy volatile asset that over time just paces with inflation. Maybe the armageddon view militates to holding physical PMs but I have never subscribed to it.

 

[OldShooter]

TIPs are protection from the inflation, if only they would reflect the true inflation and investor must be sure that the Feds will be solvent. I wonder how many people worry about Feds solvency with $26.79 trillions Debt and current $3.13 trillions budget deficit on the top of the ballooning Feds balance sheet of $5.3 trillions.

Our debts are owned in our own currency. There will never be a reason to default when making payments simply involves creating more dollars. The risk is inflation, not default, and an imperfect but pretty-darn-good protection against inflation is IMO not something to justify turning one's nose up. If you have a better alternative I'd love to know about it.

 

[VFK57]

I am not sure what IMO (venture capital?) and how it works.

 

[tenant13]

The OP states that Treasuries are a TERRIBLE investment without proposing an alternative.

I can only tell you what I do - I wouldn't dare proposing anything. When it comes to liquid investments: 30% index funds, 20% individual equities with either solid balance sheets or high yield dividends (I try not to duplicate of what funds hold), 20% international funds, 10% corporate bonds, 10% short term treasuries - yes they are terrible but that's my cash reserves, 5% precious metal stocks/funds, 5% bitcoin (I think I'll increase this). In terms of illiquid investments: rental real estate and some commercial real estate (specifically mini storage). I also have some teak in Panama but that's just so I can get residency - it won't produce any income until it's sold.

 

[OldShooter]

I am not sure what IMO (venture capital?) and how it works.

"In My Opinion"

 

[njhowie]

... 5% bitcoin (I think I'll increase this).

If you don't already, you should tune in to The Keiser Report with Max Keiser and Stacy Herbert 3 or 4 times a week on RT. It's also posted to RT's Youtube channel a day after.

 

[VFK57]

US Debt, what foreign countries hold, is $7,13 trillions. China holds over $1 trillion of that amount and threatens to dump $200 billions of our Debt on world markets if we place more suctions on them. Seems like nothing for the Feds but it will be a bad signal for the rest of the world.

 

[OldShooter]

... China holds over $1 trillion [4% of US debt] and threatens to dump $200 billions [less than 1%] of our Debt on world markets if we place more suctions [sic] on them. ...

Thereby driving down the value of the bonds they continue to hold. That doesn't sound like a real genius move on their part and, in any event, it would probably not be a big deal in the markets. Average daily trading volume of US debt is around $500B, so $200B is around 5% of a week's trading. (https://www.statista.com/statistics/189302/trading-volume-of-us-treasury-securities-since-1990/)

Trying to predict stuff like this is a fool's errand IMO. To just worry about all possible scenarios is more than a full time job. So I don't do any of that. YMMV.

 

[tenant13]

Trying to predict stuff like this is a fool's errand IMO. To just worry about all possible scenarios is more than a full time job. So I don't do any of that. YMMV.

I would definitely agree with you on the particulars: predicting events in the future is a fool's errand. But I think it's prudent to observe macro trends, look back at the history and make assessments of the current economic situation. I think that's what the article I originally linked to does quite well. Interpretations of the data may vary and that's where we also may differ when it comes to making decisions for the future (not just us on this forum - big name economists argue about all that non stop) but I just find following monetary policy more important than daily political squabbles masquerading as economic discussions. It's refreshingly apolitical while depressingly consistent...

 

[target2019]

If you don't already, you should tune in to The Keiser Report with Max Keiser and Stacy Herbert 3 or 4 times a week on RT. It's also posted to RT's Youtube channel a day after.

RT = Russian Television.
Reference: https://en.wikipedia.org/wiki/RT_(TV_network)

I did subscribe and will listen.

 

[OldShooter]

... But I think it's prudent to observe macro trends, look back at the history and make assessments of the current economic situation. ...

I agree, though I would replace "prudent" with "interesting." Otherwise why would I have subscribed to The Economist for decades? But I think "prudent" implies "actionable."

I would definitely agree with you on the particulars: predicting events in the future is a fool's errand. ... when it comes to making decisions for the future (not just us on this forum - big name economists argue about all that non stop) ...

Yes. There is no evidence that the economy is anything but basically random. And no one can predict random. I continue to recommend Nate Silver's chapter on economic forecasting in "the signal and the noise."

... I think that's what the article I originally linked to does quite well. ..

I decided to skip the article after reading her bio. She has so little confidence in her opinions and/or so little investing success that she keeps a day job. Half-remembered quotation: "The best way to make money from investing letters is to write one." To me, she is just one randomly chattering monkey in the crowd.